Saturday, June 4, 2011

A Look Back at the Silver Market

Mark Twain has been quoted as saying, “History does not repeat itself, but it does rhyme.”

Good observation...especially for investors in the silver market.

In recent months, these investors enjoyed a stunning ride to highs near $50 an ounce. This is a level not seen since the early 1980s. Then they had to endure a stomach-churning rapid drop in silver's value due largely to the raising of margin requirements by exchanges.

Rumors were rampant in the market that the only “real” reason that silver was going up was that a mysterious “someone” was accumulating a large position.

Many boogeymen were being blamed. Several prominent Russian billionaires were mentioned in the rumors, as were the Chinese. Several rumors pointed to a secret silver buying program initiated by the People's Bank of China.

Jack Farchy of the Financial Times discussed some of these rumors recently in an article.

The characters may have changed but this is very reminiscent of the late 1970s and early 1980s when the Hunt brothers tried to “corner” the silver market. This appears to be one of historic 'rhymes' that Mark Twain spoke about.

Therefore, investors today will be well served by a look back at what happened during that time.

The Hunt Brothers and Silver

It started with the Hunt Brothers buying approximately 55 million ounces of silver in late 1973 and early 1974 at around $3-$4 a ounce.

In fact, they actually physically moved the silver to Switzerland because they thought the US government would confiscate silver much as it confiscated gold in the 1930s.

The brothers continued buying silver during the 1970s.....

Subsequently, in the summer of 1979, they even went into partnership with several Saudi sheiks and set up a Bermuda-based company to buy silver, the International Metals Investment Company Ltd. This company bought 90 million ounces of silver and again took delivery of the physical silver.

Over the next few months, silver spiked from $8 an ounce to $16 an ounce as fears intensified over silver supplies at the Comex, which today is part of the CME Group (NASDAQ: CME).

Unfortunately for the Hunt Brothers, the odds were stacked against them.

The board of directors of the commodities exchanges had a number of sitting directors which came from the big Wall Street banks. And these banks, with 9 of 23 directors, were short 38 million ounces of silver. Needless to say, they were not happy with what the Hunts were doing.

Regulators Step In and On the Hunt Brothers

The first step the Chicago Board of Trade (CBOT) took was to raise the margin requirement. The CBOT also declared that silver traders would be limited to 3 million ounces of futures contracts. Anyone with more than that would have to divest their holdings by February 1980.

After these actions, the price of silver really began to take off. The rumors of a silver shortage had, in effect, been confirmed by the exchange.

Silver stood at $34.45 an ounce at the of 1979.
On January 7, 1980, the rules changed again. The exchange announced new position limits for all silver futures contracts of 10 million ounces.

After this announcement, silver really began to skyrocket! And as the price climbed, the Hunts kept buying.

Silver hit $50 an ounce.

But then the ax fell on the Hunts on January 21, 1980. The Comex said that trading in silver would be limited to liquidations only. The exchange changed the rules so that no one was allowed to open any new positions from that point on.

The next day silver fell off a cliff and plunged from $44 to $34 an ounce. Prices kept falling and falling and eventually the Hunts couldn't cover the margin for the futures they had bought.

They were forced to liquidate everything...their entire fortune would soon disappear. Mostly thanks to the exchanges changing the rules in the middle of the game to favor the “home team”.

By the way, the most famous of the brothers, Nelson Bunker Hunt went bankrupt in 1988.

Today's 'Rhyme'

Fast forward to 2011 and we see that silver recently climbed to nearly $50 an ounce again. And what happened? Once again, it appears that some big Wall Street banks were caught heavily short on silver.

And a similar pattern is beginning to emerge. The exchanges have raised the margin requirement on silver and silver dutifully plunged by 27% in a short period of time.

If silver begins to recover again back to the $50 level, look for more “rules changes” to come from the exchanges.

It's what Mark Twain would expect. And so should silver investors.