While we watch gold, silver
and other metals foraging onto new multi-year highs, I thought
I would be a good contrarian and indulge in some silver speculation
of the thinking and not investing kind. These thoughts concern
copper and silver.
Now as readers will know, gold and silver have
been money for millennia. Indeed, at various points in history,
either metal has been used to define money itself. Now if
silver has been called the poor man’s gold, then copper
is most likely to be the poor man’s silver.
The one boast copper has over gold and silver
is that it is still money. Gold and silver have not been seen
in circulating money for decades but copper is still there
in the lowest denomination coins we regularly make purchases
with. But, as with gold and silver, it will eventually succumb
to the same enemy that forced those metals out of the common
coin of the realm. That enemy is government sponsored inflation
and the intrinsic value of copper content coins will soon
stay in excess of the face value of the penny, cent or whatever
national currency. It will be all very reminiscent of 1970
when monetary debasement finally forced the last gram of silver
out of the half dollar.
But the main arena and debate for copper is
in its use as a commodity. Two interesting events dovetailed
recently regarding the copper market. One was an article by
Frank Veneroso in which he reiterated his view that traders
on the long side were manipulating the copper market and that
this will lead to a collapse in the price of copper and other
base metals. His original thesis back in June can be found
By his own admission, no collapse of any long
manipulation has transpired as copper continued to advance
to new highs. The price of copper in that time frame is shown
below. However, Veneroso thinks it is only a matter of time
before the alleged longs are burnt with a price collapse.
So what might be the event that primes a bursting
of the copper bubble and what would its implications be for
That brings us to the other interesting event
on the consumer side which is the persistent rumours that
the Chinese State Reserve Bureau is heavily short copper to
the tune of hundreds of thousands of tonnes and may be facing
a massive short squeeze. This is of course bullish for copper
if the Chinese government's traders were forced to cover their
shorts by buying up the metal in vast quantities.
However, it was an article by the ever-interesting
John Mauldin on the copper situation that suggested the complete
opposite may come to pass. His article
discusses a conversation with a seasoned observer of China
and Copper. He basically suggests that the Chinese are indeed
short by up to 200,000 tonnes of copper but the positions
are spread out over a three-year period. An unwinding of these
positions over three years does not sound so painful, especially
when it is suggested that China holds about 1.5 million tonnes
of copper in reserve. It looks like China can deliver on their
John Mauldin then indulges in some "wild
conjecture" to which I will attach my own meanderings.
Will the Chinese authorities stick it to the bourgeoisie traders
who are on the opposite side of their short positions by not
buying copper for an extended period of months? Mauldin surmises
that China could achieve this by tapping their own strategic
reserves and watching the unwanted inventories build up across
the world. With China consuming 20% of the world's copper,
this could be sustained for several months. The effect on
the price would of course be negative as demand drops from
the main buyer on the global market.
Now combine this with Frank Veneroso's conjecture
that the longs are manipulating the situation because:
"The manipulating merchants and hedge funds
have created artificial shortages of exchange stocks by accumulating
In this world of financial musings, we have
two stockpiles facing off against each other - those of the
Chinese State and those of the merchants and hedge funds.
Which will flinch first? If China draws on her reserves, prices
drop and the longs are forced to liquidate their positions
and sell off their own inventory. Meanwhile, China closes
out their shorts at a profit and uses the extra cash to buy
even cheaper copper to replenish their reserves. Eventually
the price of copper rebounds, as it must in an era of increasing
If there is indeed a manipulation, the price
drop will be even more exacerbated, I give you the bone-crunching
drop in silver prices last year as an example of rapid unwinding
of hedge-fund positions.
However, Frank Veneroso suggests the catalyst
may be a downturn in China's economic fortunes. That will
indeed happen. One only has to read about the huge amount
of corruption and bad debt within the Chinese banking system
to see that a major credit squeeze is on the cards there.
But will China first and deliberately cause an artificial
glut in copper to destroy the alleged artificial shortages?
We don't know but the ramification for precious metal investors
will be interesting.
What is the correlation between silver and copper
prices? At a purely price level, here is the relative performances
of the two metals in the last few years.
As we can see there is a high degree of correlation
between the prices as the commodity bull market has progressed
onwards and upwards. One thought that seems contrary to the
chart is that since a lot of silver production is a by-product
of copper mining, ought not this demand-insensitive silver
cause a price drop when it is dumped on the silver markets
by copper mines running at full capacity?
The answer would be "yes" if silver
demand remained static, but as we know the world's increasing
appetite for silver is consuming any inelastic supply from
base metal mining. Indeed, one may be so bold as to suggest
that the recent 16-month retrenchment in silver prices may
be due in part to the excess silver coming out of copper mines
across the world.
But that is by the by, the main question is
what will happen to silver if the price of copper drops precipitously?
Since every metal seems to be interconnected in this great
metals bull market, a temporary drop in silver prices is almost
assured. One only needs to look at the large and simultaneous
drops in silver and copper prices in April 2004 to see an
example of that. However, unlike that drop, it is copper that
has been racing ahead and not silver in the last 16 months
and so we suggest that silver has less to lose than copper
in percentage terms.
The only other question is who is the tail and
who is the dog when it comes to wagging? With world copper
production worth over 45 billion dollars per year (based on
$1.50 per pound and a 14.5 million tonne production) and silver
coming in at less than 5 billion dollars (based on $7.50 an
ounce and 20,000 tonnes of mine production), it is apparent
that the silver tail will not wag the copper dog.
The reason for copper influencing silver not
just at the mining level but at the price level is due we
think to copper being a more important barometer for the health
of the booming commodity market than silver. In other words,
if copper sneezes, every other metal catches a cold.
But then the supply and demand equation comes
into play. If silver demand remains at a faster pace than
now depressed copper and with copper mines throttling back
in production, we anticipate that silver will come out of
the blocks faster than any other metal.
If China were to cause an artificial glut in
copper, that should not affect overall silver demand, as it
is only the source of copper that has changed, not the amount
consumed. In that light, we anticipate a sharp rebound in
So, in conclusion, we must emphasise that we
are talking about a copper-silver relationship in the context
of an alleged copper stockpile manipulation. If there is no
such manipulation, we fall back on Frank Veneroso’s
warnings about a collapse in Chinese copper demand due to
a credit/currency crunch similar to the one Asia experienced
in 1997. We anticipate that particular scenario will be negative
for silver unless the financial contagion spreads worldwide
into a monetary crisis.
In that dire situation there are few places
to run to except the safe haven of precious metals.
Roland Watson writes the investment
newsletter The New Era Investor that can be purchased for
an annual subscription of $99.
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