We will continue our silver series today from our previous silver article. The full guide in our silver series can be found here. This article will assume that you have already read all the previous articles in our silver series.

As you know by now, we believe that silver prices are severely undervalued.

In fact, it is likely that it is manipulated. It seems that certain entities are using the New York Commodities and Mercantile Exchange (COMEX) to use it to offload a lot of paper silver into the silver market. To do that, it sold a lot of silver futures into the COMEX market (that is, it sold a lot of promises to deliver physical silver in the future). As we explained in How futures price affect market price, the futures price have an effect on the spot prices (market prices). By manipulating the futures prices, the spot prices of silver can be manipulated.

The problem is, the paper silver that is being sold through the futures market is unlikely to exist. Why? Commodities traders on COMEX have made bets in which they promise to deliver more than twice the amount of silver known to exists! If the traders who bought the promises to deliver silver in the future demand the physical silver, the rest of the world have to be starved of silver for more than a year. That means all production of iPhones, Blackberrys, netbooks, notebooks, etc has to be ceased for a year. No other commodity has such a large short position. In contrast, the amount of gold sold through the futures market amounts to only 2.5 percent of known inventory.

Even more suspicious, of all the commodites, silver have the largest proportion of futures contracts held by the smallest number of traders. Only 4 traders hold the vast majority of the silver short (sell) positions, of which just one or two hold more than 50 percent of all of them. This means only couple of entities are controlling the price of silver for the rest of the world. These 4 traders have sold, for future delivery, more than 4 months of worldwide silver production.

The market for paper silver is far larger than the market for physical silver, with the prices of physical silver determined by the prices of paper silver. That means that the prices of physical silver are artificially set far too low. This means that with such artificially low price, the consumption of physical silver is much higher than what it should be had market prices been allowed to find its price level. Couple that with the declining supply and constrained production of silver, it will only be a matter of time before the paper silver market will fail (i.e. all these ‘promises’ to deliver physical silver fails), sending prices of physical market soaring. As this Time magazine article reported (in 2001),

Still, the jump in price spread chaos across the market as Buffett called for delivery of more than 42 million oz. of the silver he had bought–after already having some 87 million oz. in tow. Panicky short sellers, who had borrowed silver and sold it in the expectation that the price would fall, had to swallow huge losses to complete the deals. Major buyers of silver like Eastman Kodak, which processes millions of ounces a year into film, faced big increases in raw-material costs. And everywhere families began eyeing grandma’s precious flatware as a possible source of cash. “We think we may see the spike reach double digits–maybe $10 an ounce–but one doesn’t really know in this rarefied territory,” says Nick Moore, director of Flemings Global Mining Group in London.

In 2001, Warren Buffet reported buying up 129.7 million ounces of silver. His demand for physical delivery caused chaos in the market.

This silver price fuse is a Black Swan event