Wednesday, January 25, 2012

The Sprott Effect on Metal Lease Rates

In the past century of silver history, there have been three individuals who have had the notable privilege of demanding a huge amount of silver to be delivered to their doorstep:  The Hunt Brothers of the late 1970s, Warren Buffet in 1997-1998, and now Eric Sprott.  How long will it take for the SEC/CFTC to step-in, change the rules, and curb investments into PSLV?  Interestingly, unlike in the case of Warren Buffet, today's metal lease rates have yet to show signs of a panic. 

Ted Butler released an article May 16, 1998 detailing Warren Buffets 129.7 million ounces of silver purchased  from July 25th, 1997 to January 12, 1998.  The article compared Buffets purchase to that of the Hunt Brothers.

"The effect on the price of silver that Bunker Hunt wrought is the stuff of legend. In roughly a one year period of time, the price climbed ten fold, from 5 to 50, only to crash and burn as the rules were changed and the margin calls rolled in. While the popular historical version of the event painted Hunt with the unkind brush of unwarranted greed and brashness, serious investors everywhere took note of the amount that Hunt bought and the resultant effect on the price of silver. The formula was real simple - 100 million ounces removed from the market equaled a ten fold rise in price."  - Ted Butler

Butler goes on to discuss the difference between the time period the Hunt Brothers made their purchase to that of the time period Warren Buffet was making his big purchase.

"But some things are different from twenty years ago in the silver market. For one thing the fundamentals are much more bullish. Years of persistent deficits have left existing inventories at an all time low (this for a commodity with a trading history measured in the hundreds of years). For another thing, the age old economic interplay between price and supply and demand that is the cornerstone of the capitalistic system has been replaced in the precious metals by leasing and the new substitute for price - the lease rate. But one thing has remained as it was in Bunker Hunt's silver world, the formula that taking 100 million ounces from silver inventories would increase the price ten fold. However, since the real silver market is in a much, much tighter fundamental position now than it was twenty years ago, a 100 million ounce purchase today would have a much more dramatic impact on the price of silver - say, a 50 fold increase in price, rather than the ten times increase attributed to Hunt. And that is exactly what happened to the price of silver when Warren Buffett bought his stake, it went up in price 50 fold." - Ted Butler

Butler explains the effect was on metal leasing, not on nominal prices.

From July 25 to the date of the announcement, the nominal price of silver increased maybe 40 per cent. The lease price, AKA the real price, jumped 50 times or 5000 per cent, from one and a half per cent to seventy five per cent. Also, Warren Buffett was only able to secure the quantity of silver he did, because of the very existence of metal leasing. No one would be stupid enough to relinquish such a quantity of silver at such a ridiculous nominal price, if he weren't blinded by confusion of the apparent (false) logic of metal loans.Ted Butler

What is metal leasing?
In a short summary, big banks consider silver and gold to be a stable asset of true wealth.  However, our greedy bankster friends aren’t happy with silver and gold just sitting in the vaults not generating cash flow.  Instead they loan out their silver and gold to their small town banking buddies for say 1-2 percent while still maintaining “legal ownership”.  The small town banking buddies aren’t just going to use their acquired shiny stuff for decoration on their Christmas tree.  The small town banksters sell the metal in the open market and use the capital to invest in higher yielding assets, government bonds for example, while still paying their 1-2 percent on the silver and gold loan (metal lease).  The small banksters know that the big banks won’t request the silver and gold back, the big banks are happily earning 1-2% "legally owning" the physical metal.  The problem lies with the following scenario, what if the confidence is lost on the ability of the small time banksters to return the physical metal to their bigger brothers?  When that time comes, all the large banksters demand their small town banksters to return the metal to their vault.  The only problem is that the small town banksters sold the metal in the open market and now hold t-bonds.  They would have to trade t-bonds back in for fiat to acquire the metal needed to fulfill their commitment.  Unfortunately, there is no metal to acquire because every ounce of metal that exists is legally owned by, say 100 banks.  The only individual which truly owns the metal is the one who has it in their physical possession.

And now we bring in Eric Sprott.  Sprott is currently raising $303,600,000 to purchase more physical for PSLV or $349,140,000 if the over allotment is exercised.  Current prices would enable Sprott to acquire roughly 11 million ounces or 1/12 the amount purchased by Warren Buffet in 1997-1998.  SRSrocco detailed the world silver supply situation and the fact that we are still running at a deficit not a surplus like the GFMS alleges since 1997.  Eric Sprott understands how difficult it will be to source such a large purchase of silver with investment demand, including Silver American Eagles, continuing at all time highs.  I believe this may have been why he released a call to silver producers to retain the metal as cash in order to more effectively source silver to fulfill the demands of PSLV.  Whether this hunch is correct or not, one would expect to see a noticeable if not sharp increase in lease rates when Sprott proceeds with his over $300 million dollar silver purchase similar to what was seen in the case of Warren Buffet.  However, an analysis of silver lease rates shows that there has been little change to date.  This brings into question whether the PSLV buying has begun or if the Sprott effect on silver lease rates and nominal rates has yet to be seen.