Ted Butler With The Latest On Silver

COMEX PRICE EXPLOSION?
By Theodore Butler
Late September 2008
(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.)
As most are aware, there is pronounced tightness in the retail silver investment market. It started, more than eight months ago, with U.S. Silver Eagles, and has spread to almost all forms of retail investment silver. Delivery delays and growing premiums are the core definition of shortage. This is the first time in history we have witnessed such shortages in retail silver. Many are concerned with the disconnect between the retail shortage and the sharply lower price of silver, as well they should be. To date, there has been no clear evidence of the retail shortage developing into a wholesale shortage. That may be about to change.
As we’ve seen recently, when a hurricane approaches, everyone in its path attempts to fill up their vehicles. If your car or truck runs on regular-octane gasoline, you seek to fill up with regular gas. But if regular or middle grade gas is sold-out, but premium is still available, you fill up with premium.
As more and more investors seek to buy silver in retail forms that are sold out, they will buy what is available. That’s true even if it is the premium grade and not what they wanted originally. In silver, the premium grade is 1000-ounce bars. This is the grade that the COMEX deals in. If enough investors start buying these bars, it is reasonable to assume the retail shortage can translate into a wholesale shortage. Then, it’s game-over for the silver manipulation.
I encourage all who can store silver in their personal possession to do so. That doesn’t apply to 1000-oz. bars. These bars weigh some 68 lbs., making them very difficult to lift, to say nothing of shipping. Besides, if one actually takes personal delivery of these bars, please be aware that a re-assay will be required at the time of sale, necessitating added expense and perhaps a delay in selling. Any new buyer of such a bar would rightly insist on testing (at the seller’s expense) to insure that the bar wasn’t tampered with. Be forewarned.
The best way to hold these bars is through professional and insured storage. All these bars have specific serial numbers and weights, making it easy to assure there is real silver being stored for you. Hold them in a recognized depository (HSBC, ScotiaMocatta, Brinks). They can be sold without delay or re-assay, and you needn’t worry about safety, as silver stored for you is not part of the assets of the depository.
Low prices discourage supply and stimulate demand. That is the key economic principle of our free market economy. With so many reasons to buy real silver at its artificially depressed price, and few, if any, legitimate reasons to sell, how long before the retail shortage jumps the firebreak and turns into a wholesale shortage? The fact that it’s nearly impossible to get silver in its most popular retail forms has set off a buying panic. This should motivate everyone to buy whatever physical silver is available. Everything is in place for silver to move up dramatically.
To say that the silver market is set up and has the real potential of exploding in price is an understatement. In fact, it’s hard for me to conceive of a single real bearish factor. And it’s not just that there are many bullish factors present in silver as much as it is the extreme condition of all those bullish factors. That physical supplies are as tight as they are, at the same time the market structure is set up so well, at such depressed prices is a wonder to me. I never thought such conditions could exist at the same time.
THE CLEAN OUT
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.)
There has been a dramatic improvement in the market structure in COMEX gold and silver futures, as defined by the Commitment of Traders Report (COT). The commercials (short sellers) have largely succeeded in their attempt to buy all the paper gold and silver they could by driving the markets lower. The sole reason for the price decline in silver (and gold), is the forced liquidation of leveraged paper long positions, primarily on the COMEX. This is the driving force behind the epic sell-off.
As of the most recent COT, the commercials bought from liquidating long traders 150,000 COMEX gold futures contracts net, since July. That’s the equivalent of 15 million ounces of gold and compares to the roughly 3 million ounces liquidated in the big gold ETF, GLD. Since the liquidation in COMEX gold futures was five times the amount of liquidation in GLD (as is usually the case), it’s hard not to conclude COMEX is the main price driver. In silver, the total long trader liquidation and commercial buying comes to close to 34,000 contracts, or 170 million ounces, since July. In contrast to gold, there has been a net increase in the metal holdings in SLV, the silver ETF.
This gold and silver paper contract liquidation, combined, is among the largest on record. This was the intent of the manipulators. On the one hand, it troubles me that they were successful in washing out so many margined longs. On the other hand, that washout has set the stage for a rally and, perhaps, an explosive one. It took much pain and a near 50% drop in the price of silver to accomplish the washout of leveraged long positions. Now that the clean out has occurred, the damage to the downside is largely, if not completely, behind us. The relative weakness in silver compared to gold should discourage gold-heavy investors to take advantage of silver’s gross undervaluation to gold.
In addition, a new bullish factor has emerged. Not only have the raptors (the commercials other than the eight largest traders) built up a record or near record net long position in both gold and silver futures, they have established a record long position in call options for the first time in memory. My conclusion is, not only are the near-always-correct raptors positioned for an upside move in gold and silver, they are positioned for it to occur soon.
While it may be unfortunate to see so much stress on all big financial institutions, there may be one positive effect for silver and gold. If my allegations of manipulation by one or two big U.S. banks are correct, the current stress may work to weaken their manipulative grip on prices.
The true dichotomy is that silver has never been a better investment at precisely the same time it’s price performance has never been more extreme. I couldn’t make this up if I wanted to. The current silver Commitment of Trader (COT) data is the best it has been in a year (gold, as well). Regular readers know this is not unusual, as the pain of sell-offs create the buy points that we look back upon as ideal. But, this current sell-off is like few before it, both for pain and potential reward.
We have retail silver shortages and prospective industrial shortages for one reason – the price is too low. The very last thing that will remedy a shortage is lower prices. In fact, lower silver prices will only induce a further shortage. It’s like throwing gasoline on a fire. The lower prices stimulate more demand, both for investment and user inventory, further restricting supply. This is the essence of the law of supply and demand. The urgent rush by the manipulators to liquidate every margined long by rigging lower prices was done before those lower prices activate new physical demand and curtail physical supply. There is a blow back phenomenon at work. At some point, the artificial low prices will trigger a price explosion.
Miners Subsidize Users
The dramatic price decline in silver (and gold) has brought the price to levels well below the cost of production for most producers. I’m not talking about the silly cash cost of production many miners trumpet, but the cost that must be reported in audited public earnings reports. The average price of silver was around $17.20 per ounce in Q2. At below $11 recently, the price miners receive is 30% lower, wiping out all earnings for the lowest cost producers (Pan American Silver) and creating sure losses for those miners who only broke even in the last quarter (Coeur d‘Alene and Hecla).
In essence, at current prices the miners are subsidizing the industrial silver users. They are selling their production at less than it costs them to produce. This is wasteful and cheats shareholders. If silver prices don’t rise sharply, it is only a matter of time before silver mines shut down or go out of business. Selling production below the cost of that production is a sure path to failure. It can’t continue indefinitely. Either a company must decrease its cost of production, or the price of its product must rise above its cost.
Evidence exists that manipulation may be involved in the price drop. Thanks to the Bank Participation Report, it is clear that one or two U.S. banks may be behind the big price drop in silver and gold. Hundreds of readers have written to the regulators about this issue. Now it is time for the miners to do the same.
While the miners can, and should, withhold production or, buy silver below the cost of production, at a minimum they should ask the regulators to answer questions about the U.S. banks and the severe price drop. A request coming from a producer carries more weight than a complaint from investors.
I know the miners in the past have denied that the price of silver has been manipulated, but there was never compelling evidence such as exists today. The miners (and their shareholders) have a clear choice. If they think the current price of silver is free and fair, they should shut down, instead of producing at a loss. If they think silver should climb sharply in price (as I do), then they should try to explain why it fell so sharply. If that explanation does not include price manipulation on the paper COMEX market, then let’s hear the alternate explanations. If the explanation does include paper-trading schemes, then they should go to the regulators. Shareholders must insist on hearing from management on this issue. Going silently down the tubes is irresponsible.
I try to keep things simple. At the heart of the current financial crises lies the simple problem that too many financial firms made too many derivatives bets that can’t be honored. This is the same problem in silver. The solution is to limit those bets. The CFTC should enforce legitimate position limits.
THE SENSIBLE SWISS
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.)
This week I received an e-mail from a Swiss money manager, a friend and trusted source. He informed me that a very large and conservative Swiss bank had informed a number of their clients that they would no longer be offered paper gold or silver certificates in the bank’s name. It seems the bank had previously granted the accounts because it was able to protect itself against an upside move with a derivatives contract with another financial institution. Due to the financial turmoil, the bank was no longer comfortable with the counterparty risk from the other financial institution. Instead, the Swiss bank informed its clients, all paper transactions had to be converted to physical or physical ETF positions (There are Swiss ETFs for gold and silver). My friend informed me that other Swiss banks were likely to follow this bank’s lead.
As long-time readers know, the issue of bank silver certificates that were not backed by real metal is one I have written about frequently. In essence, the banks that issued such certificates were short the metal, and taking an enormous risk in the event of a sharp price rise. Because they had been issued for decades, the cumulative amount of the short position in silver amounted to, perhaps, billions of ounces. This was a short position separate and distinct from the massive COMEX short position.
That the large and conservative Swiss bank is seeking to reduce or eliminate it’s short exposure to silver at this time makes sense. The bank has seen that silver prices can move sharply higher and that counterparty guarantees can vanish in an instant. It is sensible and practical that it would take such actions now, after silver prices moved sharply lower.
The resultant move by former paper owners of silver into real metal is destined to put additional pressure on the existing supplies of metal. It is hard to imagine a more critical time for this to occur than now. Every indication is one of tightness in the physical silver supply. The potential creation of a brand new source of silver physical demand could be profound.
TOO BAD
By James R. Cook
It’s a shame that economist Kurt Richebacher passed away before he saw his economic predictions come true. For years he warned about the collapse that would follow what he called the greatest credit expansion in history. He argued that credit growth had reached insane levels. He said this unprecedented debt level would eventually wreak havoc on the U.S. economy. He railed against the huge trade deficit and criticized the monstrous government deficit.
About fifteen years ago I read an interview with Kurt Richebacher. He said all the things I believed. He was the only economist or analyst anywhere leveling powerful criticism against the easy money policies of the Fed. He came down hard on Alan Greenspan. His views were rooted in Austrian economics.
I concluded that, if the great Austrian economist, Ludwig von Mises were still alive, his views would parallel those of Kurt Richebacher. Mises was the world’s foremost critic of socialism, big government, unsound money and inflation. In the great European inflation of the 1920s, he was asked how to end the rampant price inflation. "Stop the printing presses," he admonished.
If they were alive today, both would no doubt criticize the highly inflationary, dollar-damaging government bailouts. To them, recession has a cleansing effect, liquidating the excesses of the credit-induced boom. They advocated short-term pain rather than bolstering failed institutions with massive inflating that further debased the currency. They saw political outcomes and government intervention only leading to a greater crisis downstream. The French economist, Frederic Bastiat, taught in an earlier century that a short-term economic good had a bad long-term effect and a bad short-term economic policy had a long-term good effect. Never has this been more true than today.
Over the years I became close with Kurt Richebacher. He saw clearly into the future. He would scoff at the idea of propping up today’s economy with the same inflationary medicine that caused the problem. Most everyone will endorse the idea of a massive government bailout. They want to keep the good times rolling (me included). In such an inflationary environment, it’s my opinion there will never be a better opportunity for natural resources like silver. Socializing the financial system may work for now, but somewhere out there lies the ultimate financial crisis, the one that no government action can cure.
One final thought. The widespread call for more regulation overlooks the fact that plenty of regulation already exists. Unfortunately, most regulators are not competent enough to regulate. Those who work in an industry are the real experts. Regulators only have a superficial knowledge of what they are regulating. That’s why we have so much regulatory failure. More regulation won’t help. We need some other approach.
SILVER FOR GOLD
By Theodore Butler
Silver is an industrial metal, first and foremost, and an investment metal second. Gold is not an industrial metal, but solely an investment metal, sought for its value and beauty. Only industrial metals can go into shortage. Gold can go to any price, but not on the basis of an industrial shortage. Silver must go into an industrial shortage at some point, due to disappearing inventories.
To appreciate the eventual and inevitable impact of an actual shortage on the price of silver, one has to rely upon imagination and prior experience with other shortages. This is the stuff that, quite literally, causes me to shudder when I contemplate how high the price could go. In a true shortage, sellers freeze up and are afraid to sell at almost any price, while buyers emotionally panic into bidding at irrational prices. Short time durations, and extreme price movements characterize such emotional periods. This condition is coming in silver.
I don’t think anything could be crazier than silver being at its most undervalued relative to gold, at precisely the time that available silver inventories are approaching extinction. The ratio of silver to gold is now 65 to 1. Historically, it was 16 to 1 for hundreds of years. Very few people in the world appreciate the extreme under valuation in silver compared to gold. There’s $3 trillion in gold and only $12 billion in silver. Gold holders, by virtue of the tripling of the gold price over the past few years, are in the fortunate position to be able to take advantage of their gold buying power. They should switch to silver. They should switch into silver before the gold silver ratio returns to a historic level that would come from a big price jump in silver.