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Do paper sellers have silver to deliver?

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There are several factors when put together signal that the physical silver market could be on the brink of a panicked buying frenzy.

• In years past, bargain-hunting buyers of gold and silver would often wait weeks for a market correction or a manipulation to drive down prices and then make their purchases. A year ago, the bargain shoppers were only waiting about one day to jump in. Right now, there are obviously a lot of deep-pockets buyers who will make purchases within hours of any kind of price pull back.

• I received confirmation from one source last week that a new major buyer of physical silver had entered the market the previous week. This new buyer, an unidentified German conglomerate, had not previously purchased silver.

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• Last Thursday, Sept. 2, there were no deliveries of any COMEX silver contracts, and there were only nine deliveries the day before. In fact, there were 3,002 contracts of open interest on Aug. 31, the day of first notice, but only 292 notices of delivery. Once a contract owner of a maturing contract has given notice to take delivery and made full payment, the party who is responsible for making delivery remains liable for insurance and storage fees for each day’s delay in making delivery.  For this reason, the parties who are liable to produce the physical silver have a strong incentive to make delivery as fast as possible.  For a company to fail to make delivery might be a sign that it is having difficulty coming up with the physical metal.

• Since mid-June, COMEX silver inventories have dwindled about eight percent. Rather than being a general decline among all dealer inventories, however, the withdrawals have focused on contracts owed by HSBC and Scotia Mocatta, the two banks who are most suspected of not having sufficient physical silver to meet their obligations.

• For July, the ounces of silver traded by the London Bullion Market Association (LBMA) declined by 32.7 percent from already low June levels. The volume of LBMA silver trading in July set a record low for any month since such statistics first started to be compiled in 1996.  Although LBMA contracts are supposed to be for the physical delivery of metal, the practice in recent years has been to trade them as paper contracts without taking delivery.  Since it was revealed in the March 25, 2010, Commodity Futures Trading Commission hearings that the LBMA only has enough physical silver to fulfill 1-3 percent of all outstanding contracts, it looks as if silver buyers are moving away from paper markets and focusing on purchasing physical metal.

The price of silver closed last Friday at $19.91, its highest close since March 17, 2008.  With both the COMEX and LBMA showing problems of having enough silver to make physical deliveries, I anticipate that demand will mount in the next few weeks. There will be rising pressure from two sources. First, a number of owners of “paper silver” contracts will be trying to convert their asset into physical metal.  Second, it is highly likely that the number of professional investors, perceiving a rare opportunity to profit from a supply squeeze, will continue to increase their buying efforts.

At some point, the price of silver will rise so high that there will be a major profit-taking and retrenchment. In my judgment, we are nowhere close to that occurring. My crystal ball is too foggy to name a target price.  $25 by the end of this month is a definite possibility. $30  silver by the end of 2010 also a reasonable prospect.  But these could also turn out to be extremely conservative.

At the minimum, I would not be surprised to see the severe shortages of physical silver (and gold) that developed in late 2008 return by the end of this month. It is still possible to purchase physical silver today, and get it at reasonable premiums.  I cannot guarantee how long this opportunity will last.

Patrick A. Heller writes a weekly column for Krause Publications’ Numismatic Update e-newsletter. Sign up for free at www.numismaticnews.com. He also owns Liberty Coin Service and Premier Coins & Collectibles in Lansing, Mich., and writes “Liberty’s Outlook,” a monthly newsletter on rare coins and precious metals subjects. Past issues can be viewed at www.libertycoinservice.com. Other written commentaries are available at Coin Update, www.coinupdate.com.

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