Liquidity - Advanced Trading Concept

Silver Stock Report

by Jason Hommel, Oct 18, 2004

(revised) May 29, 2007

(to see original article go to Liquidity - Advanced Trading Concept )

Before I begin the discussion, let me state my conclusion: U.S. dollars (or Federal Reserve Notes) are probably the least liquid asset class that exists right now, which is the exact opposite of what the vast majority of market participants actually think!

Let's start with the definition of liquidity:

At Webster's, definition #4 (regarding trading) for "liquidity" is: consisting of or capable of ready conversion into cash.

At investorwords.com : "liquidity" is: The ability of an asset to be converted into cash quickly and without any price discount.

There is another word at investor words (that appropriately describes the way that many junior silver stocks trade) that helps us understand the concept of liquidity:

"thin market": -- A market with few bid and ask offers. Characterized by low liquidity, high spreads, and high volatility. Small changes in supply and/or demand can have a dramatic impact on market price. also called narrow market. opposite of liquid market.

The perspective of most people is that cash is paper dollars, and thus, paper dollars are the most liquid asset--simply by definition. There is no need to have to try to convert paper dollars to cash, as they are cash!

Thus, most people say that either foreign currencies or bonds are probably the next most liquid asset, especially short term bonds, because you can sell them and get cash for a very small discount, perhaps less than 1%. Essentially, you are trading "cash" for "cash", or "short term" cash for liquid cash.

Now, cash is defined by the dictionary as money. You knew that, of course.

But my perspective is that only gold and silver are real money, and that paper dollars are fraud! Paper dollars were exposed as fraud in 1933 when it took $35 of them to buy an ounce of gold instead of $20! Paper dollars were exposed as fraud again in 1971 when foreigners could no longer redeem them for money (gold) at $35/oz. At that point, paper dollars could only be redeemed for money (gold) at a large price discount, as the gold price (as measured by those fraudulent dollars) rose to $850/oz. by 1980.

Thus, perhaps the true and best definition of liquidity should be "consisting of or capable of ready conversion into real money (gold or silver), with little or no discount!"

As I said, most traders believe that the currency markets are the most liquid markets in the world, due to both the small spreads, and the large volumes. However, if silver and gold are money too, and especially if gold and silver are the only true money, then these paper money markets are not nearly as liquid as people think!

The currency markets move perhaps a trillion dollars back and forth, being traded from paper to paper, every day!

However, how can you move billions or trillions of dollars into silver if there is less than 1/2 of a billion dollars worth of silver, or even less of silver available to buy? (As estimates range from 60 million ounces of silver to 600 million ounces of silver left in the world.)

Frankly, you can't buy more than a billion dollars worth of silver at today's prices, and that's my point! People think the paper money markets are liquid, but they are NOT! If you have to move the price of the silver market to buy a billion dollars worth, then you are "moving into real silver" at a substantial cost, or "price discount in terms of dollars"... that hurts all dollar holders!

My point is that you cannot easily liquidate dollars for real silver bullion! Thus, paper dollars are not liquid!

But the big currency traders think that they can get silver at any time, because of the existence of the silver futures markets.

Currency traders are deluded into thinking that the open interest in silver represents the potential size of the silver market. It is NOT! The open interest in silver may be up to 100,000 contracts, but there is not 500 million ounces of silver available to purchase! As I have written previously, the COMEX may limit a single position in one delivery month to as little as 7.5 million ounces, and they may limit deliveries to as little as 1.5 million ounces of silver! And there is only 104 million ounces of silver available at the COMEX, and only 43 million registered for delivery! See the warehouse stocks for yourself at http://www.nymex.com/sil_fut_wareho.aspx

The normal perspective is that silver is an illiquid market, because the silver market is small, and the spreads are much larger than in the "normal currency" market, the narrowest spread for real silver being about 4.5% between the bid and ask at tulving.com . The spread is narrower in the paper futures market at the COMEX, down to 1%, if you ignore shipping costs.

However, when considering fundamental principles, silver is the most liquid of all, because it is real money. Silver and gold, by definition, must be the ultimate liquid assets.

People ask me, "What is the price of an ounce of silver?" Well, a silver "round" that is privately minted, is a common bullion one-ounce silver bullion piece. And, there are really 3 prices. There is the price if you buy one of them, which can be up to $1 above the spot price or more, then there is the price if you buy in bulk, which can be as low as $.40 above the spot price, and then there is the price if you wish to sell, which is usually about right at the spot price.

And even the long-winded explanation of price is not sufficient, because then I have to define what is meant by the "spot" price. And this is the price as determined by the paper futures markets.

The paper futures markets create an illusion of greater liquidity (or false sense of availability of silver) in the silver market than there really is. They make it seem as if there is plenty of trading of real silver, (100,000 contracts) but in truth, perhaps only 1-2% of paper Futures contracts result in real physical silver trading (perhaps 1-3 million ounces a month).

The real silver trading volume, monthly, is perhaps 1/12th of the 900 million ounces of silver consumed each year, (divided by 12) or about 75 million ounces per month. Most of that is traded "over the counter" and not on the COMEX exchange. Investment demand for coin silver is a miniscule proportion of the total annual silver demand, or about 25 million ounces per year, or about the 1-3 million ounces a month.

In reality, the full amount of paper futures contract longs could demand delivery. This could be 500 million ounces, but the COMEX only has 50 million ounces, or less in the registered category, available for delivery!

In a sense, the futures market is like the last silver bank in the world that is propping up the false value of all the paper currencies of the entire world, and it is operating on that same old shaky "fractional reserve" system--a system that led to the bankruptcy of all banks in history.

But this time, there are trillions and trillions of paper dollars in the world, and the smallest supply of real silver, per person, in history. This is why I believe silver bullion and silver stocks are probably the greatest investment opportunity of all of human history.

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So, what about Silver Stocks? They are also thinly traded, with large spreads between the bid and ask (buy and sell prices). This means they are difficult to acquire at good prices. A good way to buy is to place a low bid to buy, and hope others will sell to you, in their time and in the amounts that they want to sell. A good way to sell is to place an order to sell at a high asking price, and let the market come to you to buy your stock. In this way, you are acting more like a market maker with your buys and sells.

Some people are scared to invest in silver stocks due to the lack of liquidity. I'm not. The reason is that I strongly believe in the fundamentals of silver, and I know that these fundamentals of silver are not well known. I understand that the world is largely deceived as to these fundamentals about silver, and thus, I'm confident that the world will catch up and perceive reality as it is, soon enough.

My experience has shown me that highly illiquid silver stocks are becoming more liquid all the time, as the market is pouring investment dollars into silver stocks in anticipation of much, much higher silver prices.