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Why metals?

Why metals?
Executive summary 1. The demand outlook for gold and silver are bullish. With the long-term risk of ination rmly in place and central banks returning as gold buyers (versus selling) I think these two factor alone will support gold prices for the foreseeable future. As well, demand for silver as an investment is increasing greatly globally. The supply outlook for gold and silver are bullish. It appears that the mined supply of gold and silver peaked in 2001 and is now in a downtrend. The above-ground stocks of gold and silver and current mine production may not in fact be able to satisfy future demand. For the rst time in many decades we are seeing central banks turning from selling gold to acquiring gold and shifting holdings away from paper money into hard assets. It is my belief that the paper or futures markets that currently discovers the price of gold and silver understate the metals true value. With investors continuing to gobble up physical gold and silver and thereby taking it off the market it will increase futures values. The large holders of short positions in the metals have been pushing prices down which give a perfect opportunity for buyers to come in and put metal stocks in stronger hands. Stronger hands are less likely to loan or sell at current prices. The new formation of the Pan Asian Gold Exchange and Hong Kong Mercantile Exchange will have a positive impact on price discovery in both metals.

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If you wish to read further I will start with a short history on money, banking and the Fed.

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Money, Banking and the Fed If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered. - Thomas Jefferson letter to Treasury Secretary 1802 In the absence of the gold standard, there is no way to protect savings from confiscation through inflation [] Gold stands in the way of this insidious process. It stands as a protector of property rights. Alan Greenspan First, gold and silver are commodities. Lets talk gold rst. Gold has value because people want it for jewelry and wealth protection. Silver shares the same but has many industrial uses. Gold has retained its high value because it is more rare in the earth. Silver also is rare in the earth but is even more scare above the ground than gold. Much of the gold ever mined is still above the ground and available for use or investment. Silver does not share that fact. On the other hand silver is used in industrial applications or worse yet, over the years, it has been lling our trash heaps as it has been thrown away with mans productions that required its use. The invention of money has allowed man to go beyond barter and trade. The problem with barter is the aligning of wants. If you grow apples and no one wants apples you must have another means of trade. In time people found that exchanging a good or service for a commodity that was widely in demand made more sense. That commodity that worked best was money. The rate of exchange or price of the good was discovered through supply and demand. The supply of the good versus the supply of the money determined price. Over the centuries metals, pepper, salt, and shells have all served as money. In the end gold and silver have lasted the test of time as money. Gold and silver are easily recognizable, fungible, inert, divisible, malleable and rare which makes them perfect for money. Governments have always wanted to monopolize the the minting of money so they could control and manipulate the money supply. First banks In history, people who produced more than they consumed ended up with a gold supply. To safeguard their holdings people with supplies would look to put supplies in warehouses. These warehouses were the rst banks. Warehouses would charge a fee for safekeeping. Over time people gured out they could exchange their gold warehouse receipt for goods and services versus lugging around the metal. These receipts were the rst gold backed paper money. Bankers (warehouse owners) realized that the gold seldom left the warehouse this brought upon a new idea. The bank could lend out a small fraction of the gold to borrowers who would return the gold in the future plus interest. Obviously, this would only work if all of the banks deposit customers did not claim their gold at once (a run on the bank). What I have just outlined is the birth of fractional reserve banking and ination. Consider the Joe the Baker deposits 1,000 ounces of gold in the warehouse and in return get 1,000 receipts for gold. Then the warehouse issues 200 more receipts as a loan to someone. Now there are 1,200 receipts outstanding but only 1,000 receipts to back them up. With more money fetching after the same goods prices will rise unless the economy produces more. Becker Advisory Services web: BeckerAdvisory.com

Bank runs So, from above we can see that the rst banks were targets for bank runs if everyone thought the banks issued to many receipts and all came knocking for their gold. To protect themselves from runs the bankers devised a cartel - a central bank. Members of the cartel would deposit all their gold with the central bank in exchange for central bank gold receipts. Member banks would not print their own receipts anymore and the only receipts that would be in circulation would be the central bank receipts. With this structure a run on one bank could be covered by the excess reserves of the other banks. The only way a run would take down the system would be to have a run on all banks in the system at once. Today, almost all economies run under this model where a central banks issues the money for the country. US Central banks, US Government and Gold The rst US central bank was the First Bank of the United States (1791-1811) which had a twenty year charter that was not renewed. This rst bank only controlled 20% of the currency supply and the remainder was from state banks. Thomas Jefferson was very much against the central bank hence the quote above. Following the First Bank was a period where we saw a surge of treasury notes issued to fund the war of 1812 (ination). By 1816 we had the Second Bank of the United States that made it until 1836. It was basically a copy of the First Bank with another 20 year charter. Andrew Jackson denounced the bank as an engine of corruption. He did not get the bank dissolved, but refused to renew its charter. The United States ran until 1913 without a central bank. The current Federal Reserve bank came into being under rather underhanded and sneaky means. Senator Nelson Aldrich of Rhode Island, who was writing what would become the Federal Reserve Act, stole away on November 22, 1910 to Jekyll Island, Georgia. With him went a group who were the banking industry. They set forth under assumed names in a private railroad car from Hoboken, NJ on an alleged duck hunting trip. Carter Glass (D) of Virginia, ran the Federal Reserve Act through the Congress on Dec. 23, 1913, when many Congresspersons, including major opponents of central banking, had already left town. The name was meant to deceive, so they chose Federal to make it seem to be part of the government, and System instead of Bank because many Congresspersons opposed a federal bank. Banks across the US put their gold into the Fed in exchange for Federal Reserve Notes (aka US dollars). These notes were backed by gold. Gold and silver backed dollar In 1792 the founding fathers put gold and silver down as money in the mint act of 1792. The dollar was originally dened as 1.604 grams of gold or 24.1 grams of silver. By the 20th century the dollar was just 1.505 grams of gold. Note that the dollar was dened in a weight of gold which meant the dollar was a representation of gold. Lets now fast-forward to 1932 and the great depression. Americans were concerned that President Roosevelt was going to have to print more money to pay for his new deal. Such concerns caused Americans to pull money from the banks and buy gold. As the bank runs continued FDR made it illegal to own gold. Americans were forced to exchange their gold at 1 once of gold for $20.67 ratio. Once the

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gold conscation was done FDR changed the conversion price to $35 for international gold/dollar transactions. Americans could not exchange dollars for gold but foreign governments could. After World War II the Bretton Woods Agreement linked the US Dollar to gold at $35 per ounce of gold. Foreign governments agreed to peg their currencies to the dollar and the dollar would be backed by gold. Therefore, all currencies were technically backed by gold. The US agreed to intervene in gold prices to keep it at $35 per ounce and other countries agree to intervene in their currencies to maintain the dollar peg. The problem was the US could not resist printing more money which would push the free market rate for gold up. To counter a rise in golds price the Fed sold gold into the market. From 1948 to 1972 the US gold holdings fell from 21,682 tonnes to 8,584 tonnes. By 1968 the US stopped intervening in gold prices and let them rise. The dollar continued to be devalued through more money printing and foreign countries concerned about holding deating US dollars started to cash in for gold. In August 1971 President Nixon closed the gold exchange window thereby not allowing foreign governments to exchange dollars for gold. Most interesting is what Nixon said in his address to the nation about the closing of the gold window. It appears from his speech that it was not poor monetary policy and money printing but the evil speculators. Hmmm... In the past seven years, there has been an average of one international monetary crisis every year. Now who gains from these crises? Not the working man; not the investor; not the real producers of wealth. The gainers are the international money speculators. Because they thrive on crises, they help to create them. In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nations currency is based on the strength of that nations economy and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the American dollar... Now, what is this action which is very technical what does it mean for you? Let me lay to rest the bugaboo of what is called devaluation. If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today. The effect of this action, in other words, will be to stabilize the dollar. Now you have the brief history of money and gold in the US. Today, we have record debts that we can never repay with current dollars, unsustainable decit spending and a monetary base that has exploded. What follows is a run down on gold and silver which in the end are one of the only protectors against currency debasement and ination. GOLD The shinny yellow metal has been money for thousands of years. Even today gold is quickly becoming an alternative currency to government-issued at money. Gold is priced in multiple currencies but for the rest of the comments here on gold I will be writing about gold in US dollar terms. There are many forces pushing the price of gold such as central bank policies, creation of dollars, faith in at money and fundamentals like supply and demand. Gold Supply According to mining experts much of the 161,000 tonnes of gold ever mined still exists above ground. Consider that gold is not used in long-term use areas like copper and is not consumed or burned up. The

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huge supply of gold above ground has aided in keeping gold price surges at a minimum. It is thought that we have hit peak gold. Peak gold means that all of the low hanging, easy to mine gold has been brought up. In many of the largest gold mining nations gold mine supplies are in decline. Even though gold is the most widely prospected mineral on earth major nds have been in decline since the 90s. Today most nds are secondary nds with lower grade ores and higher development costs. According to a national geographic article titled The Real Price of Gold: In all of history, only 161,000 tons of gold have been mined, barely enough to ll two Olympic-size swimming pools. More than half of that has been extracted in the past 50 years. Now the world's richest deposits are fast being depleted, and new discoveries are rare. Gone are the hundred-mile-long gold reefs in South Africa or cherry-size nuggets in California. Most of the gold left to mine exists as traces buried in remote and fragile corners of the globe.

Gold Demand The two primary sources of demand for gold are jewelry and investment demand. Jewelry demand uctuates with price and currency strength. India is noted as the strongest place for jewelry demand. Close on the heels of India is China whose gold jewelry demand is rising quickly. For both China and India new wealth is pushing demand for gold in jewelry. Investment demand for gold has been growing rapidly in the last three years as global currencies are in a race to devalue currencies and major western economies print ever more at money.

Gold Price The dollar price of gold has very much to do with the supply and demand of gold and US dollars. I think there are a number of trends that will support higher gold prices. The rst is that mining supply of gold will continue to decrease over the long term while demand goes up. Historically the price of gold has much to do with the perceived availability of gold that is above the ground already. Currently about

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2,400 tonnes of gold are mined each year which is a small percentage of the approximately 161,000 tonnes that are above ground in jewelry and bullion. The theory of strong hands states that gold prices will remain on solid footing if central banks and investors are not willing to part with their gold which leads to higher values. Consider that if central banks indicated a desire to sell large amounts of gold that would surely put downward pressure on the price of gold. The current rush to gold to protect wealth from ination and market risk has placed gold in strong hands that are unlikely to dump their gold on short-term price volatility. As more gold nds its way to strong hands there will be less gold above ground for to meet demand thereby deceasing supply and supporting prices. Central Bank Gold Central banks continue to hold large stocks of gold and are adding more versus being sellers just a few years ago. There is about 30,000 tonnes of gold in the hands of central banks with the US Fed (supposedly) having the most. Until very recently many central banks were selling gold as it was thought to be a relic and non-performing asset. As recently as the early 2000s European central banks were selling gold into the market. Great timing! The potential driver is China where they have quietly increased their gold holdings from 600 tonnes in 2003 to over 1,054 tonnes currently. The US has about 74% of its reserves in gold where China, the largest US bond holder, has about 1.7% of its reserves in gold. Considering the state of the US dollar and the fact that China is attempting to diversify away from western currencies, China alone could support gold prices just by small increases relative to their massive assets. Consider that by my estimates if the G20 looked to increase their gold reserves to 10% of total reserves they would have to buy approximately 9,000 tonnes of gold at current prices.

SILVER Silver has long been considered poor mans gold but that was not always the case. As far back as the Romans silver was used in coinage along side gold. In fact, at the founding of the United States the currency was based on either gold or silver. For some it may come as a surprise that silver has more industrial uses than gold. Of all the metals in the earth silver is the most conductive metal and most malleable metal which makes it perfect for electronics. Silver industrial applications make up almost 54% of total demand for the metal. Silver is a natural antibiotic and has many medicinal uses. It is also used in electronics as well as automobiles.

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Silver Supply and Demand Silver supply and demand is not as easily explained as gold. The primary reason is that the two entities that report on the silver industry, GFMS and The Silver Institute use a category under demand called implied net investment (see the rst chart below). Implied net investment is used to capture demand for physical silver from institutional and retail investors. Sprott Asset Management, a Canadian resources expert, put together a very informative chart (see second chart below) to show the aw with implied net investment. The most glaring aw is that it is not possible that supply and demand are equal every year. The implied net investment gure is like a miscellaneous column in the budget of a family that does not follow the budget. The Sprott chart below simply shows ounces of silver in vehicles and resources that investors have sought to gain exposure to silver. By no means is this all of the sources retail investors have been using; there are also foreign silver investment vehicles to consider as well as physical silver purchases. But, what you can see is the difference between the aggregate Implied Investment Demand from 2000-2009 versus the total holdings of these popular investment products that are supposed to be backed by silver. From this chart it is clear that there is a huge disparity between what is thought to be investor demand and what has been investor demand. If the missing investment demand from Sprott is added to the demand side of the former chart we see supply as short. One other interesting facts about silver is its rarity versus gold. According to the United States Geological Survey (USGS) 46 billion ounces of silver has been mined historically of which only a billion are left above ground. The reason for so little of the silver sticking around is the industrial uses. The industrial uses require small amounts of silver that are not worth recovering and therefore end up in the dumps. Gold on the other hand has only had 5 billion ounces mined thus far with approximately 2 billion ounces still above ground. So, from an availability stand point silver is more rare above ground than gold. Consider the following theory from Sprott Asset Management.

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At todays prices you have $40 billion dollars of silver ($40 per ounce x 1 billion ounces) and $3.2 trillion dollars of gold ($1,600 per ounce x 2 billion ounces) above ground in bullion form. The size of the investment market for gold is therefore 80 times larger than that for silver. And yet, on a market relative dollar basis, investors are actually buying more silver than they are gold today. At todays metals prices, in dollar terms, the US mint has sold approximately three times more value in gold than in silver thus far in 2010 coin sales. But there should be 80 times more gold sold than silver for the market to stay in balance. None of the largest gold and silver investment vehicles reect the 80:1 ratio, suggesting that investors have a disproportionately large interest in owning physical silver. Silver and Gold Markets There are many ways for investors to gain access to the metals or the price movement of the metals. The metals market can be broken down into the spot market which is physical metal changing hands or the derivatives market which is futures contracts, options and forwards. Transactions in the metals are conducted over-the-counter (OTC) for spot and derivatives and over exchanges for exchange-traded funds and options. I rmly believe that the safest way for investors to hold metals is buying physical or physical backed investments (that are not ETFs). I do not believe investors should risk investing in the gold exchangetraded funds (ETFs). The rst strike against the ETFs is their vaulting companies. In almost every case the metals of US based metlas ETFs are housed in vaults belonging to JP Morgan and or HSBC banks. The problem I see with these two banks is a clear conict of interest in that these two banks hold large, concentrated short positions in the metals. This is especially troublesome considering that prices are rising while these companies are naked shorting the metals in a time when supplies are tight. In addition, JP Morgan has been under a dual investigation from the CFTC and Department of Justice for manipulation of the silver market. Although the ETFs make the claim to be backed by physical metal it is my belief that the ETFs are not 100% backed by physical metals. From watching vault movements of metals gures it is clear there is paper being held in place of physical metals. In addition, with exchange for physical rules which allows shares of the metals ETFs to be used in place of physical metals in settling a futures contract I believe the integrity of the ETFs is in question. Lastly, the outsized short positions that have been allowed to accumulate in the metals ETFs are concentrated and manipulative in nature and would not be allowed in a normal stock. There are a few gold and silver backed investments trusts that are not exchange-traded funds investors can use. For my clients I have used the Central Gold Trust of Canada (ticker GTU) that holds physical gold bullion and the Central Fund of Canada (ticker CEF) which holds a split of silver and gold. These trusts have metals in a vault of the Canadian Imperial Bank of Commerce. Bullion holdings and bank vault security are inspected twice annually by directors and/or ofcers of Central Fund. On every occasion, inspections are required to be performed in the presence of both Central Funds external auditors and bank personnel. As well, by charter, they do not lease out their metals and they always maintain 90% or more of assets in unencumbered, segregated and insured, passive long-term holdings of bullion. Manipulation Before we get into the conversation about metals manipulation I want to cover three terms that are important to understand. The rst term is long. An investor is long something when they own something and are looking for the price to rise. The other term is short. An investor can be short or

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naked short. A short investor, typically, borrows shares of something, sells the borrowed shares, waits for the price to drop, buys (again) the same number of shares and then delivers the new shares back to the lender. A naked short will sell shares they do not own. With the metals market manipulation we are seeing naked shorting in the futures market. A short is a open ended and losses are unlimited. The last term is a futures contract. Futures contracts require the delivery of an item at a specied price on a specied date. There are two sides to the contract the buyer and the deliverer. Futures contracts can be short or long. The systematic manipulation of the metals has been proven to the regulatory bodies from the likes of former metals traders to metals experts. But, the regulatory bodies have chosen to look the other way for the benet of their friends at the large U.S. banks that are trying to hold prices on the metals back. There are a few things manipulation cannot overcome and those are a dwindling supply of physical metals , money printing and strong physical demand for silver. Another recent manipulation obstacle is the creation of two new metals exchanges in China. The rst is the Hong Kong Mercantile Exchange and the other is the Pan Asian Gold Exchange. Both offer US dollar based gold future contracts deliverable in China. The latter will be offering mini contracts of 10 ounces of gold in US Dollars and Chinese Renminbi currency both deliverable in China and silver will follow. The opening of these two exchanges will be a big step toward getting true price discovery in metals as it will reduce the manipulative pressure of western banks. How does one support the notion that big US banks are manipulating silver and gold? The answers are in publicly available documents and in daily trading charts. Consider Chart (A) from ShareLynx.com on the next page. This chart outlines the short interest in silver by large banks. The data is pulled from publicly available releases on the Commodity Futures Trading Commissions site. It is glaring that US banks have large bets on the price decline of silver. Anyone is entitled to have short bets on silver but the bets are concentrated among two large US banks. Keep in mind total mine production of silver in 2010 was 753 million ounces. At the time of writing this report the US banks hold 23,000 short contracts on silver which amounts to 115 million ounces (23,000 x 5000). So the question is why would banks be looking for silver prices to fall in the current environment? Why do they have large short bets where they do not own the item? Typically, one shorts something to protect something they own. If you are short something you do not own you are not only speculating but in the 115 million ounce range you are manipulating. The answer is they are not looking they are forcing so they can buy silver at lower prices to settle their contracts. A more particular example is from July 19, 2011. Chart (B) below shows the minute chart in silver from 7/19/2011. What we see is silver fall off a cliff late in the trading day. In the bottom of the screen we see a red vertical line that shows the volume in trading. That red line shows that 50,000 short contracts were ooded on to the market in matter of minutes. Each contract represents 5,000 ounce of silver. So, 5,000 ounces times 50,000 contracts is 250 million ounces of silver was sold short in a matter of minutes. This 250 million represents almost a quarter of last years total mine production. As well, it is a $10 billion dollar bet. 250 million ounces at $40 an ounce is $10 billion. Who on earth can deal in that kind of money on unbacked (no physical silver behind) short contracts? Banks that are too big to fail and would be bailed out should they make bad investments. No other person or entity would dare take this kind of risk.

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Chart (A)

In the next to the last chart we see US bank interest versus foreign bank interest in silver The red is the US and the blue is foreign.

The red descending bars show US bank short interest in silver while the blue ascending show their long interest.

Chart (B)

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Silver manipulation in focus The amount of trading in silver investment instruments (not physical) leading up to the $50 per ounce mark was 800 million ounces per day. There is only about 1 million ounces per day available for physical delivery against a futures contract. This means we have an 800 to 1 ratio of people pressing buttons selling something against what can be delivered. If that does not scream concentrated manipulation what does? Then, we must realize that the amount of silver mined in a year is about 900 million ounces. When we put the facts together we see how ridiculous it is that the markets are trading in such disparity to available stocks. It is clear the few entities that are trading this much have no vested interest in silver. Leading up to the $50 per ounce silver run the press was riddled headlines about long side speculators driving silver up to frothy levels. The numbers and facts support that the true speculators were the guys shorting 800 million ounces of silver when they had no means to cover the contracts they were creating. Keep in mind the guys shorting were already out millions if not billions of dollars as silver rose from $20 to $50 per ounce in short order. At the time of writing it is no coincidence that the amount of short contracts has diminished almost in half since the beginning of 2011. This means the shorts have forced the price down so as to buy silver to deliver on their contracts. This means the heavy hand we have seen for decades is being lifted and that the physical silver that is being delivered to the other side of the short contract (meaning the person that is long silver) in most cases is going to Asians who are looking to hold the silver. In reality, the price drops in silver are buying opportunities for not only the shorts but also investors that are bullish on silver. How do we know that the heavy hand being lifted is good for the metals? The answer is because it has been happening for many years. Metals expert James Turk explained the process as an organized retreat. Over the long-term the market interest is too large for government manipulation of market to work. The manipulation in the gold market has been retreating for many years and it is no coincidence we have seen golds steady rise. Golds rise over the last ten years is not an accident or the formation of a bubble (yet) it is the result of fundamentals driving the price (currency and debt problems) while downward pressure from the Fed and their bankster buddies is slowly removed. The Fed and the banksters know that the metals are their savior to currency debasement and ination. The difference is they had bets going the other way until the market blew its lid in 2008. Now the banks have to worm their way out but do not want to pay full price. The regulators looking the other way is just another bailout for the banks. If the banks were forced to cover their bad bets they would be out at least $4.6 billion as of the time of writing this report. The Fed and banks are not dummies; they are really good liars. In the case of silver we are seeing the process of organized retreat tuning into a hurried retreat. As I stated previously, the gold retreat has been going on for some time but the silver retreat was forced upon banksters in 2008 when the banks realized that silver was going to run and run against their bad bets. Current environment for the metals Aside from the strong supply and demand argument and the diminishing manipulation for the metals the real tail wind for the metals is the toxic macro-economic environment that we live in today. The massive, global debt pool that the western world oats on is boiling and the money being printed to bailout global banks is pushing ination realities and fears. In the face of global economic uncertainty and currency debasement central banks around the world are leaving investors no choice in ways to protect their wealth other than precious metals. For centuries the metals have been how people store wealth; this time is no different. The bullish environment for the metals will only be derailed by real,

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scal responsibility from westernized governments. The problem is politicians are politicians and are not looking out for their nations but their own self interests. Parting Gifts From the fantastic work of Casey Researchs Jeff Clark here are a few tidbits to kick around. Morgan Stanley reported in 2009 that theres no historical precedent for an economy that exceeds a 250% debt-to-GDP ratio without experiencing some sort of nancial crisis or high ination. Our total debt now exceeds GDP by roughly 400%. Investment legend Marc Faber reports that once a countrys payments on debt exceed 30% of tax revenue, the currency is done for. On our current path, analyst Michael Murphy projects well hit that gure by October. Peter Bernholz, the leading expert on hyperination, states unequivocally that hyperination is caused by government budget decits. This years U.S. budget decit will end up being $1.5 trillion, an amount never before seen in history. Since the Federal Reserves creation in 1913, the dollar has lost 95% of its purchasing power. Our government leaders clearly dont know how or dont wish to keep the currency strong.

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Disclaimers Investing involves substantial risk. Becker Advisory Services (BAS) makes no guarantee or other promise as to any results that may be obtained from their views. At the time of writing Henry Becker, and clients of BAS have positions in the following that pertain to the content of this report - physical gold and silver, The Central Fund of Canada, The Central Gold Trust, and Market Vectors Gold Mining ETF. No reader should make any investment decision without rst consulting his or her own personal nancial advisor and conducting his or her own research and due diligence, including carefully reviewing the prospectus and other public lings of the issuer. To the maximum extent permitted by law, BAS disclaims any and all liability in the event any information, commentary, analysis, opinions, advice and/or recommendations in the update prove to be inaccurate, incomplete or unreliable, or result in any investment or other losses. The information provided in the update is obtained from sources which BAS believes to be reliable. However, BAS has not independently veried or otherwise investigated all such information. BAS does not guarantees the accuracy or completeness of any such information. The commentary, analysis, opinions, advice and recommendations represent the personal and subjective views of the BAS, and are subject to change at any time without notice. The update is not a solicitation or offer to buy or sell any securities.

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