Wed Post #1: An interesting proposal for Silver Miners by Eric Sprott

Eric Sprott, and Sprott Asset Management, had an intriguing message for Silver mining companies in his latest update.

Since we focus on Silver investing on the blog, you might find it it worthwhile reading.

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Silver Producers:
A Call to Action

By: Eric Sprott and David Baker

As we approach the end of 2011, the silver spot price has admittedly endured a tougher road than we would have expected. And let’s be honest – what investment firm on earth has pounded the table on silver harder than we have? After the orchestrated silver sell-off in May 2011, silver promptly rose back to US$40/oz where it consolidated nicely, only to drop back below US$30 within a two week span in late September.

The September sell-off was partly due to the market’s disappointment over Bernanke’s Operation Twist, which sounded interesting but didn’t involve any real money printing. Like the May sell-off before it, however, it was also exacerbated by a seemingly needless 21% margin rate hike by the CME on September 23rd, followed by a 20% margin hike by the Shanghai Gold Exchange – the CME’s counterpart in China, three days later.

The paper markets still dictate the spot market for physical gold and silver. When we talk about the "paper market", we’re referring to any paper contract that claims to have an underlying link to the price of gold or silver, and we’re referring to contracts that are almost always levered.

It’s highly questionable today whether the paper market has any true link to the physical market for gold and silver, and the futures market is the most obvious and influential "paper market" offender.

When the futures exchanges like the CME hike margin rates unexpectedly, it’s usually under the pretense of protecting the "integrity of the exchange" by increasing the collateral (money) required to hold a position, both for the long (future buyer) and the short (future seller). When they unexpectedly raise margin requirements two days after silver has already declined by 22%, however, who do you think that margin increase hurts the most?

The long buyer, or the short seller?

By raising the margin requirement at the very moment the long contracts have already received an initial margin call (because the price of silver has dropped), they end up doubling the longs’ pain – essentially forcing them to sell their contracts. This in turn creates even more downward price pressure, and ends up exacerbating the very risks the margin hikes were allegedly designed to address.

When reviewing the performance of silver this year, it’s important to acknowledge that nothing fundamentally changed in the physical silver market during the sell-offs in May or mid-September. In both instances, the sell-offs were intensified by unexpected margin rate hikes on the heels of an initial price decline. It should also come as no surprise to readers that the "shorts" took advantage of the September sell-off by significantly reducing their silver short positions.

Should physical silver be priced off these futures contracts?

Absolutely not. That they have any relationship at all is somewhat laughable at this point. But futures contracts continue to heavily influence spot prices all the same, and as long as the "longs" settle futures contracts in cash, which they almost always do, the futures market-induced whipsawing will likely continue. It also serves to note that the class action lawsuits launched against two major banks for silver manipulation remain unresolved today, as does the ongoing CFTC investigation into silver manipulation which has yet to bear any discernible results.

Meanwhile, despite the needless volatility triggered by the paper market, the physical market for silver has never been stronger. If the September sell-off proved anything, it’s the simple fact that PHYSICAL buyers of silver are not frightened by volatility. They view dips as buying opportunities, and they buy in size.

During the month of September, the US Mint reported the second highest sales of physical silver coins in its history, with the majority of sales made in the last two weeks of the month.

Reports from India in early October indicated that physical silver demand had created short-term supply issues for physical delivery due to problems with airline capacity.

In China, which reportedly imported 264.69 tons (7.7 million oz) of silver in September alone, the volume of silver forward contracts on the Shanghai Gold Exchange was more than six times higher than the same period in 2010.6.

It was clear to anyone following the silver market that the physical demand for the metal actually increased during the paper price decline. And why shouldn’t it? Have you been following Europe lately? Do the politicians and bureaucrats there give you confidence? Gold and silver are the most rational financial assets to own in this type of environment because they are no one’s liability. They are perfectly designed to protect us during these periods of extreme financial turmoil.

And wouldn’t you know it, despite the volatility, gold and silver have continued to do their job in 2011.

As we write this, in Canadian dollars, gold is up 23.4% on the year and silver’s up 6.8%. Meanwhile, the S&P/TSX is down -12.3%, the S&P 500 is down -5.1% and the DJIA is up a mere +0.26%.

So here’s the question: we think we understand the value and great potential in silver today, and we know that the buyers who bought in late September most definitely understand it,… but do silver mining companies appreciate how exciting the prospects for silver are?

Do the companies that actually mine the metal out of the ground understand the demand fundamentals driving the price of their underlying product?

Perhaps even more importantly, do the miners understand the significant influence they could potentially have on that demand equation if they embraced their product as a currency?

According to the CPM Group, the total silver supply in 2011, including mine supply and secondary supply (scrap, recycling, etc.), will total 1.03 billion ounces.

Of that, mine supply is expected to represent approximately 767 million ounces.

Multiplied against the current spot price of US$31/oz, we’re talking about a total silver supply of roughly US$32 billion in value today. To put this number in perspective, it’s less than the cost of JP Morgan’s WaMu mortgage write downs in 2008.

According to the Silver Institute, 777.4 million ounces of silver were used up in industrial applications, photography, jewelry and silverware in 2010.

If we assume, given a weaker global economy, that this number drops to a flat 700 million ounces in 2011, it implies a surplus of roughly 300 million ounces of silver available for investment demand this year.

At today’s silver spot price – we’re talking about roughly US$9 billion in value.

This is where the miners can make an impact.

If the largest pure play silver producers simply adopted the practice of holding 25% of their 2011 cash reserves in physical silver, they would account for almost 10% of that US$9 billion. If this practice we’re applied to the expected 2012 free cash flow of the same companies, the proportion of investable silver taken out of circulation could potentially be enormous.

Expressed another way, consider that the majority of silver miners today can mine silver for less than US$15 per ounce in operating costs. At US$30 silver, most companies will earn a pre-tax profit of at least US$15 per ounce this year. If we broadly assume an average tax rate of 33%, we’re looking at roughly US$10 of after-tax profit per ounce across the industry.

If GFMS’s mining supply forecast proves accurate, it will mean that silver mine production will account for roughly 74% of the total silver supply this year.

If silver miners were therefore to reinvest 25% of their 2011 earnings back into physical silver, they could potentially account for 21% of the approximate 300 million ounces (~$9 billion) available for investment in 2011.

If they were to reinvest all their earnings back into silver, it would shrink available 2011 investment supply by 82%. This is a purely hypothetical exercise of course, but can you imagine the impact this practice would have on silver prices?

Silver miners need to acknowledge that investors buy their shares because they believe the price of silver is going higher. We certainly do, and we are extremely active in the silver equity space. We would never buy these stocks if we didn’t. Nothing would please us more than to see these companies begin to hold a portion of their cash reserves in the very metal they produce. Silver is just another form of currency today, after all, and a superior one at that.

To take this idea further, instead of selling all their silver for cash and depositing that cash in a levered bank, silver miners should seriously consider storing a portion of their reserves in physical silver OUTSIDE OF THE BANKING SYSTEM.

Why take on all the risks of the bank when you can hold hard cash through the very metal that you mine? Given the current environment, we see much greater risk holding cash in a bank than we do in holding precious metals. And it serves to remember that thanks to 0% interest rates, banks don’t pay their customers to take on those risks today.

None of this should seem far-fetched. One of the key reasons investors have purchased physical gold and silver is to store some of their wealth outside of a financial system that looks increasingly broken.

The European banking system is a living model of that breakdown. Recent reports have revealed that more than €80-billion was pulled out of Italian banks in August and September alone. In Greece, depositors have taken almost €50-billion out their banks since the beginning of 2010.13 Greek banks are now completely reliant on ECB funding to stay afloat. The situation has deteriorated to the point where over two thirds of the roughly 500 billion euros that banks have borrowed from the ECB are now being deposited back at the central bank.

Why? Because they don’t trust other banks to stay afloat long enough to get their money back.

Silver miners shouldn’t feel any safer banking in the United States. Fitch Ratings recently warned that the US banks may face severe losses from their exposures to European debt if the contagion escalates.

There’s very little at this point to suggest that it won’t. The roots of the 2008 meltdown live on in today’s crisis. We are still facing the same problems imposed by over-leverage in the financial system, and by postponing the proper solutions we’ve only increased those risks.

We don’t expect the silver miners to corner the physical silver market, and we know the paper games will probably continue, but the silver miners must make a better effort to understand the inherent value of their product.

Gold and silver are not traditional commodities, they are money.

Their value lies in their ability to retain wealth in environments marked by

• negative real interest rates,
• government intervention,
• severe economic uncertainty,
• and vulnerable banking institutions.

Silver’s demand profile is heightened by its use in industrial applications, but it is the metal’s investment demand that will drive its future performance.

The risk of keeping all of one’s excess cash in a bank is, in our opinion, considerably more than holding it in the more enduring form of money that silver represents. It’s time for silver producers to embrace their product in the same manner their shareholders already have.

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Sat. Post #2: The Greatest Trade of All Time

Excellent article from Sprott Asset Management this week that is definately worth reading.

A summary of the article:

On its way to becoming the world’s greatest superpower, the United States pulled off some truly remarkable trades. Two notable transactions come to mind and were both outstanding bargains: 1) The Louisiana Purchase (purchased from the French); 2) Alaska (purchased from the Russians).

For a mere $15 million, America instantly doubled its size with the 1803 purchase of the Louisiana territory. Sixty-fouryears later, oil-and mineral-rich Alaska was obtained for a paltry $7.2 million. 

Even adjusting for inflation, the combined value of these deals in today’s dollars would be very small. However, these two transactions pale in comparison to the greatest trade of all time, one which remains ongoing. This particular trade has allowed the US to exchange more than $8 trillion worth of paper for an unbelievably enormous amount of real goods and services over 36 straight years. We’re referring, of course, to the United States trade deficit.

Imports have exceeded exports every year since 1975. For much of the past decade, America’s annual trade deficit has soared past the $600 billion mark, while the accumulated trade deficit has moved relentlessly higher.

Sprott then goes on to question how long this trade deficit can continue.

We could include countless examples and all of them collectively would not do justice to what an amazing trade this has been for the United States. Stop and think for a moment about how many hours of labour, manufactured goods and non-­renewable resources the United States has been able to acquire over 3.5 decades in exchange for paper promises.

Exporting nations have willingly financed this $8 Trillion trade deficit by accepting US dollar dominated paper promises in exchange for tangible goods sold. But perhaps most important of all, they’ve continued to hold and accumulate these paper promises rather than exchange them for real assets.

Presumably, they have done so on the belief that one day they will be able to convert these paper promises for at least an equivalent value of goods and services. This requires faith that the purchasing power of the US dollar will not decline by more than the returns of their paper promises and that someone in the future will be willing to give up a tangible asset in exchange for them.

We believe that the growing US Budget deficit, the Federal Reserve’s “Quantitative Easing” Program and the ongoing US dollar decline has caused holders of US dollar reserves to question their faith, re-­examine their desire to accumulate additional US dollar reserves and also look to convert their existing US reserves into real goods. Holders of US dollars had the chance to see how the Federal Reserve and the US Government would react to fiscal difficulties and we believe this ‘look behind the curtain’ has permanently altered their faith in US dollar denominated debt and sovereign paper promises, generally.

Foreign investors are not being properly compensated for the risk associated with holding US promises today. We believe they are beginning to realize that this exchange of real goods for paper promises is a
losing trade.

The move to diversify out of US dollar reserves by surplus generating nations may be the trigger that causes a complete revaluation of the risk associated with holding faith-­based assets generally, and we believe that holders of faith-­based will increasingly look to convert them to real assets as quickly as possible.

History has shown us that fiat based currencies always suffer the same fate and eventually become worthless. It is hard to predict exactly when people will awaken from this mass delusion in faith-­based assets. But, it is certain that in these times it is wise to avoid gambling your wealth in faith-­based assets when the system that you must trust has a clear history of being untrustworthy. We therefore advise you to question your faith and know what you own.

Interestingly... this is very similar to what Charles DeGaulle said in 1965.

The full Sprott article is below...


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Sat Post #1: More on Canadian Banking

Thursday's post, Will Canadian Banks will be in the market crosshairs soon?, profiled a chart posted over at Zero Hedge discussing Tangible Common Equity (TCE).

That's the ratio used to determine how much losses a bank can take before shareholder equity is wiped out.

Seems that if you rank global banks by tangible common equity, starting with the lowest first, then 30% of the worst banks in the world are our own Canadian Banks.

Bank	TCE ratio
Canadian Imperial Bank of Commerce	2.84%
National Bank of Canada	3.30%
Bank of Nova Scotia	3.37%
Royal Bank of Canada	3.43%
Toronto Dominion Bank	3.60%
Bank of Montreal	4.19%

We have covered this topic before. 

Back in December 2009, we talked about a report from Sprott Asset Management, that analyzed and compared the average leverage ratio of the Canadian banking system.

Sprott saw exactly what Zero Hedge noticed.

• "Looking at the Canadian system more closely, all five Canadian banks are levered at an average of 31:1, which is actually the lowest leverage ratio during the three years that we reviewed. This implies that if the Canadian banks’ tangible assets were to drop by 3%, their tangible common equity would effectively be wiped out.
  
  Now, that doesn’t mean they would go bankrupt per se, but it does give us an indication of how little asset prices would have to decline in order to wipe out their tangible common equity. These leverage ratios worry us because they leave such a razor thin margin for error on the ‘tangible asset’ side of the leverage equation."

Sprott and Zero Hedge are thinking alike here.  But the Zero Hedge article came out on a day when the world's stock markets were crashing on concerns of the European Banks. And in a testimony to the growing influence of Zero Hedge, the Globe and Mail newspaper picked up on the story. 

G&M points out that Canadian banks routinely disclose TCE ratios north of 10%.

Why such a huge difference from the Sprott and ZH numbers?

The wide discrepancy is due to the fact that the banks talk about tangible common equity to risk weighted assets.  The Zero Hedge graph is looking at TCE to total assets (which is exactly what Sprott Asset Management did).

The Globe notes that risk weighted assets adjust for the chance that the assets will go bad, and that's hardly a science. Total assets doesn't allow for such judgement calls. On that basis, Canadian banks are just as leveraged as European banks, and far more so than American banks.

So do the concerns that Sprott and Zero Hedge raise mean investors should worry about Canadian Banks or not?

• "[In Europe], the banks face the very real prospect of losses on the value of the bonds they hold that were issued by countries like Greece, Ireland, Spain and Portugal. Losing 4%of total assets doesn't seem like a stretch.
  
  In Canada, the concern would have to be the housing portfolios, the biggest chunks of Canadian banks' assets.
  
  If you believe that housing is in for a severe correction in Canada, and that Canadians won't repay their mortgages when the value of their homes falls, and that the banks will have to take significant write downs on the portions of their mortgage portfolios that are not insured by the federal government, then maybe you will come to the conclusion that [Zero Hedge] is onto something.
  
  If you are one of those who believes housing can never fall, or if you believe that Canadians will continue to pay their mortgages even in a housing correction, as they have always done in past, then maybe you can breathe a little easier.

Do you get a sense here of just how much of our country's future is wrapped up in our housing bubble?

The bottom line is that if the bubble bursts, what we are watching play out in Europe this week will be repeated here with lightening speed.

And it will be ugly.

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QE3? What Bernanke had to say...

So there has been considerable debate about whether or not there will be a third round of Quantitative Easing by the US Federal Reserve and whether or not Silver and Gold will be moving higher in value as a result.

Well... today US Federal Reserve Chairman Ben Bernanke appeared before Congress and here is how the appearance was reported:

• While the Federal Reserve believes that the temporary shocks holding down economic activity will pass, the central bank is examining several untested means to stimulate growth if conditions deteriorate, including another round of asset purchases, dubbed QE3, Fed chairman Ben Bernanke said Wednesday in remarks prepared for the House Financial Services Committee. Bernanke discussed three approaches to further easing in his prepared remarks. One option, Bernanke said, would be for the Fed to provide more "explicit guidance" to the pledge that rates will stay low for "an extended period." Another approach would be another round of asset purchases, or quantitative easing, or for the Fed to "increase the average maturity of our holdings." Finally, the Fed could also reduce the quarter percentage point rate of interest that it pays to banks on their reserves, "thereby putting downward pressure on short-term rates more generally." Bernanke was clear to stress that easing was not the only option under consideration and that the next Fed move could well be to tighten.

You get a sense of how desperate things are getting when Bernanke starts talking about "several untested means to stimulate growth."

This phrase is important as it hearlds what is coming.

The weakening economy and upward pressure on interest rates due to oversupply will cause further Fed intervention, even if it isn’t called QE3.

At his post-Federal Open Market Committee (FOMC) press briefing, Bernanke indicated that if job growth falls below 80,000 per month, the Fed would likely intervene again. Well... job growth has now been below 80,000 for two consecutive months.

So what will Bernanke do?

Forbes took a look back at some of Bernanke's speeches and believes they have pieced together what is coming.

On November 21, 2002, Ben Bernanke gave a talk before the National Economists Club of Washington, D.C. entitled ‘Deflation: Making Sure ‘It’ Doesn’t Happen Here’.

In that talk, Bernanke ostensibly outlined all of the tools available to the Fed if the overnight (Fed Funds) rate hit zero. At the time of the speech, deflation wasn’t expected in the foreseeable future, so he would have no reason not to outline all the tools he could think of. Here is what he suggested:

• #1: Expand the scale of asset purchases;
• #2: Expand the menu of assets the Fed buys.

Both QE1 and QE2 used these tools. In QE1, the Fed purchased non-traditional assets for its portfolio, including mortgage backed securities (MBS) and derivatives. In both QE1 and QE2, the “scale” of asset purchases was dramatically increased.

• #3: A commitment to holding the overnight rate at zero for some specified period.

This tool is currently in practice with the Fed’s “extended period” language in the Federal Open Market Committee (FOMC) minutes.

• #4: Announcement of explicit ceilings on longer-maturity Treasury debt.

This isn’t new. The Fed did this in the 1940s and a version of it again in the 1960s. During a period of approximately 10 years ending with the Federal Reserve-Treasury Accord of 1951, the Fed “pegged” the long-term Treasury bond yield at 2.5%. And, during the Kennedy Administration, the Fed sold T-bills and purchased an equal amount of longer dated T-Notes in order to reduce long-term rates. Bernanke believes that the announced policy of pegging will cause arbitrageurs to keep yields near the announced peg, especially if the Fed intervenes several times to prove its commitment.

• #5: Directly influencing the yields on privately issued securities.

Bernanke said, "If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets."  Think GM, Chrysler, AIG.

• #6: Purchase foreign government debt.

The Fed would do this, Bernanke explains, to influence the market for foreign exchange, i.e., to weaken the dollar. He points to the dollar devaluation of 1933-34 as an “effective weapon against deflation”. “The devaluation and the rapid increase in the money supply it permitted ended the U.S. deflation remarkably quickly … The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market.” (While this is true, a mere two years later, after the withdrawal of government stimulus, a second severe recession began, one that would last until the U.S. geared up for World War II. And the 1937 slump in stocks was one of the largest on record.)

• #7: Tax cuts accommodated by a program of open market purchases.

“A money-financed tax cut is essentially equivalent to Milton Friedman’s famous ‘helicopter drop’ of money”, he said in the speech. (Hence his nickname – Helicopter Ben.) The extension of the Bush tax cuts along with the reduction in the social security payroll tax is a recent example of this policy.

These 7 tools are non-traditional, and Bernanke admits that by using them, the Fed “will be operating in less familiar territory” and will “introduce uncertainty in the size and timing of the economy’s response to policy actions”.

Nevertheless, Bernanke says, “a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition … A central bank … retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is zero.”

Today, any objective economist will tell you that, despite all of the monetary and fiscal stimulus, aggregate demand and economic activity has been minimally impacted. At the July post-FOMC press briefing, Bernanke admitted that he has no explanation as to why the economy has remained “soft”. Nevertheless, as stated above, in an election cycle, the Fed would be expected to do “something”.

Of the seven available tools, #1 appears to have been taken off the table, and #3 is presently employed. Tools #5 and #7 have been used, and may be employed again. #5 was heavily used in the financial crisis (GM, Chrysler, AIG), and #7 requires the cooperation of Congress (tax cuts).

The Fed said that it won’t reduce the size of its balance sheet in the near future, holding it steady like a rock, but will invest or roll any maturities or payoffs back into the market. Hence, the Fed has already embarked upon a policy of what we will call Rock ‘N Roll. As part of Rock ‘N Roll, we also expect the Fed to change the composition of its balance sheet to attempt to impact yields on private sector bonds (#5).

Over the past 2 years, Fed actions appear to have had little impact on aggregate demand. In 2002, when he outlined these non-traditional tools, Bernanke said he had no idea of the magnitude of their effectiveness.

Bernanke is now fully into speculation  mode when it comes to trying to 'fix' the economy.

This isn't a man implementing sound economic principles... rather what we now have is a sorcerer's apprentice practicing his craft.

He is experimenting... with no idea of what will - or won't - work.

The reaction from Silver and Gold today were predictable. Gold hit new all-time highs and Silver was up over $2 per ounce at one point.

John Embry, Chief Investment Strategist at Sprott Asset Management, was commenting on the move today and noted something we had posted about in our past two posts:

• What’s been fascinating, and what was unappreciated by me in the early stages, was the enormous number of derivatives that have been created in the financial system. Because of the derivatives they’ve been able to keep this thing going for infinitely longer than any rational mind would have thought possible. You’ve been able to create leverage to the extent that you’ve never seen before and this is why I think the bubbles were able to get stretched out and last as long as they did. Because the balloon was blown up so much, I just think the aftermath in its finale is going to be extraordinarily unpleasant.”

Warren Buffet called derivatives "financial weapons of mass destruction" and as the economy continues to unwind, we are seeing this play out in spades.

The Federal Reserve has no real game plan for how to deal with it all.

And the flight to Gold and Silver will only intensify from this point onward.

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We have liftoff...

If you click on the above image to enlarge it, you will see a side by side comparison for the closing price of silver over the past three weeks.  The first is on Friday April 8th ($40.01),  the second is on Thursday April 14th ($42.09) and finally you have closing price yesterday, Thursday, April 21st ($46.61).

What can you say other than... "Wow!" 

Last Thursday's close came after an impressive climb and this week Silver's charge continued unabated with a stunning gain for the week of more than $4.50.

But on the heels of such impressive and dynamic gains I would suggest, dear reader, that you haven't seen anything yet.

Last week I was having coffee with two colleagues in a local Tim Horton's (famous Canadian coffee/donut franchise), when our silver conversation was interupted by a patron sitting at the table next to us.  He enthusiastically gushed about the prospects for silver and gold.

This marks the first time I have observed the general public keen to not only talk about the opportunities in silver, but have Joe Q. Public actually quote the current spot price of the metal.

The next day, one of those two colleagues was at the Vancouver Bullion Exchange at Granville & Broadway to buy some silver bullion.  Silver had just surged over $40 an ounce and he was keen to purchase some physical.  He couldn't get close as there was a line-up of over 100 people eager to do the same.

This growing public awareness comes on the heels of Bank of Montreal (BMO) issuing a report talking about the "New Paradigm in Silver", which we commmented on in this post.

The BMO reports outlines the reason both investment demand and industrial demand are surging. Understanding the twin demands are essential to understand what is happening in Silver right now.  As I have often suggested,  people should take a look at this youtube video clip that, while a bit sensational, outlines the silver case quite well.

Increased industrial demand is coupling with declining supplies of silver. Both factors are coming to a head with the surging investment demand resulting from concerns about sovereign debt.

It's the perfect storm, a confluence which the commentors in mainstream media and on Financial TV have simply failed to grasp and understand.

But that dynamic has not escaped the attention of Eric Sprott of Sprott Asset Management. In his latest 'Markets at a Glance' newsletter, these factors are articulated and laid out extremely well.

• The fact remains that most commentators have failed to grasp the monetary shifts that silver is signaling today, and in doing so they’ve failed to appreciate just how high it could actually go.  The financial media’s failure to grasp the benefits of precious metals ownership continues to perplex us, and it’s not just the commentators who are prone to perpetual disbelief. The sell side analysts are equally as irresolute. According to Bloomberg, the ‘expert’ consensus silver price forecast for 2011 is $29.50, representing a 31% discount from the current spot price. This same group of analysts also predicts prices will decline another 25% in 2012 and a further 9% in 2013 to $20 an ounce.  When you consider that the silver price has appreciated by over 21% annually over the past 10 years, these forecasts suggest a very dramatic change in the long-term trend. Will this reversal come true? Probably not. These were the same analysts who predicted that spot silver prices would average $18.65 this year - so they’ve missed the mark by over 100% thus far.

Sprott notes that many are evaluating Silver with financial models that dictate equity valuations but they are ignoring the most rudimentary of economic principles – supply and demand.

This phenomenon means that Financial TV is often providing backward-looking forecasts that completely miss the mark for the future of Silver.  As the greater investment community gradualy comes to appreciate what is happening, the herd will  follow behind in due course as forecasts get ratcheted higher.

Sprott outlines why he can be so confident that the price of silver will continue on its upward trajectory while 'the Street' continues to forecast a price collapse.

One of the key indicators is the gold/silver ratio.

The last time money was synonymous with defined amounts of gold and silver, the ratio was set at 16-to-one. For most of the past millennium, one ounce of gold would have been convertible to somewhere between 10 and 16 ounces of silver - an amount roughly in line with the relative occurrence of each mineral within the earth’s crust.

For the better part of the past century, due to the world’s abandonment of bimetallism and then the gold standard, the gold/silver ratio has fluctuated widely, twice reaching lows near the 15-to-one mark and a high of 100-to-one back in the early 1990’s.

The most recent high reached in the latter part of 2009 was nearly 80-to-one. Since then the ratio has been tumbling to where it stands now at 35-to-one.  Sprott believes this ratio will continue to move lower, driven by nothing more than basic supply/demand fundamentals.

One of those fundamentals is mine production. In 2010, the world mined approximately 736 million ounces of silver and 85 million ounces of gold. The world also produced an additional 215 million ounces of silver and 53 million ounces of gold from recycled scrap. When you add both together you have a ratio of production where only 9 ounces of silver are being produced for every 1 ounce of gold. 

Interestingly, this 9-to-one ratio is very similar to the ratio of available in-situ (on-site) silver and gold reserves. The U.S. Geological Survey estimates that there are current in-situ reserves of approximately 16.4 billion ounces of silver versus 1.6 billion ounces for gold, or about a 10-to-one ratio.

It all says that mining production is not keeping pace with consumption. And when you add in the industrial demand for silver, you begin to appreciate the huge supply/demand squeeze that in being placed on silver right now.

• Last year, non-investment demand for silver (which includes industrial, photographic, and silverware demand) totaled approximately 610 million ounces. This represents approximately 64% of primary supply, leaving approximately 341 million ounces to satisfy investment demand. On the gold side, industrial usage totaled 13 million ounces, or about 10% of primary supply, leaving approximately 125 million ounces left over for investment demand. So, after netting out the industrial usage the primary supply left over for investment demand is about 2.7 times that for gold. However, if we convert those ounces to dollars at current prices, we’re left with $15 billion worth of silver available for investment versus $186 billion worth of gold, or a one-to-13 ratio of silver to gold! This means that in terms of primary supply, silver only has 8% of the capacity for investment that gold does despite having equal if not more dollars flowing into it.

Some critics note that as the Silver spot prices rises, some investors will start selling thier physical silver back into the market. But even if all the silver/gold held by investors was suddenly sold back into the market as the price leaps higher and higher, there is a  one-to-63 ratio of silver to gold inventories in the investment community. Under these conditions, Silver still remains extremely scarce.

As Sprott asks, how then is silver still priced at a 35-to-one ratio with gold?! The answer is... it can't remain at this level. Demand is going to collapse that ratio.

Current investment statistics show that there is an equal amount of money being currently being invested in Silver as there is into Gold on a dollar for dollar basis.

This is placing MASSSIVE demand on Silver, causing Sprott to observe:

• Although the price ratio of silver to gold has fallen substantially since the highs of 2009, our analysis strongly suggests that this ratio must move lower to restore a fundamental balance between supply and demand. Only time will tell how much lower it will go, but we would not be surprised to see it hit single digits before settling into a more sustainable equilibrium. 

As the Silver to Gold ratio drops to around 10:1 or less, it means that Silver, assuming that Gold doesn't rise a single penny, will hit $150/ounce as that Silver/Gold ratio narrows (Gold currently sits at $1,504/ounce).

But as we have talked about constantly on this blog, Gold’s continued appreciation vis-à-vis every currency is assured because of the great flight from fiat currency that has only just begun.

And on that note, mainstream media has been slow to comment on the latest statement from China. If you missed it, China's central bank Governor Zhou Xiaochuan made a significant statment this week.

After a speech at Tsinghua University in Beijing on Wednesday, Zhou spoke of the need to reduce an excessive accumulation of foreign-reserves as those 'reserves' have exceeded a “reasonable” level and the management and diversification of the holdings should be improved.

This, btw, is the way you diplomatically say “we are sick of the US Dollar and will be taking steps to lower our holdings.”

Remember, the US Dollar is China’s largest single holding. And China has already begun dumping Treasuries (US Debt).

This comes on the heels of China deciding (along with Russia) to trade in their own currencies, NOT the US Dollar. Not to mention the numerous warnings Chinese politicians have been issuing to the US over the last 24 months.

In simple terms, China is done playing nice and is now actively moving out of US Dollar denominated assets.

It means Gold is about to soar and the price could easily go to $2,000 an ounce. With the Silver/Gold ratio collapsing, that means Silver will not only leap up to $150/ounce, but will blast through that as Gold leaps higher. If Gold hits $2,000/ounce, Silver could well hit $200/ounce or higher.

Like Gold, Silver nvestors are now buying Silver as protection from the ravages of fiat currency debasement. Bring all the factors together and Sprott observes why you will see Silver soar over the next few months:

• When compared to gold, it is silver that offers the most attractive value proposition by virtue of the gross mispricing of its scarcity, which, we might add, has existed for many years. Thus, in our opinion, as this new bimetallic standard takes root, silver investors will continue to be justly rewarded with marked outperformance. We truly believe that this is the investment opportunity of a lifetime, and increasingly so, others are taking heed. What is clear to us is that with equal investment dollars now flowing into silver and gold, the current 35-to-one ratio is unsustainable and has only one direction to go: lower.

At just under $47/ounce, Silver is still very cheap. And with the Gold/Silver ratio closing (and the fact that, on a doller-per-dollar basis, equal amounts of money are flowing into Silver as into Gold) Silver has a much higher upside potential than Gold does. It means the foundation is being laid for some dramatic gains in Silver in the coming months and all eyes are now keenly focused on the COMEX delivery month of May.

How long before the wider investment community realizes this huge upside advantage that exists if you invest in Silver over Gold? How long before investment money, on a dollar-per-dollar basis, start flowing primarily into Silver instead of Gold?

It could be that the gains of the last two weeks are nothing compared to what may happen next month.

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Eric Sprott on Silver Manipulation

In a recent interview, Eric Sprott of Sprott Asset Management commented on the topic of Silver manipulation.

As we have discussed at length, the silver market is so small it lends itself to being held down artificially.

In our last post, Harvey Organ noted that 101, 076 contracts traded on the COMEX on Monday of this week (driving down the price of Silver significantly). Each contract is worth 5,000 oz's. This means over 505 million oz's traded that day!

To put this into perspective, there are only 800 million oz's of silver produced in any given year. The 505,380,000 oz's represents almost 72% of worldly silver production if you include China and 84% if you do not include China. The reason I put the figures for China is simply because China keeps every oz of silver it produces.

And the banking cabal supposedly flooded the market with 500 million oz's of unbacked paper contracts in one day!!!

Sprott was asked what measures might free up the market movement?

• As you probably know, all sort of lawsuits accused HSBC and JP Morgan of manipulating the price of silver in 2008 when it went down. In that situation, quite frankly, I was the most surprised and disappointed person in the world to see that in the middle of a financial collapse, the price of silver—and even gold—didn't rally. It seemed so unlikely that that should've happened. In my mind, that consequentially suggested forces might have been at work that weren't normal in those markets. But the manipulation will end, if there was manipulation. I'll explain why.
  
  On commodity exchanges, the majority of transactions never settle in physical delivery. Just as an example, of the 800 million ounces of silver produced in a year, there are days when the commodities markets will trade 500 million oz. Well, obviously, nobody is settling this stuff because you can't have an 800 million oz annual market and trade 500 million oz in a day. These are just people pressing buttons on computers—you know with their algorithms or whatever—but they're not taking physical delivery. Manipulation takes place when a person who has more money than another person can drive the price of a product up or down, and it's easy to manipulate a market wherein all you need is fiat currency.
  
  Manipulation will end when enough people say, "You know what? I'll take delivery of that product." I think that's what's happening in silver. More and more people are taking delivery. The dealers who are short something like 400–500 million oz. have like 42 million oz. in storage. Our organization alone owns more than 42 million ounces. That's not a lot of silver to cover a short bet of 400–500 million ounces. With every delivery period, those inventories keep going down. They're going to go down to the point where everyone realizes there is no silver left. As a matter of fact, for all intents and purposes, I think there might be no silver available today, as some mints are no longer taking silver coin orders because they just can't provide them. So, it's obvious to me that this supposed silver inventory doesn't exist anymore and that ends the manipulation.

Eric Sprott was then asked about the fact that there are far more investors in the silver sector right now than in previous decades and what impact that is going to have on those manipulating the silver market.

• (Are there more investors in the sector right now?] Absolutely. I think the phrase that probably captures silver's behavior, to which it's always been referred, is "poor man's gold." I think those who haven't bought gold are, to some extent, seeking refuge in silver. But anybody who's been a student of the silver market, as I myself might qualify, realizes we have a very tight situation here. And as this momentum builds to participate in the silver market, the shorts are just going to get overrun and the price could get excessively explosive.

I'll say it again. Silver is the opportunity of the decade, the shorting antics of this week notwithstanding.

Beware the Ides of Farce.

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Beware the Ides of Farce (updated)

As the stock markets and precious metals plunge, a little Ides of March humour courtesy of williambanzai7 (picture above).

One of the key dynamics to watch here is the US dollar index. The Japan disaster is your quintessential black swan event. And as such there should be a flooding of capital into the safe haven of the US dollar.

That isn't happening this time.

And in the midsts of chaos, the banking cabal is taking the opportunity to try and slam Gold/Silver.

As always, analyst Harvey Organ comes up with an excellent analysis of what is happening at the COMEX.

• "The banking boys showed up in London and in the USA doing their usual, by raiding paper gold and paper silver. The real stuff, they have problems getting. Silver fell by $1.70 to $34.12, as the bankers supplied massive unbacked paper in their attempt to show the world that everything is fine.
  
  The confirmed volume for Open Interest yesterday was quite good at 61,854. The estimated volume at the silver comex today was a monster: 101,076. That kind of shows you what kind of unbacked paper was supplied today and our regulators as always look the other way at this criminal behavior."

A farce to be sure. But the key dynamic is the lack of capital fleeing into the US dollar.

The COMEX is clearly stressed to provide physical silver. In a dual attempt to prop up the US dollar and shake silver from those holding it, the banking cabal is massively raiding the price of silver.

The intent is to create a panic and fear that the bottom will fall out from beneath these recent record high's. I suspect we will see another massive raid tonight to drive the price to the mid $33.00 range.

It's such an odd scenario. Make the price cheaper so that people won't buy more?

But with capital not flowing into the US dollar, will this tactic simply create a surge in precious metal buying?

We shall see.

On another note, on last night's Fox Business television network program "Follow the Money", five minutes were devoted to complaints of manipulation of the silver market by JPMorgan Chase and HSBC.

Cited specifically was the testimony of London silver trader and whistleblower Andrew Maguire at the March 2010 hearing of the U.S. Commodity Futures Trading Commission.

Video of the segment has been posted at the Fox Business Internet site under the headline "Wall Street Conspirators Driving Spike in Silver" and you can :
find it here.

Sprott Asset Management has also come out with an excellent article titled "Debunking the Gold Bubble Myth". You can read it here.

Eric Sprott has also done an interesting interview with comments on Silver Manipulation, I will be posting excerpts later tonight after 10pm PDT.

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Eric Sprott on Silver

Multiple posts on Silver for you today.

Many of you already know about Eric Sprott. Sprott is a chartered chartered accountant who entered the investment industry as a research analyst at Merrill Lynch. In 1981, he founded Sprott Securities (now called Cormark Securities Inc.), which today is one of Canada's largest independently owned securities firms. After establishing Sprott Asset Management Inc. in December 2001 as a separate entity, Eric divested his entire ownership of Sprott Securities to its employees.

Sprott Asset Management recently established the PSLV fund, the only closed-end ETF silver fund backed 100% by physical silver.

Recently Sprott made an appearance at Casey Research Gold and Resource Summit where in addition to providing a succinct summary of all his monthly letters from the past year (whose forecasts are all gradually panning out), he spoke about the prospects for gold, and particularly silver.

The key statement from his presentation possibly answers why more and more distributors are reporting indefinite lack of physical silver inventory:

"There's $22 billion of silver available in the world, of which the ETFs already own half, and between you guys and us we probably own the other half... Which means there's nothing left."

Above is a portion of his presentation for you.
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Foreclosure in Washington and Sprott on Silver

Interesting article in the Seattle Times.

Seems the largest condo development ever undertaken in the American Pacific Northwest, basically a two hour drive from Vancouver, has been foreclosed on.

Portland-based Gerding Edlen, the developer of Bellevue Towers, has turned over the development to their lenders, an entity led by investment bank Morgan Stanley. If the development wasn't turned over, Morgan Stanley would have moved to foreclosure.

The new owners announced price cuts to help spur sales at the 539-unit development, where just 118 sales have closed since the two towers were completed nearly two years ago.

The development is two towers of 43 and 42 stories. Gerding Edlen built them in large part with $275 million borrowed in January 2007 from a consortium of lenders led by Morgan Stanley.

"This is an acknowledgment that prices today aren't what they were," Ira Glasser, an adviser to Morgan Stanley, said Monday.

When Bellevue Towers opened in February 2009, condo prices ranged from $399,000 to $4.4 million. A Gerding Edlen principal predicted the project, at Northeast Fourth Street and 106th Avenue Northeast, would sell out in two years.

Five months later, with less than 10% of the units sold, Gerding Edlen cut prices an average 20%. With the additional reductions announced last week, average prices are 30$ lower than two years ago, Glasser said.

County records indicate just three condos have sold over the last three months.

Meanwhile 2 hours north, Vancouver preens about it's resilient housing bubble.

Sprott Asset Management and Silver

Silver trading continues to be incredibly strong despite the raids from the last two days. From the source who follows the Comex:

• "The total open interest on silver remained resolute at 136,931 up a huge 645 contracts with a huge pummelling of silver by almost $1.60 yesterday. I think the bankers were more frightened with this figure than with gold. I may be mistaken but the bankers have been trying for the past month to shake the silver leaves from the comex tree and they have failed time after time. The front options delivery month of January saw its open interest mysteriously rise from 55 to 59. The estimated volume on the comex today was a monstrous 83,889. The confirmed volume for yesterday was 88,172. This is a far cry from the 16,000 contracts traded during the last week of 2010."

But the big silver story of the day comes from Sprott Asset Management.

Sprott runs a silver fund that is completely backed by Silver assets. And Eric Sprott is having trouble getting silver. Yesterday his chief lieutenant John Embry was on Eric King and predicted, based on the difficulty in acquiring physical silver, that he see's the price of silver rising above $50 in 2011 (he sees Gold going to $2000 for the same reason).

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Déjà Voodoo Economics, all Over Again. Anyone?... Anyone?....

It's funny. My posts on the sovereign debt crisis and gold have triggered a wave of emails on the economy, interest rates and real estate.

I enjoy reading the email. And I enjoy how my posts trigger some very passionate opinions. I simply don't have the time to answer all the emails, but rest assured... each and every one is read.

I see that there is a need to try and pull together some of my though lines and connect the dots on why I believe they are relevant. So this week I am going to try and do that. I hope you will find this week's posts worthwhile.

Last week Eric Sprott & David Franklin of Sprott Asset Management wrote an excellent article in their ‘Markets at a Glance’ newsletter. I am going to borrow from it to write several of this week’s posts. If you would like to see their actual newsletter click here.

The crisis of 2008 is over?

I have talked numerous times about how many of us really don’t understand the depth and breadth of the financial earthquake that struck the western world in 2008.

Many believe the worst has past.

I maintain that – far from being over – we are plunging headlong into the worst phase of the crisis. Rather than mitigating the fallout, our government has simply compounded the problem and is intensifying the looming repercussions.

You need to understand what happened, appreciate what is developing, and then make your own decisions on the validity of the danger we face.

Then you have to make your own decisions on how best to prepare for what is coming.

The genesis of our current situation

The seeds of the financial mess we are currently experiencing began in the mid-to-late nineties.

As we approached the year 2000, a widespread belief developed that new technology would rewrite economic rules. The euphoric years between 1995 and 2000 became known at the dot-com era. And that euphoria blew into a massive bubble on the technology-heavy NASDAQ Index.

Watching those developments caused Alan Greenspan to first utter his now famous “irrational exuberance” warning in December 1996.

Despite recognizing what was going on, it wasn’t until mid-1999 that the U.S. Federal Reserve actually acted. The Fed increased interest rates in an attempt to quell the overheated stock market. Six times between June 1999 and January 2000 interest rates were raised in an attempt to cool the overheated economy.

On March 10, 2000, the dot-com euphoria burst when the NASDAQ peaked at 5,132 (more than double its value from only a year before). The NASDAQ bubble was born out of over-enthusiasm for the prospects of new technology and the Federal Reserve correctly tried to cool the bubble down, however feebly, in the years before its peak.

And when it burst, the economy should have gone through a recessionary period to consolidate and restructure.

But the NASDAQ collapse compelled Alan Greenspan and the Federal Reserve to embark on the largest rate cuts in US history in an effort to soften the impact of what should have been a difficult recession.

In hindsight we now understand that this was a massive mistake.

Our collective inability to face the consequential economic pain of the dot-com market crash ultimately set the stage for the second bubble of the decade, this time in housing.

By setting out to ‘rescue’ the economy, the Federal Reserve lowered interest rates thirteen times between January 3, 2001 and June 25, 2003.

This ‘economic cushion’ allowed for increasingly easy access to credit on a worldwide scale. And it wasn’t long before the second bubble began to develop.

Call it the law of unintended consequences, but in trying to help the economy, Greenspan unleashed a sequence of events that set the stage for the 2008 financial crisis.

People accessed that easy credit to purchase real estate in euphoric waves. It was as if the basic economic rules were trying to be re-written once again, only this time as they pertained to real estate.

Buying a home was transformed from serving as a place to live... to one where a home became an ‘investment’.

Lower and lower interest rates pushed real estate values higher and higher. Home prices rose at an annualized rate of more than 11% from 2000 to the peak on July 31, 2006 - more than doubling in that time period.

Real Estate became an irrational path to wealth and the warning signs were everywhere. The Economist magazine noticed, stating on June 16, 2005, that "the worldwide rise in house prices is the biggest bubble in history."

Servicing the housing boom propelled the financial sector into the US economy’s central economic driver, generating up to 41% of all corporate profits and making it the fastest growing sector of the economy.

In July 2005, Greenspan described certain real estate markets as "frothy" and recommended that the Federal Reserve rein in lending standards.

It was never done.

Again, in hindsight it’s very safe to argue that the Fed probably shouldn’t have lowered rates thirteen times between January 3, 2001 and June 25, 2003. It proved to be an extremely damaging policy.

Artificially low rates created a lending mania of enormous proportions which dragged consumers along for a debt-fueled buying orgy. It triggered a massive Ponzi scheme sustained by overleverage as the financial sector piled new mortgage financing schemes one atop one another

What happened next was more than just a market failure. It was a systemic meltdown. But it was a meltdown that happened so fast that it seems to have failed to burn into our collective memory.

Everyone remembers that we went into a severe recession in late 2008, but do they know the details of what actually transpired?

Tomorrow we will discuss the collapse of 2008.

Then, later this week, we will discuss how the stage is being set for a Canadian collapse of historic and massive proportions.

To read the next part, click here.

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O tidings of comfort and joy...

You may have seen them if you occasionally read the comments section of this blog.

Some like to chide me for being so negative and repeating, ad nausem, my warnings about debt and rising interest rates. The number of comments pale in comparison to the dozens of the emails I get on that theme, but I love to read them.

So it makes me wonder if similar letters and emails are now being sent to Bank of Canada Governor Mark Carney.

'Cause let's face it... his public statements lately are inter-changeable with the posts of those in the blogosphere.

And yesterday the Governor had more tidings.

Speaking to a business audience in Toronto, Carney delivered this clear and unequivocal warning to Canadians:

• "Responsibility starts with the individual. Our advice to Canadians has been consistent: We have weathered a severe crisis—one that required extraordinary fiscal and monetary measures. Extraordinary measures are the means to an end: the return to the ordinary. Although we expect the recovery to be gradual and protracted, these measures are working. Ordinary times will eventually return and, with them, more normal interest rates and costs of borrowing. It is the responsibility of households now to ensure that in the future, when the recovery takes hold and extraordinary measures are unwound, they can still service their debts."

As we are found of reminding faithful readers, 'normal' interest rates over the last 20 years mean a rate of 8.25%.

Yikes.

The implications for many recent homebuyers in the Village on the Edge of the Rainforest who have taken out variable mortgages at rock-bottom rates and maximized the amount they could borrow are clear: any rise in interest rates risks putting a financial squeeze on a large number of debt-laden Vancouverites.

Even the Mortgage Brokers Association of B.C. is starting to take notice as they said yesterday that, "Canadians are potentially leaving themselves wide open for significant financial obligations once interest rates begin to rise."

Really, who could have known?

But it didn't end there. Carney once again focused on a fact we quoted yesterday from The Globe and Mail:

• "The ratio of mortgage debt to household incomes in Canada recently hit a record 70%, up from 65% a year ago. And 40% of home buyers are opting for short-term, variable-rate mortgages, which will eventually ratchet up, leaving some owners in deep financial trouble."

To this Carney told Canadians that the nation “must be vigilant” in containing the threat rising rates would have on increasing the debt-servicing costs for Canadians who have taken on increasing levels of debt.

Sorta rings hollow because what is coming is serious business and I think it's too late to be 'contained'.

Consider the bold prediction earlier this week from economist and author Jeff Rubin. He predicted the jump in interest rates could be as steep as 3% to 4% over the next two years as the Bank of Canada struggles to contain inflation caused by increasing energy costs.

3% - 4%! Yikes again.

That type of increase could add up to $1,000 to the monthly payment on a $400,000 Vancouver mortgage.

And everyone I know that has bought a house in the last three years is carrying much more than a $400,000 mortgage.

None of them can afford even a $500 increase in their monthly payments, let alone $1,000 or more.

While the Globe and Mail can publish joyous, helpful little articles like this one that urges Canadians to "Wrestle Down That Debt While You Can", the reality is that its too late, the damage has been done.

Maybe that's why Carney had this Christmas message for banks:

• "Similarly, lenders have responsibilities. Financial institutions should actively monitor risk stemming from households and not take false comfort derived from mortgage insurance and past performance of household credit. As our simulations suggest, the overall credit profile of Canadian households could well shift if debt continues to grow at current rates."

Oh... it will shift alright. And it's going to create a dire situation for banks. Under one of Carney's 'stress test profiles', the BOC hypothesises that:

• "the consequences for financial stability from the potential impact of a more severe economic downturn on households could result in a hypothetical increase in unemployment that could produce loan losses for financial institutions representing about 10% of their Tier 1 capital."

And as faithful readers will recall, Sprott Asset Management predicted that if the Canadian banks’ tangible assets were to drop by 3%, their tangible common equity would effectively be wiped out.

Double Yikes!

But bloggers have seen this scenario coming all year. And did anyone catch American Karl Denninger on BNN yesterday?

He was asked to be on the Canada's Business News Network to talk about housing. After his appearance he wrote about it on his blog:

• "[I did] a bit of research after the show [and] I came up with the following....
  
  Canadian family income as a whole ("families of 2 persons or more") is allegedly $70,000 (approximately.) The average house price? $325,000.
  
  That's a multiple of 4.64, or dramatically into bubble territory (the maximum for affordable housing is roughly 3x, so this is 154% of the maximum!)
  
  It's worse in places like Vancouver - there the ratio is over 10 (!) for single-family homes and about 8x for all residences.
  
  Let me be clear, strictly on the numbers: Canada is in for a housing bust WORSE THAN OURS.
  
  Beware Canadians..... you can argue over the timing of the outcome here, but if you think the 'bad event' won't happen and act on that belief, don't cry when a year or three down the road I start piping up with 'I told you so!'

And some think I'm too negative when I call for a collapse of over 40% in the value of Vancouver houses and over 50% in the value of Vancouver condos.

God rest ye merry gentlemen... Let nothing you dismay.

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The 'B' Word

Today's post is brought to you by the letter 'B'.

It could be 'B' as in Bubble, as more and more people are starting to acknowledge here in Canada.

As faithful readers know, Bank of Canada Governor Mark Carney’s pledge to freeze record-low borrowing costs through June 2010 is single-handedly responsible for the stunning recovery in home prices.

'The Cabel' disputes this assertion, insisting that the state of the housing market is simply reflecting what Carney has called “an element of pent-up demand” (Carney speech to reporters Nov. 19).

“Rates are exceptionally low, affordability has improved in part because of the low level of interest rates and part because of some former price adjustments, and we are seeing a housing-price response,” said the Governor.

Pundits insist that they don’t believe that there’s a bubble, that most of the market action is from typical Canadians trying to buy their first home or move up. Rising prices? That's just an unintended consequence of the current low, low rates.

But when Canadians are waiving conditions and paying 10% (or more) than a home's asking price you know it's not a regular market - particularly when we sit in one of the worst economic times since the Great Depression of the 1930s.

The most notable thing here is that Carney insists that what's happening in the housing sector is simply an unintended by-product of his attempt to help the economy recover from its first recession in 17 years. Carney says he has given 'clear guidance’ on why he has taken the actions with interest rates he has.

“Rates are exceptionally low, they are exceptionally low for a purpose and we have given pretty clear guidance on how long we expect they will have to remain at these levels in order to achieve the inflation target,” Carney told reporters Oct. 22.

But Eric Lascelles, chief economist and rates strategist with TD Securities Inc., raises a point that more and more people finally raising. In Toronto Lascelles noted that the central bank hasn’t talked much about house prices, “to the bafflement of international investors.”

“It makes perfect sense that there is a good appetite for the housing market,” Lascelles said. What no one seems to want to address is “whether this is a bubble in the making or simply a recovery from earlier softness.”

David Laidler, a former visiting economist and special adviser at the Bank of Canada and now a fellow at the C.D. Howe Institute, a Toronto research group notes that “the worry has got to be that you might be getting a housing bubble out of this.” Laidler is a member of the institutes's Monetary Policy Council, which studies central-bank decisions and said in a Dec. 3 statement that a “possible unintended effect” of Carney’s commitment is “the buoyancy of mortgage lending, particularly variable-rate mortgages, and the housing market."

Unintended... there's that word again.

And it's that word that rankles the most.

Do people truly believe that the astonishing rebound in housing prices - with no intervention from the Bank of Canada - is simply an 'unintended' by-product of Carney's actions to recover from recession?

Maybe today's 'B' word actually stands for 'B' as in Banks.

In a fascinating report from Sprott Asset Management, the average leverage ratio of the Canadian banking system is analysed and compared.

Sprott notes that the average leverage ratio of the Canadian banking system is higher than that of the largest US banks in all periods reviewed.

Now each of the top ten US banks received common equity injections by both shareholders and the US government, thereby improving their respective leverage ratios during this economic crisis.

And the Canadian Banks?

• "Looking at the Canadian system more closely, all five Canadian banks are levered at an average of 31:1, which is actually the lowest leverage ratio during the three years that we reviewed. This implies that if the Canadian banks’ tangible assets were to drop by 3%, their tangible common equity would effectively be wiped out.
  
  Now, that doesn’t mean they would go bankrupt per se, but it does give us an indication of how little asset prices would have to decline in order to wipe out their tangible common equity. These leverage ratios worry us because they leave such a razor thin margin for error on the ‘tangible asset’ side of the leverage equation. We are always cautious about investing in companies that have zero or negative common equity - we’ve seen what happens to public companies that trade at those levels, General Motors being a good example.
  
  Acknowledging the leverage levels above, you may wonder how the Canadian banks escaped the 2008 meltdown unscathed. The answer is that they received significant assistance from the Canadian government. First, they received $65 billion in liquidity injections from the Insured Mortgage Purchase Program (IMPP), whereby Canada Mortgage and Housing (CMHC) purchased insured mortgages from Canadian banks to provide additional liquidity on the asset side of their balance sheets.
  
  Next, the Bank of Canada provided them with an additional $45 billion in temporary liquidity facilities. Finally, a Canadian Bank also received assistance from the Canada Pension Plan (CPP) through the purchase of $4 billion in mortgages prior to the IMPP program, for a total government expenditure of $114 billion."

When the Bank of Canada slashed interest rate to dirt they helped to artificially preserve real estate asset prices by creating another irrational housing euphoria in the country.

Unintended... Or a deliberate calculation to preserve the "razor thin margin on the tangible asset side" of the Canadian Banks leverage equation... a group the Canadian Government had just moved heaven and earth to protect?

Sprott goes on to note that,

• "for reference, the entire tangible common equity of the Canadian Banks in 2008 was $68 billion. Can you put two and two together?"
  
  "The Canadian government injected a sum through mortgage purchases worth more than the entire tangible common equity of the Canadian banking system! On top of that, the Bank of Canada provided more than 50% of the tangible common equity of the system in emergency liquidity facilities."

The Canadian housing market continues to baffle observers in the United States and around the world. We are daily fed propaganda that tells us that the dramatic performance of our nation's real estate during this worldwide economic crisis is all a result of the solid foundation of our nation's banks and the virtuous conservatism of the Canadian financial system.

Uh-huh.

The Sprott report is simply the latest that sumarizes the many concerns critics have had about what's happening with Canadian Real Estate, CMHC and the banking system.

Increasingly it seems we are only a couple moves away from the symbiotic relationship that exists between those two other well known 'B' words: Boom and Bust.

The 'Boom' is currently happening and observers are raising alarm bells.

Be wary. The next time you hear "give me a 'B'...", you might just see the market kick back the word investors dread the most... bust! A development which would lead to today's true 'B' word; a word that summarizes our thoughts on all this malarky about 'unintended' consequences .

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