Market Review: Silver Spoons and Blood Brothers

As I walked into the old Commodities Exchange Center, located on the fifth floor of the old World Trade Center, on an early morning in late summer 1989, little did I know my life would change forever. All I was thinking about was my new $22,000-a-year job and having money to buy food.

A few months earlier, my good friend and fraternity brother Tim helped me land a job with his twin brother, David, on the Cotton Exchange. Tim’s other brother, Thomas, was also a member of the New York Cotton Exchange and started working on the floor right out of high school. He began his career on the COMEX, where gold and silver were traded.

Back then, the COMEX was the most expensive seat on the trading floor, and also the most prestigious. Back in the day, the trading badges were green, cotton was orange and the rarely seen gold-colored badge meant you could trade on any market on the floor, from coffee to cotton and from crude oil to orange juice. The NYMEX was still fairly new and not as coveted, and NYMEX badges were yellow.

Anyway, I made my way up to the fifth floor of the World Trade Center. I was dressed in a suit and tie, and it was pretty much the first and last time, at least on the trading floor.

As I got my temporary security badge, I peered out onto the vast trading floor. It was completely dark and silent. But it wouldn’t remain that way for long. I had arrived around 6 a.m., before the exchange came to life. So I walked around the floor in relative darkness, looking at the glowing of all the old terminals, watching the old clackboards on the walls as some of them changed with the night markets. And the distinctive sound of all of the time stamps on the floor snapping at once with a big "thwump" at the half-hour mark. The floor was carpeted and without a scrap of paper on it – not so much as a paperclip. The ceilings soared three stories in the air, and the trading pits were raised above the floor.

I knew the minute I walked around the old exchange I was home.

One of my favorite stories from the old-timers on the floor was the story of the Hunt Brothers’ Silver Market Debacle. I will share with you the history of these events as told to me back then by COMEX (the former Gold Exchange) members, traders and old-timers in my first weeks of working on the floor.

In the late 1970s, two Texas oil barons with no shortage of money or guts moved to corner the world’s silver market.

William Herbert Hunt and Nelson Bunker Hunt had been accumulating silver for years, and the only way they could make their scheme work was to partner with some wealthy Arabs.

At first, their timing seemed brilliant. The Hunt Brothers had hit a gusher, so to speak, when the price jumped in 1973 from $1.95 per oz. to $5 in 1979. During that critical six-year period, the Hunt Brothers had amassed the equivalent of approximately half the world’s deliverable cache. They also managed to help drive the price even further to above $54 per oz.

By March 1980, just when the Hunt Brothers were sitting pretty, the Federal Reserve pulled the rug out from under them by changing important COMEX trading rules. Suddenly, silver plunged 50% on March 27, 1980 – a day that will live forever in the hearts of us traders.

The high-flying Hunt Brothers had crashed big time. They became one of the biggest bankruptcies in U.S. history. And as if ending up the poor house wasn’t sufficient punishment, they went down the road a piece to the big house after their conviction of conspiring to manipulate the market.

While it certainly was the end of the Hunt Boys, that wasn’t necessarily the case for silver.

After the Hunt debacle, silver fell into a deep sleep – falling to about $3.50 in the 1990s. It took a long snooze in that price range, with the exception of a brief spike to the $7.50 range in 1998 when Warren Buffet started accumulating it. During those years, probably the only thing more boring than trading silver was watching water boil.

Then something curious started to happen…

After bottoming out in November 2001 at $4.06, silver woke up — soaring 63% to the $6.60 range. The rise was particularly interesting when compared to gold, which itself has risen 80% from the depths of February 2001. The difference was that gold is a world currency, and silver is not. Gold’s price is influenced by currency markets, while silver’s is driven strictly by supply and demand.

As a result, there are three primary markets for silver:

* The ornamental market serves jewelry and silverware.

* An investor segment concerns silver bars and coins.

* And the industrial part includes photographic film and paper, computer components, brazing alloys, pharmaceuticals and alternative energy applications.

What works in your favor is that few people know that the industrial sector is the biggest for sliver, while the investor segment is the smallest.

The biggest dilemma – and opportunity – for speculators is that silver is getting to be very hard to find. The fact of the matter is U.S. government supplies are long gone and they now need to purchase silver just to meet demand for coin and bars. Central banks sold out most of their supply of silver as prices languished.

Some ultra-wealthy investors such as Warren Buffett, George Soros (through Apex Silver) and Bill Gates (through Pan American Silver) have taken on significant silver positions. I hardly think that any of these well-known investors might be the next Hunt brothers, but more likely these masters of wealth see a profitable trade in having major positions in silver where others don’t.

The moral of the story: Silver has been undervalued for far too long and now seems to be having a rebirth for smart investors who only know the story of the Hunt brothers as something that happened a long time ago. The happy ending may be for those investors who are buying silver at these levels; they just may end up living happily ever after, after all.

Kevin Kerr
for The Daily Reckoning

November 27, 2005

P.S. In the summer of 1989, I was returning from a three-month trip to Europe after attending New York University and the University of Southern California, full of hopes and dreams and, most of all, empty pockets.

Let’s face it, even a degree in philosophy with honors doesn’t open up a clear-cut professional pathway. What was to be next? Law school, real estate, McDonald’s? I’m sure that all parents have that dream of their child stepping up to the podium and saying, "I would like to thank the Nobel Foundation." Then there’s that other dream where the kid is saying, "Would you like fries with that?"

Well, suffice it to say I am not at either end of that spectrum, but the way my career path unfolded wasn’t orthodox, and I wouldn’t have it any other way. In my almost 18 years in the commodities business, I have seen an incredible amount of changes. I have had quite a career, and it gets more interesting every day.

— Daily Reckoning Book Of The Week —

Empire of Debt: The Rise of an Epic Financial Crisis
by Bill Bonner and Addison Wiggin

"Watching the news is a bit like watching a bad opera," say bestselling authors Bill Bonner and Addison Wiggin. "You can tell from all the shrieking that something very important is supposed to be happening, but you don’t quite know what it is. What you’re missing is the plot."

After a generation of being spoon-fed reality by media, it’s understandable that Americans are confused about the state of their nation. In their newly released book, Empire of Debt, Bonner and Wiggin wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions.

Americans are rapidly facing a choice: recognize these dangerous delusions and take steps to avoid their collapse. Or remain ignorant of them and risk losing all of their wealth when the house of cards comes crashing down.

———————

THIS WEEK in THE DAILY RECKONING: While you were stuffing yourself with turkey and stuffing this past Thursday, we were hard at work here at The Daily Reckoning. In case you missed our Thanksgiving issue because you were asleep on the couch, watching football, or hiding from your relatives, we have it catalogued here…

Land of the Deadheads     11/25/05
by Bill Bonner

"Yesterday was the greatest of American holidays, Thanksgiving Day. It is the day we are meant to show appreciation for all the many blessings showered upon us…but as Bill Bonner points out, that tradition seems to have gone by the wayside…"

Thanksgiving      11/24/05
by Bill Bonner

"Somewhere deep in the most primitive part of his medulla oblongata, the part of the brain where race memories are stored, Beirne resists Thanksgiving. It is, after all, a Yankee holiday."

What Hath Alan Wrought?     11/23/05
by Bill Bonner

"Alan Greenspan is the most famous bureaucrat since Pontius Pilate. Like Pilate, he hesitated, but ultimately gave the mob what it wanted."

The Great Debate     11/22/05
by Puru Saxena

"So, on one hand, the Federal Reserve continues to inflate, and on the other hand, it is raising rates. ‘But why would they do that?’ you may ask."

Enter the Recession     11/21/05
by The Mogambo Guru

"The Fed is so desperately trying to keep this contraction ("deflation") from taking hold in the first place, by creating inflation, which will kill us just as fast."

FLOTSAM AND JETSAM: As a result of its free market-friendly policies, Hong Kong has grown tremendously in importance economically. Capital and Crisis’ Chris Mayer reports from the Far East…

One Country, Two Systems
by Chris Mayer

Hong Kong may be the only city in the world where you can legitimately use four different currencies to pay for things — Chinese yuan, Hong Kong dollars, U.S. dollars and euros.

On my last day there, I unloaded the last of my yuans and HK dollars – and mixed in some good ‘ol American greenbacks for good measure – to pay for my ride to the airport. The driver cheerfully accepted all of it and explained to me that in Hong Kong, people will generally accept these currencies – plus the euro.

In Hong Kong, I often heard people use the phrase, "One country, two systems." It describes the odd situation in which Hong Kong finds itself. Once a British colony and still symbolic of the riches of capitalism and markets, today Hong Kong is part of China, which is, at least nominally, communist.

Hong Kong has among the freest economies in the world, as rated by the Heritage Foundation. The city has inherited a strong legal system, maintains English as the official language and has a rich pool of professional talent with expertise in matters of finance and international trade. No wonder it is an important hub of business activity in the region.

Taxes are low and simple. The corporate tax rate is only 17.5%; the top income tax rate only 15.5%. One of the American expats living here told me it takes 15 minutes to fill out a personal tax return, which is only a couple of pages long. All capital gains are tax-free. Any personal dividends, bank interest or foreign-sourced income is all tax-free.

As a result of its free market-friendly policies, the city has grown tremendously in importance economically. Hong Kong is the largest recipient of foreign investment in Asia, and it is the largest source of funds for the mainland. It is the world’s seventh largest center for foreign exchange trading and the ninth largest stock market.

That stock market, on the surface anyway, appears to be a relative value. There are approximately 915 listed companies, with an average price-earnings ratio of only 14.5 and an average yield of 3.07% — numbers that look enticing from a U.S. perspective.

At least some savvy value investors are snapping up Hong Kong shares. Michael Winer, who runs the Third Avenue Real Estate Fund, has purchased a couple of interesting real estate companies in Hong Kong. One of these is Hang Lung Properties, one of the largest property development companies in Hong Kong. "The company is very conservatively financed (very low debt levels), and the common stock is trading at a substantial discount to net asset value," he wrote in his latest quarterly letter.

The other purchase was Tai Chung Holdings, with a portfolio of 2.2 million square feet of office space in and around Hong Kong. Again, Winer believes it trades at a significant discount to net asset value.

Marty Whitman, in the new introduction to his recently reprinted book The Aggressive Conservative Investor, talks about his penchant for buying banks that are extremely well financed and that trade at substantial discounts to net asset value. He notes that the "only place" he is finding such investments in 2005 is in Hong Kong.

Too bad it is difficult for U.S. investors to purchase Hong Kong securities through a regular brokerage account. As more and more economic activity and investment happen in the East, Hong Kong is likely to be at the center of that mix.

Chris Mayer
for The Daily Reckoning

P.S. I’ll have more to say on investing in China, especially as it relates to stocks, in my next issue of Capital and Crisis. In the meantime, you can check out my latest report in which I’ve detailed a company that I believe is poised to become the next Berkshire Hathaway. This company is hell-bent on one thing only – building real, tangible wealth.