Butler On Silver

BACK TO THE START
By Theodore Butler
Mid-August 2008

The recent price smash in silver has created questions as to what happens next. This is particularly true for those new to silver and those in the position to add to existing holdings. The sell-off has been so severe that it demands more than simple answers. It requires that we go back to square one. Silver is a better investment today than ever. And that’s considering that silver has already been among the best investments over the past three to five years. I can’t turn back the clock to $5 or $7 silver. However, I can present a case that the value of silver today is priced at the equivalent of $5. It’s all about risk, value and reward.
A sharp sell-off in any item we own causes the emotional side of us to grow more fearful of a continued decline. The logical side of us knows that price declines reduce future risk. The price of anything that has true value gets more attractive, the lower it goes. Silver, as an item valued by the world for 5000 years, is certainly no exception. All markets are driven by fear and greed. While greed can last for very long periods of time, fear is a much more intense emotion and, as such, can only last for short periods. Being "scared to death" is not a state of permanence; you either die, sell out, or adjust to it. That means the fear of lower prices in silver should pass quickly.
A few years ago, when silver dropped to $5.00 after a COMEX-generated price smash, it caused the market structure to improve dramatically. Back then I said, "Dimes to the downside, dollars to the upside." I used that expression to make the point that COMEX price rigs to the downside created phenomenal low risk and high reward situations in silver. It underscored the essence of success; don’t risk a lot, in order to make a lot. I used my dimes expression on more than one occasion, and it turned out to be extremely lucrative for those who took advantage of those past sell-offs. I am sure that it will turn out to be just as lucrative for those who seize the present opportunity.
Silver is a unique asset. It’s an age-old investment asset that can’t become worthless or go bankrupt. It is an asset that is no one else’s liability. It will always have worldwide recognition and ready liquidation value. There are not many other assets you can say that about. Any common stock or bond can become worthless. Silver can’t. The closest practical example to this uniqueness of silver is gold. But silver is rarer than gold. Now there are strong indications that silver is becoming scarce, in addition to being rare. Holding gold may make sense, but holding gold and not also holding silver is silly, in my opinion. If there were no such substance as silver in existence, then I would be attracted to gold. But silver does exist, even though only a very small amount of it remains and it is incredibly low-priced compared to gold.
So, if silver (and gold) can’t possible go bankrupt or go to zero due to its very nature and essence, should we apply standard risk/reward measurements to it? Common stocks (even silver mining stocks) can and do become worthless, while silver can’t. That protection and guarantee against an investment becoming worthless should be worth a heck of a lot to an investor in an uncertain world. This is precisely the true meaning of "dimes to the downside, dollars to the upside." In other words, the real return to an investor who bought silver at $5 several years ago is not just triple his money over several years (at $15), but more than 30 times the amount he actually risked (say 30 cents compared to a $10 gain, so far).
Likewise, a new investor at current price levels, or an existing silver holder, should not realistically consider the full current price of silver ($15) to be at risk, as silver can’t possibly fall to zero, as many other investment items can. Let’s face it, it’s not so much about how much you invest, but how much of your invested money is actually at risk?
In the case of silver, the real risk is not the full amount of your investment. It’s some small portion of that, (assuming you buy at low-risk times) like now, and buy the right kind of silver. Therefore, since only a portion of one’s investment capital is actually at risk, I believe it is proper to view potential future returns against that risk, in addition to the total amount invested. Doing that, I would calculate the real risk/reward ratio in silver presently is 10, 20 or 30 times to one. For every dollar truly at risk at current price levels, there will be long-term rewards many times that. Just as there was for silver at $5.
One of the key factors used to determine risk is considering where the current price is in relation to value. If price is lower than true value, then price is at a discount to value. Obviously, it is very desirable and usually quite profitable to buy assets at a discount to value. The trick, of course, is to determine the true value of an asset.
Since it is a vital industrial commodity that is consumed, a continuous supply of silver is necessary. This requires steady mine production. This mine production is dependent on the cost of mining compared to the price the miners realize. While higher prices won’t always result in increased production prices lower than the cost of production will always crimp production.
The current price of silver is below the cost of marginal production, and if the price of silver does not rise, mine production will be reduced. As proof, I would direct your attention to the recent second quarter earnings reports of two well-known silver producers, Hecla Mining Company and Coeur d’Alene Mining. Hecla reported an operating loss, while Coeur d’Alene earned a penny a share, even though the price of silver averaged over $17 in the quarter. If someone told me four or five years ago that silver would be 3+ times higher and miners like Hecla would report operating losses, I wouldn’t have believed it.
I didn’t anticipate the shocking rise in the cost of silver production. Since silver is $2 lower than it was in the second quarter, it doesn’t take a rocket scientist to predict further losses for these miners, unless the price of silver rises. At some point, barring higher silver prices, silver production becomes questionable. No one can produce anything at a loss indefinitely. That puts a floor under the price of silver and strongly suggests that silver is quite undervalued.
That’s not to say that the dealers on the COMEX can’t or won’t continue to drive the price lower temporarily. But even this is instructive. COT data shows, as it has always shown, that it is these dealers who are aggressively buying their self created sell-offs. They are, obviously, anxious to buy back as many of their short positions as possible. These are not stupid people. Follow what they do, not what they say. If they are buying aggressively, so should you. We are at a point where prices will rise sharply in time (and perhaps in a short time), even if they sell-off further.
Another indication of silver’s current value is the collective behavior of investors in real silver. While there has been much selling of paper silver contracts on the COMEX by over-margined speculators, there is compelling evidence that investors have been net buyers during the current decline. This is unusual and telling. Margin call paper selling coinciding with cash buying of real silver strongly suggests value.
Many have pointed to the broad selling in commodities and the strength of the dollar as suggestive of continued price risk in silver. I would disagree. I’ve written several hundred articles over the past few years analyzing and extolling the virtues of silver as an investment, including trying to warn at times of high risk. In none of those articles have I suggested buying silver because I felt the dollar would be weak. I don’t intend to start doing so now. I have chosen to focus on the merits of silver. It doesn’t matter much to me what the dollar does, or how the overall commodity market fares. Extremely bullish silver fundamentals are the issue.
The argument that money will flow out of silver into bonds and stocks sounds like a reasonable one, until you comprehend just how little capital is tied up in silver. Assume there’s one billion ounces of silver bullion in existence (that’s much higher than any reputable published estimates). At current prices, that’s only $15 billion. Financial companies write that amount off daily. If the financial system needs money flowing from silver, the system is in serious trouble. On that note, while it never was a prime reason for me to suggest silver as an investment, I respect the feelings of those who hold silver as insurance against bad times.
Risk and value are the most important aspects to any investment, because the first commandment in the investment world is not to lose big. But let me offer a few words about potential silver reward. It is great. More than 99% of the investment world does not have a clue to the profound and dynamic change that has occurred in silver over the past few decades. As more investors become aware of the true silver facts, the effect on price will be dramatic.
Few know that, as a result of a structural deficit that lasted for more than 60 years, world silver inventories have been depleted to levels 90% less than what existed 65 years ago. Few know that, as a result of this depletion caused by industrial consumption, there is actually less investment silver in the world than there is gold, even though gold is more than 50 times the price of silver. Few know that silver has the largest concentrated short position in financial history.
For the first time in decades, silver investment demand is exploding. In the past year alone, around 100 million ounces of silver has been bought by publicly owned investment vehicles. This is unprecedented. It’s as if new industrial demand consumed 100 million ounces of silver. It is hastening the day when the wholesale shortage can no longer be concealed. It paints a bright bull’s eye target on the big shorts. Yes, they have caused prices to get smashed again, but the relentless tide of investment demand for real silver renders them sitting ducks.
It has been my contention for the past year or so, that investment demand would be the driving force in the price of silver. This will be what drives the price of silver sharply higher. Value and low risk and high reward is a potent brew. It is hard to imagine the facts about silver becoming more bullish than they are now. It’s simply a matter of more people becoming aware of the facts. That’s inevitable.
Please take the time and closely examine all the real facts in silver. If you do, I’m sure you will come to appreciate the spectacular risk/reward that has just been created. We’re back to the equivalent of $5 silver. Don’t let it get away from you.
BUTLERS BASICS
By James R. Cook
Since we have so many new readers, it makes sense to go back to the basics and review the reasons to own silver. Thanks to the world’s foremost silver analyst, Theodore Butler, we have a lot of new information about the silver market. Mr. Butler is acknowledged to be the ranking expert on silver. He started writing for us in 2000 when silver was $4.10 an ounce. He predicted an imminent price rise. Many financial newsletters and analysts scorned silver. They were wrong and he was right.
According to Mr. Butler the most significant historical fact about silver lies in its evolution from use as money into a modern industrial metal. Silver became money thousands of years ago. It did not rust or corrode and it was portable. This made it an ideal medium of exchange. Its great beauty and reflectivity, along with its ease in bending, twisting and shaping also made it ideal for adornment.
By the twentieth century silver’s amazing properties began to be recognized by industry. With the advent of electricity, it became the best and most efficient electrical conductor. Today it’s used in every appliance, TV, cell phone, computer and whatever else you can think of that uses electricity. A modern kitchen can easily have a dozen items using silver in multiple applications. The wall switches all have silver and so does the security system. A washing machine uses silver in 18 places. The car in the garage has silver in 40 places.
Silver alters the chemical properties of various compounds. Plastics, from dinnerware to computer keyboards, are made with silver as a reagent. Seven hundred tons of silver are in constant use in these manufacturing processes.
The ancient Greeks used silver to line their jars and vases that held food and wine. They knew silver killed bacteria. Today these bactericidal properties are used in medical devices like catheters. Silver is also the preferred ingredient for treating burn victims. It’s also used in water purification. We all know about silver use in mirrors, silverware, jewelry and coinage. However, most are probably unaware of the large quantities used in soldering, brazing, batteries, electroplating and ball bearings.
The amazing properties of silver make it more useful and necessary to a modern civilization than anything else (other than oil). It’s splendid qualities make it ripe for new applications that will use up even more of the world’s silver. Office buildings now use glass tinted with silver that cuts down on energy loss. All forms of alternative energy, including wind power, use silver in the collection and transmission process. Vast new solar farms are scheduled to come on line with large silver panels. Photovoltaic cells require silver. Smart cards and RFD chips use silver. When Mr. Butler calls silver a miracle metal, he does not exaggerate.
For two thousand years most of the silver mined was used in coinage or stored above ground. Like gold, the quantity above ground increased over time. Then came industrial demand and the supply of silver began to shrink. Most of the silver ever mined has now been used up by industry. It’s gone forever. All the gold is still with us, but the silver has disappeared.
Three billion people in Asia hope to enjoy a lifestyle that’s the equivalent of what we have in America. Most of the consumer goods that improve living standards require silver. People everywhere want refrigerators, microwaves and television sets. In Asia alone, ten times the population of the U.S. are now getting the money to buy products that require silver. Meanwhile, the supply of silver diminishes.
A few years ago Ted Butler wrote about the impact of investment buying on silver. He predicted that this new buying would run up the price. He also suggested that an influx of buying was inevitable. This proved to be correct to the point shortages of silver bars and coins appeared. He predicted that the impact of the new exchange traded funds would drive up the price, which it did. Now these funds have purchased over 200 million ounces. Mr. Butler then warned that a large chunk of silver in one of the exchange-traded funds was being sold short. He reaffirmed the need to own only physical silver and, if you store silver in your name, make certain you get the serial numbers of the bars.
Recently, investment buying of silver began to accelerate. A slumping economy, coupled with high inflation, spooked many investors. Tangible assets that have yet to experience price inflation are rapidly gaining attention. Mr. Butler thinks that concerns about the economy, the dollar, and the stock and bond markets make silver the premier "flight to quality" asset.
Demand for silver grows relentlessly. Meanwhile, supply fails to keep up. Major mining companies continue to lose money, even at today’s prices. New mines are discouraged because the price still isn’t high enough to make silver mining profitable. Most silver comes to us as a byproduct of copper, lead and zinc mining. These mines will not be ramped up to get more silver. This means that, to some extent, the supply of silver is price insensitive. There won’t be that much more silver from mining, despite higher prices.
This price insensitivity also applies to the demand side. Industrial users will not curtail demand if prices go higher because they use so little in each application. Mr. Butler argues that a silver shortage is inevitable, and may already be here. The day the industrial users can’t get silver is the day they would be forced out of business. Consequently, they will pay any price to get the silver they need. The American public, who owns silver, will grudgingly give it up at what Mr. Butler suggests will be astronomical prices.
As if these bullish factors aren’t enough, Mr. Butler’s analysis of short sales in the futures market (and elsewhere) boggles the mind. Many times more silver has been sold short than any other commodity on the futures market. A handful of big financial entities have a huge concentrated short position. It’s in their interest to keep the prices down. Mr. Butler calls this manipulation and collusion. Ultimately, when industrial users can’t get enough silver, the price will explode and the short sellers will be forced to buy back and cover the silver they sold short. "He who sells what isn’t his’n, buys it back or goes to prison."
This rhyming couplet really applies to another vast, worldwide group of silver sellers who have never bought the silver they supposedly have in storage for clients. Last year Morgan Stanley admitted in a court case that the silver they were storing for clients didn’t exist. One of their defenses was that ‘everybody does it." Think of all the brokerage firms, Swiss banks and bullion sellers that have sold silver in these pool accounts. They use the money for their own purposes while charging storage fees on silver that doesn’t exist. Mr. Butler estimates there may be a billion ounces of silver sold worldwide in these accounts. "You couldn’t make it up if you tried," says Butler.
When you think of what could happen in a runaway silver market when the short sellers on the commodities market are trying to cover, and the nonexistent silver in pool accounts is being bought back, you have to lick your chops. Mix in shell-shocked industrial users, attempting to stockpile silver to keep their doors open, and inflation-ravaged investors pouring in as the price rises. According to Mr. Butler, long-term silver holders may find this is the ticket to stupendous financial gains that offset losses elsewhere and assure future prosperity.