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It’s a Bear Market

Monetary Digest, February 2001

The stock market remains a key to a bull market for gold and silver. Calamitous events aside, as long as most investors are bullish, they will ignore gold and silver. However, those investors who have investigated gold and silver have found an outstanding opportunity.

Not only do gold and silver hold tremendous upside potential because of the neglect, their downside risks are small. Now is the time for investors who still own stocks to move to gold or silver, getting out of overblown investments and into undervalued ones.

Yet, swapping stocks for “under performing” assets such as gold or silver takes courage. Main stream analysts remain bullish on stocks. Some are even “super bulls.”

Harry Dent Jr., the author of The Roaring 2000s Investor, sees current low stock prices as a “great buying opportunity.” Dent believes demographic factors-birthrates, age-related spending patterns, baby boomer prosperity-to be the catalysts that will propel the Dow Industrials to 35,000 by 2008. He doesn’t see stock faltering until baby boomers begin to retire at the end of the decade.

James Glassman and Kevin Hassett, authors of the 1999 book Dow 36,000, argue that the Industrials should already be near 36,000, based on their studies of the stock-bond relationship. The real super bull, however, is Charles Kadlec, chief investment strategist at New York’s Seligman mutual fund group. Kadlec, author of Dow 100,000: Fact or Fiction, also published in 1999, sees more lenient tax policies, subdued inflation, freer trade, the spread of liberty, and the end of the Cold War as developments that could push the Dow Industrials to 100,000 by 2020.

These forecasts fall under the “new paradigm” concept: This time things are different. Bear markets are a thing of the past.

After all, this has been the greatest bull market the world has ever known. Never have so many people made so much money. Until last year’s devastating downturn in the NASDAQ, many thought that stocks carried no risks. And, why not think that?

Many investors, even those in their fifties, have never seen a bear market in stocks. While some may argue that the 1987 decline was a bear market, it did not last long enough to damage the psyches of most stock investors, just as the present stock decline has not yet dampened stock enthusiasm of most investors. Not until the bulk of 401K money starts going into bonds, CDs, gold, and silver, we will know that investors have had enough of stocks.

Most stock analysts continue to issue buy recommendations. Rarely do they even suggest that a primary bear market could be taking hold. Most investors are in the same camp, and they vote with their money, which is still going into stocks. Yet, despite all the money pouring into stocks, stock averages have not risen higher. In fact, the NASDAQ, as everyone knows, suffered horribly last year.

However, stock analysts who adhere to the Dow Theory believe that the bear has its claws in this market. Richard Russell, probably the dean of the Dow Theorists, maintains that stocks have entered a primary bear market. He further believes that based on historical measures, this stock market is vastly overvalued. (While valuations are an integral part of the Dow Theory, Russell seems to put more importance price action.) The price/earnings ratio for the Industrials is 21; for the S&P 500 it is 25. These are P/E ratios seen only at bull market tops. In fact, these PEs are as high as any seen at any bull market top. Yet, most stock analysts assert that the declines seen last year were only corrections and presented “buying opportunities.” Such analysts are called “perpetual bulls.”

As justification for their optimism, bulls note that the Dow Industrials are off their October 2000 lows and that the NASDAQ rose during January. Russell takes a different view. He sees the NASDAQ rise as a normal correction, and a weak one at that. As for the Dow Industrials, he sees continued signs of “topping out.”

While the term “bear market” rarely has been uttered by analysts in this market, the word “distribution” probably has yet to be used. A distribution occurs at a top in a market, and it describes the transfer of stocks from strong hands to weak hands. During a distribution, “smart money” sells. Distributions often mean that investors who thought they would never sell their stocks have become sellers because they could not say no to such high prices. Massive distributions take place with huge increases in volume (the number of shares traded).

Note in the 10-year graph of the Dow Industrials how the volume over the last fourteen months ran seven to eight times the levels of the first half of the 1990s. Yet, despite the increased volume, Dow stocks have gone sideways, refusing to better their previous highs. With such huge quantities of funds moving into stocks, as evidenced by the increased volume, one would think that stocks would have moved higher. They couldn’t because of massive selling, a massive distribution taking place, another sign of a market top.

Now, we’re supposed to believe that with the Fed pledged to lower interest rates and to pump more money into the system, stocks are going to go higher. What the Fed is doing is making money available to unsophisticated investors who buy at market tops. Smart money is likely to continue selling, even if stocks rise to new highs.

Increased volume in NASDAQ stocks occurred also. However, it started much earlier than in Dow stocks, and it should have. Smart money knew that most NASDAQ stocks were speculative, and the collapses among the stocks have proven it.

Russell says that bear markets have three stages, the first being the wiping out of the “froth” that comes with unchecked bull markets. That was the collapse of the stocks. The second stage occurs as the better quality stocks weaken on the recognition that the economy is slowing, or heading toward a recession. The bad news accompanying the second stage invariably include the cutting of dividends, widespread layoffs, and bankruptcies. AT&T has already slashed its dividend and announced layoffs. Late January, DaimlerChrysler announced plans to cut its workforce in the US by 20%. Once venerable Montgomery Ward is gone. And, the second stage is just getting started.

In the third stage, investors throw in the towel, vowing never again to buy stocks. At the bottom of a bear market, brokers “can’t give stocks away.” The dangers now are thinking that normal “market corrections,” i.e., rallies, are starts of new bull markets. The bottom is years away. Not until PEs are 8 to 10 and blue chip stocks yield 6% will stocks bottom out.

Now is the time to be in gold or silver. The bottom in the metals was a long time coming because the metals market is the other side of the investment coin. With stocks enjoying the greatest bull market ever, the metals sank as investors ignored them. But, with stocks headed down, the metals will reemerge as viable alternatives to stocks. The metals run should be good for five to seven years, longer if a depression engulfs the world’s economy, which is a possibility. Then, gold and silver will again be recognized as the foundations of all investment portfolios.

Gold Coins Versus Stocks

Instead of gold or silver bullion, many investors opt for precious metals mining stocks because they normally yield higher percentage increases than gold and silver when metals prices rise. Thus, precious metals mining stocks are said to have a higher “beta” than the metals. However, investing in precious metals stocks carries risks beyond buying gold or silver bullion.

The risks are many and varied, and sometimes unforeseen problems can send stock prices plummeting, which, of course, is true of all stocks. Management mistakes cause most mishaps. In case of precious metals and other mining stocks, the sizes and grades of ore deposits can be overestimated or the cost of extracting the ore can be greater than expected, resulting in lower profits or even losses.

Additionally, businesses always struggle with other risks, such as economic downturns, interest rate increases, labor troubles, governmental interventions, and environmental requirements. (Heaven forbid a condor decides to bathe in a cyanide pond.) Increases in energy costs, and energy shortages, could plague some mining companies, notably those operating in Nevada’s famed Carlin Trend.

For disastrous management decisions, Sunshine Mining and Refining Company comes to mind. Once a favorite of silver stock investors, Sunshine (SSCF) traded at $13 in early 1998 on the NYSE. Now, Sunshine is in Chapter 11 and is worth about a dime on the NASDAQ.

In 1996, Sunshine’s management borrowed $30 million and in 1997 an additional $15 million for development of its West Chance ore body at the Sunshine Mine, after which the company is named. Part of the borrowed funds were used to delineate what the company calls a “world-class” ore body in Argentina.

Although management claims the West Chance efforts were successful, management misjudged cash flow and was unable to meet interest and principal payments on the $45 million. Efforts to refinance were unsuccessful, and the lenders will soon take over the company. Existing shareholders will wind up with about 4% of the company, and that’s why Sunshine’s stock is trading at a dime.

In 1972, a fire in the Sunshine Mine nearly destroyed the company. While Sunshine’s stock price suffered, the company managed to survive. Now, Sunshine Mining has essentially been taken over by its creditors.

Ashanti Goldfields (Ghana) and Cambior (Canada), two gold producers, also exemplify what can happen to share prices when managements make bad decisions. In early 1996, Ashanti (ASL) traded at $25; today Ashanti trades at $2.50. In early 1996, Cambior, traded at $16; now it is about thirty cents.

Both companies got caught up in forward sales, and their balance sheets were severely damaged by margin calls in 1999 when gold rallied from the $250 level to $335 on the announcement that 15 European central banks would limit gold sales and leasing for five years (The Washington Gold Agreement). Since then, both companies have had to liquidate assets and/or convert loans to equity shares at rates that effectively destroyed the value of the stocks.

Forward selling remains a threat to other gold mining companies because the amount sold short via forward sales is disproportionate to the size of the gold market. Some estimates have total forward sales equivalent to three to five years of production. One or two smaller short positions could be unwound with only minor price increases. But, the total position is enormous, and reversing it without the price of gold skyrocketing will be difficult, if not impossible.

Forward selling involves borrowing gold and selling it, and it is done mostly by mining companies because, logically, they can replace the gold out of future production. Forward selling is profitable because the lenders, primarily central banks, lend with charges (lease rates) of about 1%, sometimes even less. The borrowers sell the gold with effective returns of somewhere between 6% and 10%, depending on the borrower’s credit rating.

If the funds from the sales of the gold are invested in high-grade bonds, the borrowers receive probably 6% to 8%, for a tidy margin of 5% to 7%. However, if the borrowers use the funds in operations, thereby permitting them to forego borrowing in the credit markets, then they effectively receive higher rates, depending on the company’s credit rating.

Hundreds of millions of dollars are made via forwarding selling. The central banks earn fees on an otherwise “sterile” asset. The mining companies earn 5% to 9%, and the bullion houses that arrange the central bank loans and handle the sales earn huge fees. Forward selling pays off like a broken slot machine-except for gold mining companies’ shareholders. Shareholders lose because forward selling artificially increases the supply of gold, which adds downward pressure on the price of gold. And, forward selling is not without its risks.

If the price of gold rises, the lenders want additional margin deposits, which is what put the final nails in the coffins of Ashanti and Cambior. (Despite the borrowers having millions of ounces of gold in the ground, the central banks require “margin deposits,” usually US treasuries. This works much the same way as margin deposits do on futures and stock exchanges.) So, the players recognize that forward selling has risks. In fact, it is believed that some bullion houses have even given the central banks guarantees that the borrowed gold will be replaced.

To reduce the risks, forward sellers buy calls or other complex instruments that give them the right to buy gold at or near the prices at which they sold forward. So, in theory, if the price of gold rises, what the forward sellers lose on the gold sold short is made up by gain on the calls. However, those calls are only as good as the entities who sold them.

If the sellers of the calls go bankrupt, then the calls become worthless, and the forward sellers become “naked,” unprotected. Further, one has to wonder if the calls have force majeure clauses that would permit the sellers to wiggle out of complying. As the old saying goes, “There’s many a slip between the cup and the lip.” The forward sellers, such as Barrick Gold, had better have luck on their side. Getting out of those forward sales positions could be much more difficult than getting into them.

Barrick Gold (ABX on the NYSE and formerly known as American Barrick) pioneered forward sales and has possibly the largest forward sales position in the gold mining industry. On its Web site (, the company boasts of “innovative financial strategies that resulted in record earnings in 1999.” The Web site further brags that “Barrick has the right strategies in place to achieve strong, profitable growth regardless of the gold price.” Forward sales are part of those “innovative financial strategies.” However, Barrick’s Web site does not acknowledge that the electricity crisis in the West could hamper production at the company’s huge Carlin Trend operation. (The Carlin Trend is the reason why the United States is one of the world’s largest gold producers.)

The enormous shovels that scoop ore from the ground are powered by electricity, which is a major cost of mining at the Carlin operation. Although Barrick may have contracted for electricity for years, force majeure provisions could triple or quadruple Barrick’s cost of electricity. That’s if the company is lucky. The shortage of electricity could result in no electricity.

California’s electricity crisis is not so much about deregulation but the failure of the state to permit the construction of new power generating stations. The power industry long ago warned that the state’s growth, both population and new industry, was going to swamp the state’s generating capacity. But, average Californians couldn’t have cared less. After all, whenever they flipped their switches, lights came on. What was the problem? Now, they know. And, it could get worse.

If it gets worse, Californians will cast covetous glances at neighboring states’ electrical supplies. Already, Phelps Dodge, the world’s second largest copper producer, has announced it may be forced to close two operations in New Mexico and one in Arizona because of energy costs. “This situation in California is absolutely killing us,” CEO Steve Whisler said. Phelps Dodge’s electrical costs more than tripled. Diesel fuel costs jumped 15 percent, and natural gas costs are up 125 percent since the second quarter. The company warned it might cut its dividend and predicted a net loss of 10 to 20 cents a share in the first quarter of 2001.

The energy crisis would also hurt the economies of the Western states, Phelps Dodge’s CEO said. He has talked to other CEOs and predicted airlines would cancel flights and railroads would delay shipments as energy problems mount. Some analysts agree with Whisler’s dire assessment of the energy situation and predict more layoffs because an immediate change in energy costs is unlikely.

California’s energy crisis will not be solved easily. It will take years to build new generating capacity. Meanwhile, electricity will have to be bought on the spot market at costs several times what consumers are now charged. If California continues to prohibit the utilities from passing on higher costs to consumers, the state will have to buy the electricity for the utilities, a cost laid directly at the California taxpayers’ feet. It’s a no-win situation. Californians simply screwed up when they let whacko environmentalists stop the construction of power plants. However, there’s another side of the coin.

California has the world’s sixth largest economy. If it unwinds, the whole nation’s if not the world’s economy will be affected. And, everybody knows the Fed is in a near panic about the economy. So, federal legislation (or pressure) could result in electrical allocations according to bureaucratic determinations. Gold mining will not be high on the list.

Furthermore, if a court has to decide who gets the electricity-a community of 50,000 or a mining company-guess who loses? The West’s power crisis could cause central banks to be less willing to lend gold for future forward sales. And, the crisis could cause some lenders to ask for return of gold already lent. Such a development could cause metals prices to move up while gold stock prices suffer because of the short positions.

Precious metals stocks are a way to participate in the gold and silver market; however, compared to gold and silver bullion, stocks are risky. No one ever went broke holding gold or silver. The same cannot be said of paper assets.

Coins to Avoid

US gold coins and obscure European gold coins are often promoted as having numismatic potential. CMi urges investors to avoid obscure European coins; rarely do they attain real premiums. At times, the common European coins (British Sovereigns and Austrian 100 Coronas, for example) are good buys because they can be purchased at or near spot. However, they do not have histories of picking up significant premiums.

Old US gold coins, on the other hand, have achieved high premiums several times over the last quarter century, but under unusual circumstances. Old US coins will probably again achieve premiums, but it is more likely that their premiums will fall further before rising. Therefore, CMi does not recommend them for the average bullion investor. A little explanation is in order.

After gold peaked in January 1980 at $850, it entered a bear market, and over the following few years many investors chose to invest elsewhere. Additionally, Ronald Reagan had just taken office, renewing America’s confidence after four pitiful years of Jimmy Carter, and Fed chief Paul Volcker declared war on price inflation. This made gold even less attractive as a hedge against inflation, and more investors abandoned gold. In the face of all this, coin dealers struggled to stay alive, and many turned to telemarketing gold coins.

The first victim of the telemarketers was the South African Krugerrand. In the early 1980s, the anti-apartheid movement in the US really picked up steam. Tele-marketers used the opportunity to scare gold investors into believing that Krugerrands would be confiscated; they cited Roosevelt’s 1933 call-in as evidence. Although nothing was ever proposed along those lines, many investors were talked into trading Krugerrands for other gold coins, primarily Maple Leafs. (The Gold Eagle had not yet been minted.)

Because gold had entered a bear market, little new money flowed into gold. So, the swapping of Krugerrands for old US gold coins enabled the telemarketers to stay alive-at the expense of their clients. But, an even better story was invented: Old US gold coins, with dates of 1933 and earlier, could not be confiscated. Period.

Nothing supported this allegation, but how could average investors have known differently? Consequently, thousands of gold investors swapped Krugerrands for old US gold coins, receiving less gold in return. It was common for investors holding 20 Krugerrands to trade for 12 or 13 ounces in old U.S. coins. The story was ideal for the telemarketers because their clients (victims?) had no way to find out the real prices of the old US gold coins. While one dealer sold a coin for $600, another peddled the same grade at $700, claiming it was “choice,” or “flawless,” or “gem quality.” The “non-confiscatability” of the old US gold coin story sold so well that it continues to this day.

The popularity of old US gold coins grew, and in the late 1980s a prominent Wall Street firm introduced a gold coin index. That index was widely used to promote old US gold coins for years, but today it can’t be found. And, about that time, there was talk of two or three new mutual funds that would buy old US gold coins. Those rumors further stimulated interest in old US gold coins and sent their premiums higher. However, the funds managers quickly learned that the old US gold coin market was so thin it wasn’t feasible to invest a couple hundred thousand dollars in it, much less millions.

Finally, came the Y2K scare; it was a promoter’s dream. Concerned about the end of civilization as we then knew it, thousands of Americans threw logic out the window and sank millions in old US coins. The lie that they are “non-confiscateable” enhanced the story, and Double Eagles flew across the country to unsuspecting investors. By January 2000, it was clear that Y2K wasn’t going to be a problem, and the selling began. The prices of and premiums on old US gold coins sank all last year. It is likely that those premiums will continue to fall for one major reason: European banks still hold millions of old US gold coins.

From the end of WWII to 1970, when President Nixon closed the gold window, Europeans laid claim to half our gold. Much of that gold was old US gold coins. Until gold sank below the $330 level in 1997, European banks were steady sellers, and hundreds of thousands of coins were shipped back to the US and graded by PCGS and NGC. This can be seen by the significant increase before 1999 in “population” of slabbed coins, which is coin industry vernacular for PCGS- and NGC-graded coins. Although the slabbed coin population grows monthly, it is not growing at the hectic pace of the mid-1990s.

It is likely that as gold rises to the $330 level, European banks again will become sellers, putting downward pressure on old US gold coin prices. Unless a huge “scare story” develops, there will not be enough buyers for the old US gold coins to carry any premiums at all. CMi believes that raw old US gold coins (VF through BU) will sell at or near spot when gold hits the $330 level. We expect MS62 and MS63 coins will carry small premiums, perhaps $20-$40 a coin, as they did in the early 1990s, when sales slowed. Then, old US gold coins will be good investments. However, now CMi recommends bullion coins.

Bullion coins sell for the value of their gold content plus a small premium. By studying the Prices box on page 8, you can see which are the cheapest. However, the cheapest are not necessarily the best.

Coin investors profit not only from increases in the price of gold but also from increases in the premiums on the coins they purchase. CMi urges its clients to buy low-premium bullion coins that have the potential to achieve premiums. The best are the Perth Mint’s Gold Dragons and the Year 2000 Gold Eagles.

Production of both coins has ceased. Of the 1-oz Gold Dragons, fewer than 6,000 remain at the Perth Mint. Production was limited by Australian law to 30,000. Gold Dragons still sell at their normal premiums. However, the premiums on Year 2000 Gold Eagles are starting to creep up.

The Dragon is Dead

Production has ended for the Perth Mint’s Year 2000 Gold Dragon, the most successful coin so far in the Mint’s Lunar Series. Thirty thousand of the 1-oz coins were minted, and less than 6,000 remain to be sold. None of the four coins minted before the dragon came close to reaching the 30,000 limit. The tremendous response was because of the popularity of the dragon, the only mythical animal in Lunar Calendar.

Because of the success of the dragon, more collectors now know about the Perth Mint’s Lunar Series. Many have purchased the earlier coins, despite their high prices. Those collectors will, undoubtedly, buy the coins of the other years as they become available. But, a significant demand for the Gold Dragon, and the other coins, comes from the jewelry industry.

One CMi client, who lives in New York City, says the Lunar coins, and especially the Dragons, are in every jewelry store in Chinatown. Coins used for jewelry purposes become worn and scratched, and afterwards carry no collector premiums. There is no way of knowing how many Dragons the jewelry industry used, but the number was large.

Investors who own Dragons should keep them in pristine condition, so that in the future the coins can be sold to collectors as well as the jewelry industry. There will not be another Year of the Dragon until 2008. But, more important, 2008-dated coins will not be millennium coins.

Additionally, there’s the possibility the Perth Mint will not continue the Series, except the Silver Dragons, which were added in 1998. Logically, the Silver Dragons will be minted through 2010 to complete the Series.

As long as Gold Dragons are available at small premiums over bullion coins, investors should buy them. The remaining 6,000 coins should be gone by summer, sooner if a telemarketer decides to promote them.

Mount Fuji Set to Blow

Recently, devastating earthquakes laid ruin to parts of Mexico and India. Newspapers ran pages of photos, told of brave rescue efforts, and detailed the suffering. The TV networks flashed photos of crumpled houses and interviewed survivors. Then, the media went on to other subjects, important items such as what the Clintons’ stole from the White House on departing.

If big quakes were to hit an important financial center, such as Los Angeles, San Francisco, or Tokyo-which are famous for earthquakes-the events would not soon disappear from the front page. Destructive quakes in those cities could have catastrophic financial and economic aftershocks. Tokyo is especially vulnerable.

In the early 1990s, a book titled Sixty Seconds That Changed the World predicted dire financial fallout from a major quake in Tokyo. Tokyo, which lies where three plates meet, incurs more earthquakes than any other major city. Tokyo is also home to some of the world’s largest banks. When the book was written, the Japanese banks were the world’s largest. However, bank mergers in the US and Europe (and between US and European banks) plus hard times in Japan have reduced the relative size of Japanese banks. But, they are still huge, and bad earthquakes there would have repercussions around the world.

The book had two major premises. One, that Tokyo was due a big quake, citing a 300-year cycle. The book also noted that just as important as the intensity of a quake is the duration. A 7.0 quake on the Richter scale lasting sixty seconds could be more wreak more havoc than a 9.0 one lasting ten seconds. Hence, the title Sixty Seconds That Changed the World. It is not known if the Kobe quake in 1995 satisfied the 300-year cycle.

The second premise was that Japan’s banks were not set up to handle a destructive quake. For example, they don’t have good backup systems, such as keeping computer databases away from Tokyo. It is not known if Japanese banks have since remedied that situation. But, now comes the threat of another natural disaster to Tokyo: Mount Fuji, the world’s most famous volcano, which some 2.5 million tourists visit annually, is threatening to blow.

Not only is Japan the earthquake capital of the world, it coexists with 86 active volcanos. The picturesque Mount Fuji stands only 60 miles from Tokyo, where 11 million people live. More than 110,000 people live at the foot of the volcano on the Yamanashi side.

Before September, electronic monitors registered an average of ten tremors a month inside Mount Fuji. Tremors are evidence of movement of magma, possibly toward the surface. While as few as five tremors a month would raise eyebrows, in September 35 were registered. October recorded 133, and November 221. In December, the number fell to 143. Seismic and volcanic activity has increased dramatically in Japan over the last years. Mount Usu in Hokkaido erupted in March, and Mount Oyama, on Miyake island south of Tokyo, blew in July. Both eruptions followed a significant increase in low-frequency earthquakes. While most scientists insist these are not signs of an imminent eruption, Professor Shimozuru at the University of Tokyo’s Earthquake Research Institute, said, “An eruption of Mount Fuji in the near future is likely after its long period of dormancy and probably will be as explosive as was the 1707 eruption.”

Mount Fuji’s last eruption buried Tokyo-then called Edo-under inches of volcanic ash. Since then, the outskirts of Tokyo have spread toward the volcano. Resorts, gold courses, villas, and the headquarters of various religious sects crowd around Mount Fuji’s massive 78-mile perimeter. The hope is that in case of an eruption, the lava would flow down the prefecture toward Shizuoka. However, the Mount St. Helen’s eruption proved that such expectations cannot be taken for granted.

The winds tend to blow from Mount Fuji toward Tokyo. An eruption would have an impact on airports, trains, cellular phone service, electrical generators, water, and food supplies. Obviously, it would further damage Japan’s struggling economy. A worst case scenario, lava flowing toward the more populated areas, would wreak havoc on Japan. It is another situation where Mother Nature can damage a nation’s economy.

The Silver Bull

Several stock market bulls are noted in the lead article, It’s a Bear Market, for predicting 35,000 and even 100,000 for the Dow Industrials. Not all super bulls, however, promote stocks. Ted Butler, best known for his articles on the Internet site, sees a possible gain of 1000% to 2000% for silver. If that’s not bullish enough, Butler likes to quote the late Jerome Smith, another silver bull: “Within our lifetime, silver may very well become more valuable than gold, as it was in ancient Egypt.”

Over the last few months, a large telemarketing firm has been mass mailing six-page reports covering Butler’s reasons for his bullish position on silver, and many CMi clients have called asking if we see any validity in Butler’s reasoning. We do. CMi has long held that silver will rise higher, on a percentage basis, than gold in the next bull market. Further, we believe that silver can begin a bull market without gold because of the industrial demand for silver. But, we find it difficult to believe the price of silver will exceed the price of gold “in our lifetime.” And, while we believe Butler is inclined to hyperbole, we concur with much of his analysis of the silver market.

Butler believes several potential developments could propel silver higher, one of which is the massive short position in the world’s futures markets, mainly the COMEX in New York. Butler notes, “There has never been a case, except with COMEX silver, of a commodity futures contract having a larger open interest, and therefore short position, than world inventory or world production.” Butler is right on here. The futures markets’ positions for oil, corn, wheat, and a myriad of other commodities are but a fraction of the physicals markets. In other words, much more oil, corn, and wheat actually change hands in the real world than trades on futures markets.

Futures contracts for silver on the COMEX are in danger of disappearing. In early 1998, silver in COMEX approved warehouses received a lot of attention when it dropped to about 72 million ounces. Shortly afterwards, some 28 million ounces appeared, boosting inventories back to the 100 million-ounce level. COMEX-approved warehouses have a little less than the desired 100 million ounces.

When inventories drop again, the efficacy of futures contracts in silver will be questionable. With a production deficit running more than 100 million ounces yearly, COMEX inventories will continue to fall.

Butler also sees forward sales of silver as an albatross around the neck of the silver market. (The concept of forward sales is discussed in Gold Coins Versus Stocks. Forward sales differ from futures markets short positions in that forward sales involve someone lending the physical metal, which is sold for cash. In futures markets, it is pure speculation on price movement.) Butler estimates forward sales of silver equivalent to about two years world production. He doesn’t tell how he came up with the number, and CMi cannot agree with it or refute it. Still, we wonder how he came up with it. Forward sales of silver exist, but at the “two years production” level?

According to CPM Group, silver production for 2000 was about 485 million ounces. Twice that is 970 million ounces. Where did all the silver come from to support forward sales? While the silver stockpiles have shrunk significantly, those declines were because of annual production deficits. CMi knows of no reports of stockpiles being depleted, secretly or openly, to meet forward sales. As for the two years claim, we believe Butler got swept up in his own hype.

However, the issue does raise another: Just how much silver is left to meet the production deficit? (For those new to the silver market, the production deficit is the shortfall between mine production plus secondary recovery and industrial demand.)

In its Silver Survey 2000, CPM Group estimates 756 million ounces aboveground to meet the production deficit. The 756 million ounce figure includes warehouse bullion stocks and individual investors’ holdings (100-oz silver bars, Silver Eagles, 90% circulated coins, etc.) It excludes some 153 million ounces held by governments. With an annual deficit of 120 million ounces (1999’s deficit), that is about a six-year supply. The Survey estimates only 331 million ounces in bullion form; in 1989, that figure stood at 1.8 billion ounces. If anything, those statistics evidence the voracious appetite our industrial economy has for silver.

Butler also considers it significant that the United States government is about to cease being a supplier to the silver market. CMi concurs. Since CMi’s inception in 1973, we have had to contend with rumors (and sometimes threats) of the US government selling silver from the Defense Department National Strategic Stockpile, which stood at approximately 139 million until 1986, when the US Mint began minting Silver Eagles. Now, the stockpile has been nearly depleted.

Since 1986, the US Mint has used silver from the Strategic Stockpile at the annual rate of about nine million ounces for the Silver Eagles program and silver commemorative coins. A few months ago, the last 15 million ounces were turned over to the Mint. Next year, the Mint will be a buyer of silver for the first time since the 1920s. Butler thinks that demand for Silver Eagles could surge to 20 or 30 million ounces. CMi hopes not. Silver Eagles are not the best way to invest in silver.

CMi recommends circulated pre-1965 US 90% silver coins and 1-oz silver rounds for investors wanting the flexibility to deal with possible financial chaos. One-hundred ounce bars are excellent for investment purposes. Although Silver Eagles are beautifully stuck coins, their premiums are too high for investment purposes. For buyers wanting small forms of silver for survival purposes, circulated 90% coins and 1-oz silver rounds would work just as well as Silver Eagles.


Silver still holds the greatest upside potential of the precious metals. It moves higher on a percentage basis in bull markets-and falls further in a bear market. Yet, investors unable, or not wanting to, handle silver’s weight and bulk should not hesitate to buy gold. At present levels, both metals-at inflation adjusted prices-are at record lows. There will come a time when many investors will bemoan not having invested at these levels. This will be especially true for those sticking with stocks, which are now in a primary bear market.

Investors should avoid platinum at these levels because it holds as much downside risk as upside potential. Gold and silver, on the other hand, have very little downside risk.


CMi recommends circulated 90% coins because they normally pick up premiums in a rising market. Presently, they are selling a little above spot.

One-hundred ounce bars are a convenient way to invest in silver, but rarely do their premiums increase. One-ounce rounds are ideal for investors who want flexibility. Right now, both 100-oz bars and 1-oz rounds are selling below the cost of production, but a few cents above spot.


Australia’s 1-oz Gold Dragons are the best buys in gold coins. By law, the Perth Mint can produce no more than 30,000, and that cap has been hit. But, only about 6,000 remain unsold.

Gold Dragons are priced only a few dollars more than other bullion coins. CMi believes that the uniqueness of the Year of the Dragon falling on the year 2000 will cause Gold Dragons coins to achieve high premiums over the next couple of years.

It now looks like 2000 will one of the lowest mintage years ever for 1-oz Gold Eagles. With the huge number of collectors interested in American gold coins, these coins could also pick up premiums over the next couple of years. If you don’t go with Dragons, then Gold Eagles should be your choice of gold bullion coins.


CMi does not recommend platinum at these levels. Although there is a growing demand for platinum in meeting environmental goals, the big consumer of platinum is the Japanese jewelry market. And, the demand for platinum jewelry is increasing in the US. However, if Japan’s problems compound, and the US economy turns recessionary, both jewelry demand and industrial demand would be curtailed. Platinum is risky at current levels.