David Morgan: LBMA Silver Market Still Near Break Point

Key Concepts

• LBMA (London Bullion Market Association): The primary hub for global precious metal trading, clearing, and settlement.
• LPMCL (London Precious Metals Clearing Limited): The clearing network within the LBMA responsible for processing daily silver settlements.
• Allocated vs. Unallocated Metal:
  • Allocated Metal: Physical silver bars that are specifically identified and held in a vault for a particular owner.
  • Unallocated Metal: A claim on silver that is not specifically identified or segregated. It's essentially a ledger entry representing a quantity of metal.
• Lease Rates: The cost associated with borrowing physical precious metals. High lease rates indicate scarcity and demand for physical metal.
• COMEX: A commodity futures exchange where silver contracts are traded.
• ETFs (Exchange Traded Funds): Investment funds that hold physical commodities like silver.
• Bullion Banks: Financial institutions that act as intermediaries in the precious metals market.

The Silver Market: Stress Testing the LBMA

This analysis delves into the current state of the global silver market, focusing on the operational capacity and potential vulnerabilities of the London Bullion Market Association (LBMA) clearing system. The core concern is the system's ability to deliver physical silver when trust tightens and participants demand allocated metal, rather than just paper promises.

The Heart of Global Silver Settlement: The LBMA Clearing Network

The London Precious Metals Clearing Limited (LPMCL), part of the LBMA, is central to global precious metal settlement. It processes an estimated 200 million ounces of silver on a net basis daily. It's crucial to understand that these are primarily ledger entries and offsetting numbers between major financial institutions like HSBC, JP Morgan, and ICBC, not necessarily physical bars changing hands.

The Critical Juncture: Demanding Allocated Metal

The system's integrity is tested when participants shift from unallocated claims to demanding allocated metal, meaning actual silver bars. This is the current situation, raising questions about the true availability of physical silver.

Available Silver vs. Claimed Silver

While LBMA vaults reportedly hold around 790 million ounces of silver, a significant portion is already committed to:

• ETFs
• Industrial contracts
• Central bank accounts

This means the readily available physical silver for new demands might be considerably less than the total vault holdings.

Stress Test Scenarios: The London Squeeze

The analysis explores three scenarios to gauge the LBMA's capacity under increasing physical demand:

Scenario 1: Minor Shock (25 million ounces of physical demand)

• Process: A relatively small demand for physical silver.
• Outcome: The system handles this smoothly. Bars might move from COMEX to London, spreads could narrow, and there would be no significant panic or crisis. This is considered a manageable situation.

Scenario 2: Moderate Shock (75 million ounces of physical demand)

• Process: A more substantial demand for physical silver. This scenario is exacerbated if investors simultaneously convert unallocated silver holdings to allocated accounts.
• Key Point: The distinction between unallocated and allocated accounts is critical. A shift from unallocated to allocated removes metal from the LBMA's immediate delivery inventory.
• Supporting Evidence: Reference is made to John Adams' work in educating people about this distinction, which previously caused a temporary stir as people moved from unallocated to allocated accounts.
• Outcome:
  • LBMA immediate delivery inventory thins.
  • Lease rates are likely to stay high or increase.
  • Refiners may face further backlogs.
  • Shipping costs could be affected.
  • Overall market strain and a rise in premiums are probable.

Scenario 3: Significant Shock (150 million ounces of physical demand)

• Source: This figure is cited from a reliable source, suggesting a substantial deficit.
• Process: This level of demand could arise from simultaneous delivery requests from entities like India's new silver ETF, Chinese industrial users, and Western investors, coupled with COMEX driving down the required amount to feed London.
• Impact:
  • Nearly one-fifth of London's total vault stock could be required within weeks.
  • Lease rates would be pushed even higher.
  • Refinery operations might halt temporarily.
  • A brief dislocation between paper and physical prices could occur.
  • Serious strain on the market.
  • Hedging becomes nearly impossible.
  • The market would clear, but only at significantly higher prices after demand is met.

The Intermediaries: Bullion Banks and Global Flow

The settlement activity primarily involves bullion banks acting as intermediaries for ETFs, sovereigns, and industrial buyers. For instance, if India's new silver ETF accumulates inventory, it likely sources it through a London-connected bullion bank, which then delivers from London vaults or via LBMA-approved bars shipped to Mumbai. The LBMA essentially acts as the clearinghouse for global silver, meaning events in London dictate the tone for markets in Mumbai, Shanghai, and New York.

What to Watch For in the Coming Week

The analysis highlights key indicators to monitor:

1. Lease and Forward Rates: Elevated rates suggest continued tightness and demand for physical metal.
2. Vault Drawdowns: A drop of another 10-20 million ounces would confirm ongoing settlement stress.
3. India's Imports: Rising demand from India's solar industry and ETFs could be a significant, albeit silent, factor tightening global supply.
4. ETFs: If new bars are being allocated faster than they are replaced, the "paper market" may need to reprice physical silver upwards to attract new supply.

Conclusion: The Power of Physical Demand

The question of whether London truly needs 150 million ounces to clear the market is posed. The argument is that in a system built on leverage and belief, a significant demand for physical metal can exert immense pressure, even on a trillion-dollar clearing house.

The closing thought, attributed to a "favorite philosopher from a galaxy far, far away," emphasizes the enduring truth of silver and the fading illusion of paper, urging listeners to "Hold you must. If free you wish to remain."