$950 gold then surge?

In an interview with the ET Now, website of The Economic Times, commodity guru Jim Rogers last week said, “The U.S. dollar is not a safe haven but people think it is, and they do not know what else to do. In any case, they are not going to go to the yen or euro. It [the dollar] is going to go higher as more turmoil comes in. It might even turn into a bubble because people get desperate.”

Later in the interview, Rogers said he expected that the U.S. Dollar Index will top 100 in the short term (it closed at 95.03 last Friday). He also expects there to be a bubble surge in the index in one to two years, simply because people will not perceive any other options to hold money. Because he anticipates a surge in the dollar, he suspects that the spot price of gold will decline to $950 or less in a year or two. If that happens, he expects to be a heavy buyer of gold.

In multiple previous interviews, Rogers has said that he expects the dollar to fail before the end of the decade. He did not confirm or change that forecast in last week’s interview.

I have another thought on the subject. When the dollar plummets in value, people will quickly learn that physical gold and silver have a multi-thousand year track record of never failing as money. Enough people will seek to convert their dollars into precious metals that I expect gold and silver prices will soar. When? That is the ultimate question to which no one knows the answer for sure.

Last week, the government of Zimbabwe announced that it will this week begin redeeming the nation’s dollars that failed at the end of January 2009. By the time the currency collapsed, the government was issuing 100 trillion dollar ($100,000,000,000,000) notes. The exchange rate for the currency is that people will be paid $1 U.S. for every $35 quadrillion of Reserve Bank of Zimbabwe notes redeemed. If you were turning in $100 trillion notes, you would need 350 of them to receive one U.S. dollar.

If the U.S. dollar does fail as analysts such as Jim Rogers and Eric Sprott (and also me) expect, that means that all the debts owed by the federal, state and local governments (Social Security, Medicare, Medicaid, pension payments, loans, etc.) could be technically paid off in full, but in a currency that is basically worthless.

In the meantime, paper trades.

Last Friday, the COMEX silver futures market had open interest (outstanding contracts) of 191,663 contracts. Since each contract represents 5,000 troy ounces, that indicates a potential liability to those who have sold those contracts of 958,315,000 ounces. That is an all-time high for open interest in the COMEX silver markets. This liability exceeds global annual silver mining production.

At the close last Thursday (reported last Friday), the COMEX only had 57,845,972 ounces of registered silver inventories available and committed to fulfill delivery against all of these contracts. The COMEX warehouses also held 122,009,153 ounces of eligible silver, which are not available to fulfill maturing COMEX contracts unless the owners agree to convert them to registered inventories. Combined, the COMEX held 179,855,125 ounces of physical silver.

Obviously, there is far too little of silver inventories to delivery over time against maturing contracts. However, the ratio of coverage is not too far off of normal. Most COMEX traders are investing in the price of silver rather than in the physical metal. Most contracts are closed out before maturity or are traded to other contracts with maturity dates further into the future. The percentage of contracts that are held to maturity to receive physical delivery are only a small percentage of the total open interest.

Still, the net liability of 780 million ounces should be waving a red flag. The total liability has surged significantly in the past one to two months. In the Commitment of Traders report issued last Friday for activity in the week ending Tuesday, June 10, the commercial traders (generally the major bullion banks) reduced their short positions by more than 120 million ounces. At the same time, speculators increased their short positions by an offsetting amount. This tends to indicate that the bullion bank traders believe that the silver price under $16 last week was low enough to cover some of their short sales. At the same time, the speculators, such as hedge funds and other investors, were sticking their necks out further that even lower prices could happen in the immediate term.

If the commercial traders continue to buy back their short positions in such large quantities, a significant silver supply squeeze could develop. If the silver price rises even as high at $16.25 this week, there could be many stop loss orders triggered, which would add even more demand for paper silver to close out short sale contracts.

A rising silver price in the paper contract markets such as the COMEX would almost certainly spark higher demand for physical silver as well. I am not necessarily predicting a near-term sizeable jump in the spot price of silver. Instead, I am pointing out that the huge short position in the COMEX paper contract market makes the silver market more risky for a sudden price jump.

Patrick A. Heller was the American Numismatic Association 2012 Harry Forman Numismatic Dealer of the Year Award winner. He is the owner emeritus and communications officer of Liberty Coin Service in Lansing, Mich., and writes “Liberty’s Outlook,” a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Other commentaries are available at Coin Week (http://www.coinweek.com). He also writes a bi-monthly column on collectibles for “The Greater Lansing Business Monthly” (http://www.lansingbusinessmonthly.com/articles/department-columns). His Numismatic Literary Guild award-winning radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 a.m. Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com).