Eyes Wide Shut

Paul Krugman, the economist whose work you either love or hate, had a compelling editorial this week in the NY Times, titled, “From the Big Short to the Big Scam”, in which he compared the real estate bubble of 2006 and subsequent crash to cryptocurrencies today. Because the article was behind a subscription paywall, I’ll not link it here, and my purpose today is not to agree nor disagree with Krugman’s connection of the real estate bubble/bust to crypto’s, but to bring out a most astute observation he made.

Krugman made the compelling case that what enabled a relative handful of market participants to recognize and act upon the extreme mispricing of real estate into the 2006 bubble peak and sell short subprime mortgage derivatives contracts was the belief among the majority of market participants that real estate would not collapse. His term to describe the widespread belief at the time that real estate prices would continue to climb was the “incredulity factor” and to use Krugman’s own words, therein was the problem, namely, –

“…the sheer scale of the mispricing that the skeptics claimed to see. Even though there was clear evidence that housing prices were out of line, it was hard to believe they were that far out of line – that $6 trillion in real estate wealth would evaporate, that investors in mortgage-backed securities would lose around $1 trillion. It just didn’t seem plausible that markets, and the conventional wisdom saying that markets were OK, could be that wrong. But they were.”

If you get a chance to read the entire article, I’ll leave it up to you to decide if Krugman made the case between the real estate boom/bust of 2006 and crypto’s today. Instead, the lightbulb that went off in my head when reading his piece concerned – what else – silver. I was particularly taken with Krugman’s use of the term “incredulity factor” to describe what blinded the majority’s opinion about real estate back then and crypto’s today was the broad and innate belief that then-current market prices couldn’t be that far off from whatever levels they were trading at – when the history of markets strongly suggests that yes, indeed, there are times when markets can be extremely mispriced.

While it’s true that Krugman was using two examples of markets that were or were perceived to be extremely over-priced, that doesn’t automatically exclude the presence of the incredulity factor in an extremely underpriced asset like silver. Simply put, silver’s extremely low price over the past few decades has told, in no uncertain terms, the vast majority of the world’s investors to just move along – that there is nothing to see here. It would defy credulity for the majority not to think that the persistent low price of silver wasn’t due to ample or oversupplied market fundamentals. That’s just normal collective investor behavior.

But even a slightly more in-depth look at silver would result in the realization that the actual supply/demand fundamentals in silver are nowhere near as negative as the low price would suggest. An even deeper review would raise more substantive questions concerning why, of all commodities, silver is still more than half of its non-inflation adjusted price highs of both 42 and 11 years ago. Adjusted for inflation, silver’s low price is downright shocking.

A reasonable person, when presented with silver’s extreme undervaluation compared to its actual fundamentals would conclude something is wrong – but, according to the incredulity factor (referenced by Krugman) therein lies the problem, namely, the vast majority of reasonable people are not even looking, due to the deeply-imbedded collective sense that current market prices can’t be that far off from where they should be. I’ve been asked more times than I could possibly recall why someone big hasn’t bought silver (apart from JPMorgan). The answer is elementary – because the persistent low price has signaled it’s not worth the time to investigate.

Complicating the issue in silver is that the reason most eyes and minds are closed when it comes to questioning the possibility that the persistent low price is that far off from where it should be, is that the answer is particularly hard to accept. After living and breathing the intricacies of silver for close to 40 years, there’s not the slightest doubt in my mind that the low price is a result of an ongoing manipulation by certain large traders on the COMEX, as I’ve tried to document all along. I’ve come to accept most will never go that deep, but broad acceptance of my take is not required.

If any market is extremely mispriced, as I contend that silver is to the downside, then it’s only a matter of time before the mispricing must come to an end. Just like housing’s extreme overvaluation was rectified starting in 2006, so too will silver’s extreme undervaluation be rectified ahead. The really important point here is that just like only a relative handful of market participants profited greatly from the housing bust by going against the majority who didn’t comprehend the extent of the inevitable housing collapse, a similar circumstance is likely to be experienced in silver – with a special twist.

Those that profited mightily in the housing bust did so by dealing in highly-esoteric and complex mortgage derivatives securities way beyond the capacity of the regular investor to understand or have access to. To truly profit from the housing/mortgage bust one would have had to deal in derivatives contracts well-beyond the reach of the average man in the street. In contrast, the beauty of capturing the coming radical upward adjustment in the price of silver is about as easy as falling off a log. In fact, there are almost too many really simple and good ways of buying silver to mention – no need to have to resort to anything complicated or esoteric. A bigger plus factor and advantage would be hard to find.

As was vividly portrayed in the movie and book, “The Big Short”, before real estate prices began their descent after 2006 and derivatives bets against housing began to pay off, many holders of the short derivatives bets were pressed up against the wall, struggling to maintain their short bets and having to meet increasing margin calls to hold on to the positions. I know many silver investors, after so many years of waiting for the actual fundamentals to kick in and bring about the inevitable higher prices to come, must hold similar feelings as faced by the margined holders of what turned out to be the spectacularly profitable results of those that bet on a housing collapse.

But here’s the real beauty of buying and holding silver, as opposed to betting against housing in 2006 – there is no margin or leverage required. Sure, there are opportunities galore for those who choose to “up the ante” by going on margin and deploying leverage when buying silver, but that is not required by those looking to take advantage of what I feel is the single best investment opportunity available. In fact, knowing the stresses associated with borrowing and utilizing leverage to most people, I strongly advise against buying silver on anything but a cash on the barrel basis. Silver is going to explode in price to such an extreme extent that leverage is not required. All that is required is an open mind and eyes.

Ted Butler

June 9, 2022

www.butlerresearch.com