Mike Scully "borrows" our friend Steve (SRSRocco)'s silver charts in this excellent summary of silver's bullish fundamentals.
Price, as they say, is determined on the margins. This is especially true for inelastic goods. If 100 Tickle Me Elmo dolls exist in Walmart on Christmas eve, and 100 people absolutely need to have them, you don’t have a problem. The price will be some reasonable markup on the cost of production. However, if one more person walks in fearing the wrath of his child if there’s no Elmo under the tree, Walmart (WMT) can quickly turn into a war zone. In Walmart, this supply shortage might be settled by shoving and hair pulling. In a civilized market, this supply, demand inequity is settled with price.
In the case of Elmo in 1996, some dolls were reportedly sold in aftermarkets for $1500.
This is an important concept to keep in mind when evaluating the silver market. Silver is interesting because it is actually two different markets. On one hand, silver is a physical commodity that is used in industry or warehoused as physical savings. This market is rather inelastic on the supply and demand side as I will discuss in a bit. On the other hand is the silver derivatives market, paper contracts for silver, that set the spot price on the margins. The paper market is elastic and depends more on investor psychology than underlying fundamentals...
As physical silver is removed from the foundation of the paper market, leverage will increase until a leveraged short can't get the silver and defaults on his contract. That's when promises are broken, confidence turns to panic, and the leveraged derivatives house of cards comes toppling down.
To continue my multiple metaphors, that's when the derivatives dam breaks. That's the 101st Elmo buyer entering Walmart with a thousand determined shoppers close behind him. That's what folks like Ray Kurzweil might call "the singularity". It's the point when all hell breaks loose and things go hyperbolic. The stampede for physical silver will begin. Paper futures contract holders will increasingly stand for physical delivery, creating the ultimate short squeeze as paper shorts frantically try to acquire physical metal that is nowhere to be found to cover their positions. Manufacturers who use silver in their products will scramble to secure physical silver supply lines to prevent their manufacturing lines from grinding to a halt, buying up anything and everything they can get their hands on. Governments who have been net sellers of silver for the past 30 years and now have virtually no silver stocks, will be competing to increase their sovereign stockpiles of this strategically critical element at any price. The general investing public will become fully aware of the incredible supply and demand story for silver that had been hidden under the surface by the murky layer of paper scum, and dive in to get a piece of the action. In the words of that COMEX manager, "price will solve everything." Indeed. A much, much higher price.