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    David Morgan
    Precious Metals Analyst

    The Smartest Money

    While attending the Chicago Natural Resources Conference, the owner of a well-known precious metals web site introduced himself to me. It was a pleasure to meet him in person and put a face to the name. We discussed the conference and some of the companies that were in attendance. Finally, I popped my favorite question. What do you think about silver? Do you think as I do, that it has even more potential than gold? His reply was both profound and accurate. “David,” he said, "The smart money is moving into gold, but the SMARTEST money is moving into silver!"

    Naturally, I would agree with this view, but it did give me pause. Warren Buffett, Bill Gates, and George Soros have all staked out a silver claim. Smart money? I would venture most would agree. It has been some time since publishing anything for the public at large. My aim is to provide as much fact as possible to the reader and let each determine individually, how silver stacks up to gold or visa versa.

    Plain and Simple: There is more Gold Bullion than Silver Bullion

    There is less silver available for investment than gold. I am often chastised about this bold statement. So, let us use the most recent CPM study and see for ourselves. According to CPM Group's Silver Survey 2002, there are approximately 400 million ounces of silver bullion and 2 billion ounces of gold bullion.1

    The silver market is not only much smaller than the gold market physically, but it is also true monetarily. Look at this graph. It shows the known amount of gold versus the known amount of silver. Another study estimates the total bullion to be higher by about 200 million ounces.2 This amount is 200 million ounces held in government inventories. In my view, this silver is leased and therefore subject to double-entry bookkeeping. In other words, the 200 million ounces on government books is leased out and that means those ounces aren’t in government vaults. This additional 200 million being leased is conjecture only, so be advised.

    Silver Coinage
    In the past, my main concern has been silver bullion. The reason is because this type of silver is required in the market place for futures trading and quoting the bid and ask price. Coins present several variables. First, there is junk silver which is only 90% fine. This of course is silver, but it is not deliverable against a futures contract. Also, there are silver bullion coins such as the silver Liberty (silver eagle).

    Since the inception of this minting program, there are approximately 100 million ounces in this category alone. The reason this category is different than .999 fine silver bullion is that much of this silver will need higher prices than straight bullion to come to market. Why? A premium is built into this market even at the dealer level. Even 90% coins bags are carrying a premium now. However, in the interest of being as fair and complete as possible, let us look at the total silver supply, which accounts for bullion-deliverable silver and coin silver. The total here is about one billion ounces and is still only one half the total amount of gold bullion.

    Silver coinage has been a major source of silver. The silver content is relatively high when compared with other sources like silverware for example. This fact means that coinage is vulnerable to being melted in response to the changing price of silver. This was most apparent during the 1979-1981 period when silver peaked at $50/troy ounce and when much of the then-existing silver coinage was melted. According to Charles River Associates (CRA), about 10% of the silver coinage minted from 1911-1990 remained in 1991. This means that nearly 90% of the coin silver was melted and turned into silver bullion. At that time, the figure of total worldwide coinage was just under one billion ounces.3

    Silver Art
    Before I move ahead, let me address a common and very important question. What about all the other silver? What other silver? The other category is what I call silver art. Bear with me for a moment. Going back to 1992, CRA conducted a rather exhaustive study on the total silver market. At that time, this organization attempted to do independent research on silver to determine the actual amount of silver worldwide and the amount that would be available to the marketplace under different market conditions. A significant quantity of silver is not available to the market according to this study because it is "uneconomic." Let’s look at two examples.

    Silver or Gold Jewelry
    The amount paid for this type of gold or silver (art) is far and above the melt value. Take a typical man’s silver wedding ring for example. The price paid for the ring far exceeds the melt value of the metal involved. This holds true for most silver jewelry. In other words, most of the jewelry and artwork are not coming back to the market. There are some cultures that do use jewelry as a medium of exchange, but in this case, most of the metal (jewelry) stays within the local region.

    Religious Silver
    The CRA study determined that the amount of religious articles made of silver was significant. Again, I agree with the CRA study. The study indicated, "The liquidity of art forms is certainly more difficult to project owing to the diversity of the silver types that constitute this category as opposed to the simpler bullion and coinage forms. Several of these categories lend themselves to virtually no liquidity, even at $20 per troy ounce silver price. Most notably, the decorative and collected silver in museums, palaces, embassies, and so on is of such historical and collectible value that only theft is likely to bring it into circulation. The same may be said of ecclesiastical silver which ranges from chalices, to frames, to gilding."4

    The Argument Continues

    Let us move ahead now. One of the main arguments against the silver bulls is the supposition that there is so much silver. They argue that bulls like me do not address this. It is important to look at all factors in a market and therefore I am going to address this in a way that may provide food for thought. As most familiar with my work know, my main objective is to get the reader to think. Some background is necessary. Did silver reach a peak price of $50 per ounce in 1980 or did it not? Was there approximately 1.5 BILLION more ounces of silver available then or not? Where am I going with this? Straight to my physics background... all things are relative. The money supply in the U.S. has gone up nearly six-fold since the 1980 peak in silver prices. So, the silver stockpile has decreased and the money supply has increased SUBSTANTIALLY since 1980! This stockpile has been reduced by at least 1.5 billion ounces due to the silver deficit, which has continued for twelve consecutive years.

    Ted Butler of Butler Research makes the case that silver leasing has supplied the market for a long time. Ted's argument is verified in part by the CRA study. As early as 1992, CRA's study makes reference to "silver leasing." Also, the price projections from the study give us the following information. According to page 1 of Stocks of Silver Around the World, ”Only a small portion of the worldwide stocks [stockpiles] are potentially available to the world market under a realistic set of market conditions. Thus, for all practical purposes, the ‘truly relevant stocks’ are available at the following prices:

    $5 146 million troy ounces
    $10 541 million troy ounces
    $15 1,148 million troy ounces

    Interesting, the CRA study was published in October 1992 and these projections have been wrong. Why? Can anyone say “leasing”?

    Gold vs. Silver Leasing

    Comparing silver leased versus gold leased provides one of my most important points. As some may know, I made reference to the published statistics on silver leasing during a conference call to one of the major silver mining companies several months ago. The question was simple. If the GFMS study from 2001 shows the amount of silver leased between 1997 and 2000 inclusive as 800 million ounces and the same study shows only 700 million ounces actually available, how on earth can all the silver be paid back? Before I move on, let me dwell on this important point. This period is only four years worth of silver leasing. Additionally, this is transparent silver leasing. That is to say, silver leasing that has transpired in the Over the Counter market is not considered. How much silver has been leased since 1993? I do not know. But I would suggest for your consideration that it is much greater than the 12,000 tonnes shown in this graph. Another fact that must be kept in mind is how much of the available silver bullion is owned?

    Let’s Do Some Math

    Mr. Buffett has 130 million ounces. Silver in the eligible category at the COMEX is about 30 million and most analysts believe this to be long-term holders. These two holders amount to 160 million. If we take the low total world estimate from the CPM Group of 300 million and then subtract the 160 million, we have a total of 140 available million ounces. We need to pause here for a moment because the latest CPM Group's Silver Survey 2002 has projected the 2002 silver requirements to be 120 million ounces.5 Does this get your attention? If we subtract the 2002 required amount from the total, we only have 20 million ounces of COMEX-quality silver available at the beginning of 2003. This admittedly is the best case scenario for the bulls. Take a hard look at CPM Group's higher estimate, or 500 million available ounces, and still the silver bullion situation is serious.

    How does this compare to gold? To be consistent would be best, but the data is not available to me. Using the work of Frank Veneroso, the high estimate of gold leasing is roughly half the available supply.6 This is indeed a serious condition but not nearly as serious as the silver situation. If we look at the total amount of gold leased versus total supply of gold, we see about half has been leased. Now let us look at the silver situation. Nearly twice the amount of available silver (bullion) has been leased. Pause here for a moment and let this situation sink in for a moment or two. Can anyone explain why "The Commercials” are short even one ounce of silver right now?

    The Economic Equation

    Now, indulge me for the macro economic picture. As of May 28, 2002, gold closed at 325.5 and silver closed at 4.882. Remember the relative situation. Many, who are concerned with the global economic picture, look at the coming dollar crisis in a very serious way. Looking back at history, most countries that continue with a severe balance of trade deficit, end up using hyperinflation to eliminate their debts. I have been through this before [See Engineering the Price of Gold] and will not expand on it now. I think that the deflationary forces will overcome the authority’s ability to expand credit further. The Federal Reserve has done their best with interest rate cuts and failed. I truly believe the Market is bigger and smarter than any government. Need proof? Taken a look at the precious metals lately? Where do you think the smartest money is moving?

    David Morgan
    © May 29, 2002
    [email protected]

    1 CPM Group's Silver Survey 2002, CPM Group, p. 13.
    2 World Silver Survey 2001, GFMS, p.29.
    3 Charles River Associates, Inc., Stocks of Silver Around The World, Study Conducted for the Silver Institute, October 1992, p. 69.
    4 Ibid., p.1.
    5 CPM Group's Silver Survey 2002, CPM Group, p. 22.
    6 Veneroso, Frank, GATA African Gold Summit in Durban, May 2001.


    David Morgan has been a private economist for over two decades. His background in engineering with an advanced degree in Economics/Finance gives a unique perspective to the financial markets that pure business majors often miss. He applies the discipline of logic to verify the basics of economic law. Mr. Morgan has been published in The Herald Tribune, Gold Newsletter, Resource Consultants, Contact, News Gurus Magazine, Common Ground, and The Idaho Observer. His work has appeared on the internet at Silver-Investor.com, 321Gold, Le Metropole Cafe, Goldseek, Gold-Eagle, and Silicon Investor. He has been interviewed on Don McAlvany's radio talk show, Financial Sense Newshour, Hard Money Watch, Truth Radio and appeared on television. He hosts a weekly precious metals wrap-up on internet radio every Saturday with Jim Puplava. Mr. Morgan was published in the global investor regarding ten rules of silver investing. Currently, he is speaking with a publisher regarding a book on silver. His private email newsletter is $78 U.S. by email. It includes 12 issues per year, plus email updates as required at no additional charge.


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    The Effect of the Financial Sector Crisis on the Gold in Japan
    Recently, gold has been regaining its luster in Japan with individual investors. This move back to gold as an investment is not because Japanese investors believe that gold outperform other investment products, it is because Japanese investors are searching for investment assets that will help preserve their wealth.

    Conservative Japanese Investors
    The Japanese people, on average, are very conservative investors, which can be seen from the make-up of their savings portfolio presented in the Chart 2 below. From this breakdown it can be seen that the most important investment objective for the average individual Japanese investor is to MAINTAIN THEIR PRINCIPAL! This may not be the most prudent investment strategy out there; however, it is on that has become ingrained in Japanese investors over the past decade-and-a- half.

    Their risk aversion is a direct result of investment losses resulting from the hype driven bubble economy, and scandals involving variable annuities in the 1980s, and more recently losses such as the ones resulting from MMF funds (Money Management Funds) that had invested in Enron bonds. Returns on these MMFs took a nosedive following the demise of Enron in the United States. MMFs were once thought to be relatively risk-free by most investors; however, four MMF funds proved otherwise, as they cashed-out almost 40 billion-yen (CDN$487.8 million) in Enron bonds holdings at 20% of their face value, causing their price to drop below their fixed par value.[1] As a direct result of this, investment in the entire MMF industry declined by nearly 5 trillion-yen (US$40 million) in November 2001. Luckily, since this incident, the FSA has implemented new regulations restricting the risk-level of bonds that MMFs are allowed to invest in to help rebolster investor confidence in Money Management Funds. However, the damage that was caused by this will take time to repair.

    Source: Statistics Bureau & Statistics Center, Ministry of Public Management,

    Home Affairs, Posts and Telecommunications

    A recent study conducted by the Bank of Japan (BOJ) stated that the most important investment criteria listed buy Japanese investors was Safety (44%), followed by Liquidity (26%). Profitability came in a distant third at 13%.[1] This sentiment has existed for a long period of time, and is reflected in the make-up of the average investment portfolio of Japanese investors.

    Safety first, is a concept that has been evident in household investment portfolios for over 10 years, with each investment instrument maintaining a relatively stable level as compared to total savings (see the Chart below). In the year 2000, the average Japanese investor held approximately 42.80% of their savings in time deposits and 11.42% in demand deposits. That is almost 60% savings investments that yield close to zero percent. And this asset allocation has only recently has this begun to change.

    Trends in Average Savings (by investment instrument)

    Source: Statistics Bureau & Statistics Center, Ministry of Public Management, Home Affairs, Posts and Telecommunications

    In the past six months, savings flowing out of time deposits have increased immensely, as the April 1, 2002 deadline for the reintroduction of the deposit guarantee cap on time deposits approached. The cap limits government insurance coverage for time deposits to 10 million-yen (CDN$122,000), which prompted investors to move significant portions of their savings out these accounts and into other investment instruments that they considered to safer havens.

    Demand deposits benefited the most from the outflow of savings from time deposit accounts. Demand deposits, which include ordinary and current accounts, began to increase noticeably in the latter half of 2001. This increase continued in February and March 2002, with February recording 21.9% growth and March recording 28.1% year on year basis, according to the Bank of Japan. This demonstrates the average investors continued motivation towards protecting their principal. However, the image of demand deposits as safe havens is being challenged by the continued instability in the banking sector, and the reintroduction of a deposit guarantee cap on demand deposit accounts, which is scheduled for April 2003. These concerns are adding to investor’s anxieties over how they can protect their savings.

    Continued Instability in the Banking System

    The bank’s ongoing problem with nonperforming loans (NPLs) remains the number one source of instability in the sector, and the main factor holding the Japanese economy back from recovery. The most recent estimates of NPL write-offs for FY2001 put the total at approximately 8.5 trillion-yen. This surpassed both FY1999 and FY2000 write-offs, which demonstrates this problem will not be going away in the near future. Further, as a result of these write-offs a majority of the major banks will most definitely be reporting overall net losses for FY2001. Making the 8th consecutive year of Net Losses for the sector (see The Write-off of NPLs FY1993 –FY2002 presented below). These are factors that are not good for improving investor confidence.

    Another factor that demonstrates that this problem will continue into the near future, is the level of NPLs that still remain on the books of the banks (i.e they haven’t been written off yet). In the last 9 years, the banks have written-off an estimated total of 76.26 trillion-yen (CDN$930 billion) in nonperforming loans. This includes the estimated 8.5 trillion-yen for the current fiscal year. However, these write-offs have not brought down the balance of NPLs still outstanding on the bank’s books. At the end of FY2000 (i.e. March 31, 2001), there were still approximately 35 trillion-yen in NPLs still outstanding, according to the guidelines in the FRL[1] (see the chart below for a breakdown of NPLs outstanding each year).

    [Note: FRL guidelines classify NPLs into three different risk levels; (1) Unrecoverable or valueless assets (approx. 8 trillion-yen); (2) Risk Assets (approx. 15 trillion-yen); (3)Assets requiring special attention (approx. 12 trillion-yen)[2]]

    Further, if you add the liabilities resulting from the 20,052 companies that went bankrupt in FY2001 to the outstanding amount from FY2000 results, there will be a net increase in the NPLS outstanding as of March 31, 2002. This is after the estimated 8.5 trillion-yen in NPL write-offs have been deducted! In FY2001 bankruptcies left behind debt totaling an estimated 16.14 trillion-yen, which leaves 7.64 trillion-yen in additional NPLs outstanding. This will increase the total NPLs on the books of the banks to approximately 42.64 trillion-yen (see the chart above).

    Now, if you combine the continuing problem with NPLs at the Banks, with the fact that 100% blanket protection on regular savings accounts (demand deposits) will also be lifted on April 1, 2003, it is very easy to conclude that the average individual’s image of the banks being SAFE Havens for their life saving must be dwindling. These factors will most likely result in an outflow of funds from demand deposit accounts over the course of the current year, which should have a positive effect on other safe haven investments, including GOLD.

    Gold and the Bank Crisis
    While the largest portion of the money that flowed out of time deposit savings flowed into demand deposit accounts, GOLD also benefited from the reintroduction of the deposit guarantee cap on time deposits. In the just prior to the reintroduction of the guarantee cap on time deposits, domestic demand for gold surged in Japan. In the fourth quarter of 2001 (October – December) the World Gold Council reported that investment demand for gold increased by 20% to 32.5 tonnes, and in the month of February they released a report stating that the estimated sales for the month reached approximately 25 tonnes.

    The World Gold Council was not the only source reporting the resurgence of interest in gold, one Nikkei Keizai Shimbun report stated,"The number of first-time buyers who purchase 1-3kg is rising…[and] there have been a number of cases where large-lot buyers purchase more than 30kg (retailing for about 42 million yen [approximately CDN$512,000] of gold at retail stores…”

    This increase in the demand for gold by individual investors seems to be growing out of anxiety over the continuing instability at the Japanese banks. In an effort to discover how the ongoing instability in the banking system may be affecting gold purchases, we conducted a comparison between the TOPIX banking sub index and the domestic price of gold. In this comparison we hypothesized that the price of the TOPIX banking sub-index represented the population’s confidence in the banks, and analyzed how gold prices have reacted when this “confidence” moved up or down.

    In our analysis some interesting trends came to light. First, over the ten-year period that we used in the analysis, we found that there was positive correlation between the Japanese banking stocks and gold. This finding runs contrary to the results found in other studies, which have compared gold prices to equities and found gold to be negatively correlated to equities and bonds. This trend of gold prices and banking stock moving in conjunction may partially be a result of the government’s temporary introduction of 100% guarantees on time deposits and demand deposits, which helped to maintain investor confidence in the security of their savings at the banks.

    In 1999 this positive correlation changed, as can be seen in the chart presented above. From 1999 onward the correlation between gold prices and banking stock became strongly negative, and as bank stock prices (i.e. the populations confidence in the banks) continued to drop, gold prices started to rise. There are many events that may have contributed to this change, but the most significant one’s related to the ongoing banking crisis included,

    v In fiscal 1998 (ending March 31, 1999), the banks recorded the largest NPL write-offs (13.5 trillion-yen), since the NPL crisis first came to light in FY1995, with the collapse of the Jusen (housing loan companies).

    v The injection of 6.2 trillion-yen in public funds into the troubled banks, to help them maintain their capital adequacy ratios.

    These kinds of events do not instill confidence in the stability of the institutions where you have a majority of your life savings deposited. And as we presented above, this situation has not changed much in the three years. Currently, there is an estimated 1,400 trillion-yen (CND$17.08 trillion) in individual savings held by Japanese households, with nearly 60% in time deposits and demand deposits. That is approximately 840 trillion-yen (CDN$10.08 trillion). With changes to deposit guarantee legislation, and the potential for the banks to still falter, there is a lot of potential for these households to move into other safe havens to protect their wealth, which means that there is a lot of potential for individual investor anxiety over the banks to continue to fuel the demand for gold in Japan.

    Written/researched by:

    Brent Borger,

    Vice President Research, Corporate & Government

    Jory Capital Inc.

    e-mail: [email protected]

    Approved by: Investment Strategy Committee

    Opinions, estimates and projections contained herein are as at the date hereof and are subject to change without notice. The information and opinions herein have been compiled from sources believed to be reliable but no representation or warranty, express or implied, is made as to the accuracy or completeness thereof. Jory Capital Inc. accepts no liability or responsibility whatsoever for any loss which may result from the use of the information contained herein. In addition, information may be available to Jory Capital Inc. which is not reflected herein. This information is not, and is not to be construed as, an offer to sell, or a solicitation of an offer to buy, any security. Jory Capital Inc., and its directors, officers and employees, may from time to time acquire, hold or sell securities mentioned herein as principal or agent. Jory Capital Inc. may act as an advisor to certain issuers which may be referred to herein, or may act as an underwriter of the securities mentioned herein, and may receive remuneration for same.

    Note: We would only recommend a purchase of the above investments after a personal review of each individual’s financial objectives and risk tolerance.

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