Something strange in the precious metals pits

COMEX gold declined a small amount, but silver prices are surging today. This bifurcation is unusual, as these precious metals usually move in tandem. I've posted numerous blogs on the dual utility of silver as an investment and industrial metal--and how the price suppression by bullion banks in London and New York is exacerbating the shortage in physical inventory. Eventually, the price of the futures markets becomes disconnected from the physical markets, as industrial buyers scramble to find supply.

Unlike retail consumers who are typically price-sensitive (i.e. retail gold jewelry buyers are priced out when when prices rise), industrial buyers must find physical supply wherever they can in order to keep their production lines humming, so they will bid up prices in tight markets. For instance, a buyer of a Bill of Materials does not want to be in the critical path of the supply chain for Apple's popular IPad, because delays translate to millions in losses. There is silver content in products as diverse as electronics, solar panels, disinfectants, antibiotics, mirrors, optics, silverware--in addition to jewelry.

A run on physical silver will eventually spill over into the paper futures market where most contracts are settled via cash. However, if longs (buyers) insist on physical delivery, there would be a deeper run on silver, causing a huge short squeeze and soaring prices. Both longs and shorts scrambling to cover their shorts will intensify buying pressure. With naked shorting prevalent in precious metals futures markets, the COMEX could experience a default, where futures contracts are undeliverable. Longs expecting delivery would be defrauded.

That's why taking physical possession is so crucial in the event of a default.

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Disclosure: long physical gold and silver, long mining shares.