Thursday, October 30, 2008

Commentary From The Silver Boys

By James R. Cook
Mid-October 2008
I talk to silver analyst Ted Butler every day and lately I’ve never heard him give a more optimistic view on silver. About eight years ago he affiliated with my company and we’ve literally had thousands of conversations since then. Never was he willing to put his predictions in any kind of time frame. Now, in our private conversations, he’s telling me this is it. A price explosion is imminent. He may not want to go public with that bullish forecast, but with me it’s different. He claims the shortage in silver must now worsen and the price rise high enough to change the dynamics of silver forever.
The one thing he always told me for the past eight years was that before the big upward explosion took place, the price would be crushed. He said the big shorts would be among the first to notice a shortage in silver. They would then do everything in their power to extricate themselves from their short position. They would manipulate a big sell-off so that when those who held silver on margin were forced to sell, they would buy back their silver and thereby reduce their short position. They could never cover all of it, but they would make their short position more manageable. They would still be trapped and suffer losses when silver rose, but they would only lose a toe and not a foot.
More importantly, those who once maintained large short positions would be reluctant to do so again. They would not put their head in the noose again because they had information on silver that indicated the price must rise. This absence of short sellers would be tremendously bullish. It would mean that buyers would not find ready sellers. Nothing could be more bullish than not having anybody willing to go short.
The information that makes the short sellers queasy has to do with the enormous current investment demand that’s now superimposed on already strong industrial demand. Mostly it comes from people who believe they can profit from owning silver. That’s been augmented by nervous individuals who see silver as a safe haven and others who are concerned about inflation and a weak dollar. As Ted Butler has pointed out, this investment demand curtails the amount of silver available for industrial use. The heated demand for silver has made many silver products unavailable. It is truly unprecedented. We’ve never seen anything remotely like it.
From the beginning Ted Butler has told me the silver manipulation (which he has proved without doubt) would be ended by a shortage. That shortage appears to be unfolding. Ted claims that when that happens, the industrial users will dramatically bid up silver. In fact, he says they will panic because they must have silver, no matter what the price. Without silver, they would have to close their doors.
In the past eight years, Ted Butler has been a pioneering thinker on silver. He has shown an incredible breadth of knowledge about silver and the futures markets. For the most part, he has been phenomenally accurate on what he said would happen. He warned about the possibility of every price decline, including the last one. The only time he has been wrong is on two occasions when he thought the price correction was over sooner than it was. His amazing record of predictions and fresh insights on silver argues for everyone to pay close attention to his advice and act on his instructions to buy physical silver. This has never been more true than today when his innermost belief is that we are on the eve of a breathtaking shakeup of the silver market.
Such opportunities do not come around very often in a person’s lifetime. I’ve personally put a lot of money into silver because I see it as the greatest profit opportunity to come along in decades. There’s no guarantees in life, and without taking some risk you can’t earn a high enough return on your money to beat inflation. It’s time to have 10% to 20% of your net worth in actual physical silver. If the greatest silver expert who ever lives (no doubt a genius on the subject) is telling you this is the moment in time we’ve been waiting for, then you should act on that advice.
By Theodore Butler
(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)
When fear and emotion run high, as they presently do, it often creates exceptional profit opportunities. In other words, when everyone is running scared and is concerned about risk, it is precisely the time to look for rewards as well. We are currently positioned the best I have ever witnessed for risk and reward in silver. The downside looks extremely limited and the upside looks explosive. Yes, volatility is great, but everything is lined up perfectly.
I would like to revisit a familiar theme - the suggestion that gold-heavy investors take advantage of the extreme undervaluation of silver compared to gold. This is not intended as a knock on gold, or a suggestion that gold can’t or won’t go higher. It would not surprise me if gold moved much higher. I hope that it does. Then why would I suggest that gold owners convert some of their gold into silver? For the simple reason that silver should climb much higher in value than gold. Maybe two or three times, and perhaps much more.
In fact, if silver eventually reverts to its historical ratio of 16 to 1 to gold, that means silver would have outperformed gold by more than four-fold. At that rate, every dollar invested in silver would return four times more than a dollar invested in gold. What are the chances that old ratio could return? Quite good, I think.
It has been a long time (except for a brief moment in 1980) since the world has witnessed a 16 to 1 gold/silver ratio. This is the ratio that prevailed for hundreds of years. This ratio was set arbitrarily, by government edict back when gold and silver were money. Regular readers know I don’t envision silver as being used as money again. So why would I think the ratio would move to 16 to 1, when conditions are much different today?
When the ratio was 16 to 1 there was much more silver in the world than there was gold. In fact, much more than 16 times more. That was before the industrial revolution at the turn of the last century, when it was discovered that silver was a marvelous and versatile industrial material. After the industrial consumption of the past 100+ years, there is no longer more than 16 times more silver in the world. There is now much less silver than gold. I am talking about bullion material available to the market at anywhere near current prices.
Maybe one in a million of the world’s citizens realizes that there is much more gold in existence than there is silver. If sufficient numbers of people knew this fact, gold would not be 70 times the price of silver. In fact, gold might be a lot less than 16 times the price of silver. This isn’t complicated. When enough people come to learn that there is less silver than gold in the world, they will buy silver (and maybe sell gold) until the relative price of each reflects silver’s greater rarity.
While silver’s rarity to gold is the main factor assuring that silver will climb in value compared to gold, there are other reasons. For one, the price of silver is below the cost of its primary production for many miners, while the gold price is currently above the cost of production. This suggests a contraction in silver production compared to gold. And while silver is produced as a byproduct for the majority of its production, many of the base metals, like zinc, are below the cost of production, suggesting a curtailment of supply.
Additionally, a large amount of the world’s gold inventory resides in government hands. While there does appear to be a lull in central bank gold sales, higher prices and budget pinches may induce more official gold selling in the future. This is a threat largely absent in silver, because so little is in government hands.
Further, a larger percentage of the remaining world silver inventory is in the control of publicly-owned investment entities, like ETFs, closed end funds and exchange-licensed warehouses. Such holdings are less likely to be sold than government metal. More often with these the metal goes in but rarely comes out. I estimate total world silver bullion inventories to be one billion ounces. More than 460 million ounces, or almost 50% are in publicly-held funds and exchange warehouses. In gold, two billion ounces exist in world bullion inventories, and less than 50 million ounces, or less than 2.5%, are held in publicly-owned entities. What this means is that not only is there much less silver than gold in the world, the silver is held in much stronger hands. This silver is much less likely to be sold than gold. Certainly, silver doesn’t face the threat of central bank or IMF dumping.
Silver is basically an industrial commodity, while gold is not. However, any fear of a decline in industrial demand for silver is misplaced because 70% of silver production comes as a byproduct to other types of mining, such as copper, lead and zinc. The real advantage of silver being an industrial commodity is lost in the current financial crisis. That advantage is profoundly powerful. Because silver is an industrial commodity, it is a candidate for an industrial shortage, while gold is not. We already have a widespread retail silver shortage, so a wholesale shortage is likely. What clinches the likelihood is that the world’s vast army of silver industrial consumers hold little in the way of inventories, thanks to just-in-time inventory and production practices.
When they face delays in silver shipments the industrial users will panic and attempt to build inventories all at once. I see them as a vast herd of wildebeests on an African plain, nervous and easily spooked. It won’t be the scent of a lion that sets them off, it will be a phone call from their silver supplier telling them there will be a 10 day delay. This is unique to silver and not gold.
If you are gold heavy and silver light, please fix that. If you are just silver light, fix that as well.

By Theodore Butler
(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)
It’s hard to imagine now, but there were times when I worried about having anything fresh to write about silver. Lately it has been choosing from many different topics. This week, the choice was easy. Amid the continuing swirl of major financial crises, one issue rose to the top.
On Thursday, September 25, the Wall Street Journal carried an article announcing that the Commodity Futures Trading Commission (CFTC) had opened a new investigation into allegations of manipulation in the silver market.
Furthermore, on that same day, Commissioner Bart Chilton e-mailed a copy of the Journal story, along with his own comments confirming the investigation, to those who wrote to him about the issue. Both the article and Chilton’s e-mail made special note that the silver investigation was being conducted by the Division of Enforcement, and not the Division of Market Oversight, which had previously investigated the silver market. In simple terms, Enforcement is the muscle.
Whether an entire market, like silver (or gold), is manipulated or not is a matter of utmost importance. In fact, nothing could possibly be more important. Market manipulation is a violation of law and a serious crime. Market manipulation damages everyone in the long run.
Because market manipulation is the number one priority of the CFTC, any revelation that they might be investigating a manipulation in any commodity is big news. So big, in fact, that such investigations are almost always kept strictly confidential while the facts are determined. This is usually so as not to disturb the market. That the CFTC has chosen to openly reveal this silver investigation is almost unprecedented.
Moreover, what makes this silver investigation a rare event is that the allegations are of a manipulation in progress. To my knowledge, all past investigations were revealed after the manipulation itself was concluded. Not only is it rare for the CFTC (or any government agency) to reveal a serious active investigation, it is unheard of to reveal an investigation of a potential crime in progress. If a regulator suspects a crime in progress you would assume the regulator would first end the suspected crime and then finish the investigation. If the regulator didn’t think there was a sufficient evidence of an ongoing crime, then why reveal that an investigation has been opened?
I think this is why there is universal expectation (including by me) that the silver investigation will be a whitewash. I know that silver is manipulated, and I’m glad to see the CFTC investigate. But I can’t help but feel suspicious of their objectivity, because they have adamantly denied such a manipulation for more than 20 years. How can they conduct a fair investigation and not be influenced by their past findings? I have been here and done this many times, and I don’t feel like getting fooled again.
Why the CFTC is investigating a silver manipulation is somewhat of a mystery to me. I certainly didn’t ask for an investigation. I did ask you to ask for them to explain the data in their August Bank Participation Report, in my "Smoking Gun" article
This is the report that is directly responsible for the investigation. This is the report at the heart of the matter. But there is a difference between explanation and investigation.
When I first uncovered the data in this report, a little more than a month ago, I couldn’t believe my eyes. I had studied the data in previous Bank Participation Reports for years, but that’s because I’m a silver data junkie. This is usually a nothing report. In all the years I studied this data, it seemed like a waste of time. It was an obscure report that I never heard anyone ever refer to before. But the data in the August report was so disturbing that, in order to make sure I wasn’t imagining things, I asked two trusted associates, Izzy Friedman and Carl Loeb, to review the data with no advance suggestion from me as to its meaning. I wanted their unvarnished opinion.
When they confirmed that this was the clearest case of manipulation possible, I faced a new dilemma. I was inclined to believe that the data was in error. I suspected the CFTC would retract the data. So I was worried about being publicly embarrassed for making a big deal out of what may have been a clerical error. But the more I matched this data against the weekly Commitment of Traders Report (COT) data, I could see the data was accurate. Certainly, if the data was incorrect, the CFTC would have said so by now.
The data is clear - one or two U.S. banks sold short the equivalent of 140 million ounces of silver in one month. That’s more than 20% of world annual mine production. Less than three U.S, banks sold more than 10% of world annual mine production of gold simultaneously. The price of silver and gold then collapsed by an historic amount. These same banks have used the sell-off as an opportunity to buy back as many of their short positions at a giant profit. Those are the facts.
It is important to put these numbers into perspective, in order to appreciate their significance. One way to do that is by comparing what just took place in silver to other commodities. If one or two U.S. banks sold short, in a period of one month, the equivalent of 20% of world annual production of corn, that would equal one million futures contracts. (25 billion bushels x 20% divided by 5000 bushels). Since the entire open interest in corn futures is one million contracts, a sudden short sale of that amount would crush the price.
If one or two U.S. banks sold short 20% of the world annual production of crude oil, that would be the equivalent of 6 million NYMEX futures contracts. (30 billion barrels x 20% divided by 1000 barrels). Since the entire open interest on the NYMEX is around 1 million contracts, a sudden sale of 6 times that amount would drive the price of oil to ten cents a barrel. It would also be market manipulation beyond question.
The CFTC doesn’t need to investigate. They only need to explain why their own data fails to prove manipulation in silver and gold. Save the taxpayer some money and all of us some time. This needn’t take days, weeks, or months. This should take, literally, minutes. Why maintain and publish the data in the Bank Participation Reports if the CFTC won’t recognize an obvious manipulation that is a crime in progress.
The latest COTs confirmed the one thing I was hoping and expecting them to confirm, namely, that the biggest shorts continued to cover their short positions in gold and silver. What makes their short covering most noteworthy is that the buybacks in the most recent report occurred on a sharp rise in price, some $3 in silver and $120 in gold for the reporting week. This tells me that the big short, the U.S. bank(s), is serious about getting out of as much of its massive silver short position as it can.
From the time of the August Bank Participation Report, the big shorts have now covered nearly all of the gold short position put on during July. Therefore, the manipulation in gold was a complete success. In silver, while the manipulation must be considered a success, because the big short has covered an impressive amount, it has not covered all of its manipulative short position. In looking at the structure of the COTs, it does not appear to me that much further liquidation can occur to the downside. To say that the COTs are structured bullishly, would be a gross understatement.
My mentor, Izzy Friedman, recently asked me to turn the clock back to a year ago, and then try to imagine that we would have a severe retail silver shortage. A shortage that now seems to be spreading to gold. It’s a powerful and profound thought process.
This silver retail shortage is completely underappreciated. I don’t think there could be more clear proof that silver has been manipulated in price. The talk that it’s "only" a retail shortage and not a wholesale shortage is silly. The silver retail shortage is so widespread in scope, it’s only a matter of time before it spreads to the wholesale sector. That’s especially true considering the record inflows into the silver ETFs. When the wholesale silver shortage hits, it will make a mockery of any CFTC investigation into manipulation.
The reason I believe the retail shortage is not truly appreciated is because of the boiling frog syndrome. Put a frog into a pot of cold water and increase the heat gradually to a boil and he won’t jump out. Because the silver retail shortage has been so persistent and gradual for the past year, we have grown accustomed to it. Most dealers have little to sell. Nowadays, it’s news when a dealer gets in a supply of silver, which is invariably sold out quickly. Guess what? That’s not normal, and just because it has been a gradual development doesn’t make it normal.
In fact, the growing and persistent physical silver shortage promises to be with us for a long time. Look around at the financial world. Do you see anything better to hold than real silver? Can you imagine owners of real silver rushing to dump their metal at depressed prices. To do what with the proceeds? Rush to put them in a failing bank?
It pains me to see so much financial peril around. Regular readers know I prefer supply/demand considerations and analysis of market structure. I’ve always considered the flight to quality aspect of silver as a bonus. But I see signs of that flight to quality in the current physical shortage. I don’t think that is going away any time soon. How many reasons does one need to load the boat with silver?
About 75 years ago the government gained a monopoly on our money. That meant you had government (an incompetent organization) inflating money and credit for political purposes and social engineering. Since that time the dollar has lost 95% of its value.
The current financial debacle stems from a combination of loose money, subsidized mortgages for the underclass and the utter failure of sleepy government regulators. Mix in a combination of arrogant pride and avarice from main street mortgage brokers to Wall Street investment bankers. There’s no citizen that can’t become greedy when the central bank is throwing wads of money around.
We have unsound money in America. That’s the root of our problems and we will careen from one crisis to another until the ultimate hyperinflationary collapse ends our sorry experiment with government monetary management.
The current rush into gold and silver gives us a glimpse into the future when the paper dollar expires. It probably makes sense to get 10% of your net worth into silver now strictly for hedging purposes.
That says nothing about the splendid case for the fundamentals of silver made by Ted Butler. It’s one thing to offset inflation, it’s another thing to profit mightily as Mr. Butler predicts.

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