Production Deficits & Dwindling Stockpiles

Yet there is another side of precious metals that will take gold and silver to heights never imagined before. That is the huge short position in gold and silver, both in bullion and in equities. The supply deficits of the last decade have exhausted many of our above ground stockpiles in silver and gold. As Sharefin has so carefully researched, the deficits in gold and silver over the last three decades are as follows:

· Gold deficit over last 30 years is 19,700 tonnes or 633.5 million ounces
·          Silver deficit over 20 years is 133,000 tonnes or 4.3 billion ounces
(Most silver is consumed -- not stored or worn as jewelry.)

Most of the deficits listed above have been drawn down from centuries of accumulated stockpiles. The annual deficits each year have been made up from stockpiles that have been drawn down over the last three decades in gold and the last two decades in silver. In the last precious metals bull market in the 1970s, the U.S. government had close to 1.6 billion ounces of silver that had been stockpiled since the Great Depression and World War II. Now the US government has exhausted its silver stockpile and must now go into the market and purchase silver for its silver eagle program. If it were not for the mammoth central bank sales of bullion and bullion leasing programs of the last decade, the price of gold and silver would be much higher today. By selling off much of their gold reserves, the price of gold has been artificially suppressed in the same manner it was suppressed in the late 60's during the infamous London Gold Pool days. We all know what happened to the price of gold and silver afterwards. The only difference between that bull market and the present new gold market is this time around much of our stockpiles have been carelessly drawn down. In the case of silver, it is estimated that above ground stockpiles outside of coins is around 400 million ounces according to CPM group. Silver deficits are averaging around 80-100 million ounces a year.

It just isn' t the simple fact that we are running large annual supply deficits in both gold and silver ands other precious metals. It also relates to an ever-growing demand/supply imbalance that is growing larger by the year. The twin decade bear market in precious metals has driven many mining companies out of business or into bankruptcy. Those who have survived have gotten larger or have been taken over by bigger fish in order to survive. Most major mining companies quit exploring for new supplies or have drastically reduced their exploratory budgets. In order to replace their reserves, they have resorted to the same tactics used by the oil majors they are buying their reserves by acquiring smaller independents. The only problem with this approach is that it isn' t expanding the supply base. Acquiring the reserves of our gold or silver mining company does nothing to increase supply. As the next four graphs show the gold and silver supply deficits that have occurred over the last three decades in gold and the last two decades in silver have greatly depleted the above ground stockpiles in both precious metals. We in effect have been consuming our seed corn.

Unlike corn or wheat, the supply of gold and silver can' t be grown overnight. From the time of discovery to the time the precious metal is mined and brought to market, it could take as long as 10 years, especially in today' s hostile environmental climate. Finding gold and silver takes time. It takes time to find it, time to drill for it, time to get a mine permitted and approved, and time to build the infrastructure necessary to extract it.

The Short Seller's Nightmare

What is even more important to understand is that these supply deficits occurred at a time when there has been no investment demand for the precious metals. These deficits have occurred as a result of only industrial demand. The precious metals markets are too small to handle worldwide investment demand that is now starting to surface around the globe. In the case of gold, there is always the possibility, but unlikely event that central banks could supply the markets with gold with their last remaining reserves. According to GATA, central bank gold sold or leased out is estimated to range between 10,000-15,000 tonnes of gold. This is about 45% of the central bank holdings of gold. The central bankers are looking pretty foolish for selling off half of their gold reserves at the bottom of the markets. They would look even more like idiots if they were to sell off their remaining reserves in order to keep prices suppressed. A greater possibility is that they begin to start buying it again as they are now doing in the Middle East and in Asia.

In the case of silver, there are no large central bank hoard of silver that has been stashed away that could be easily lent to the market. In the case of silver, it is consumed not stored like gold. The situation in silver is even more dire than gold. Why do you think Warren Buffett owns close to 130 million ounces of the stuff?

The silver and gold deficits have taken place against a background of meager investment demand. If investment demand returns, as I believe it will, the price of silver is going to explode in a more dramatic fashion than the price of gold. Both precious metals are just in the beginning phase of a decade-long bull market. The price of metals is going to go much, much higher and stay there for years until enough new production is brought on board or enough scarp and coin is brought to market as prices explode.

In the meantime, according to the latest Commitment of Traders report on the COMEX, silver short positions are net 66,781 contracts, which equals 333,905,000 ounces of silver sold short against COMEX supplies of around 107 million. From where and from whom will the supplies come from? As Sharefin' s research shows in the above charts, supply deficits over the last few decades have been made up from above-ground stockpiles. Where are the stockpiles that will make up the deficits of the next twenty years? Furthermore, what happens if investment demand returns as major fiat currencies around the globe depreciate against the king of all metals? There is simply not enough gold or silver currently in existence at today' s prices to handle investment demand.

The BIG Squeeze Revisited

There is another element to this market that is even more explosive in both gold and silver, but especially silver. That is the huge short positions that now exist in the bullion and in the stocks. As I wrote last week, the short positions in the gold stocks and in the silver stocks are someone' s worst nightmare. In the case of silver, the hedge fund and bullion bankers are short both the metals and the stocks. What is worse is there are no large above-ground stockpiles that come close to matching the short position in silver. In the case of silver, pure silver producing or silver exploration companies can be counted on both hands. There are not more than ten pure silver producing companies in the world. Also with silver, most of it comes to market as result of a byproduct of base metals mining. Currently most base metal mining companies are shutting down mines or are curtailing production as a result of the global recession.

There are other smaller and minor companies that are insignificant. There are also gold mining companies whose mines also have large concentrations of silver. For most gold companies, silver is sold as a byproduct and credited towards the cost of gold production. Pure silver companies are as rare as the future position of the metal. It is a very small universe that isn' t large enough to contain or handle future demand. It is why there is so much dis-information regarding the metals market. The short position in paper bullion and in the stocks is maintained only through ignorance or disinformation. 

If long holders of silver began to start demanding delivery, the paper shorts would be finished as well as bankrupted. At the moment, they are a privileged and protected few that hold their positions at the expense of investor ignorance. That is why if you own a contract you should demand delivery. A day is coming soon when you won' t be able to get delivery. How can a short position of 334 million ounces stand against a supply in the COMEX warehouse of only around 107 million of which some of that silver is already accounted for? That short position exists and rests on a steep precipice of investor ignorance. Some day the longs will wake up and demand delivery, realizing their position of strength and the shorts' vulnerability. That is the secret nobody wants to let out of the bag. When that secret is out, some very big players are going to go under. Their identity is kept hidden and you won' t know about them until the headlines tell of their bankruptcy. At the moment, they are indeed a protected and privileged group feeding on the backs of poor miners and investors who have been fleeced of their rightful profits. More will be written on this subject in days, weeks, and months to come. Lets just say the heat is on.