Monday, June 15, 2009

Butler On Silver

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.)
I’ve just learned something about silver that I was vaguely familiar with. It had a big impact on me. When I shared it with my mentor, Izzy Friedman, the person who first got me interested in silver, he called it a bombshell. I was vaguely familiar with the subject because it dates back 44 years, to 1965. I was 18 years old and had just graduated from high school. I was thinking about college, the Vietnam War, cars and girls, though not necessarily in that order. I was definitely not thinking about silver. Izzy hadn’t even come to America yet. Even if you are 80 years old, you were only 36 in 1965.
Thanks to a post on the Internet, I had the opportunity to read the speech that President Lyndon Johnson made on July 23, 1965, in which he announced the US Government’s plan to remove silver from the coinage. I had not read the speech before. The President said this was the first change in our nation’s coinage in 173 years, since the very first Coinage Act of 1792. Here are the pertinent sections.
"Now, all of you know these changes are necessary for a very simple reason--silver is a scarce material. Our uses of silver are growing as our population and our economy grows. The hard fact is that silver consumption is now more than double new silver production each year. So, in the face of this worldwide shortage of silver, and our rapidly growing need for coins, the only really prudent course was to reduce our dependence upon silver for making our coins.
If we had not done so, we would have risked chronic coin shortages in the very near future.
Some have asked whether our silver coins will disappear. The answer is very definitely-no.
Our present silver coins won't disappear and they won't even become rarities. We estimate that there are now 12 billion--I repeat, more than 12 billion silver dimes and quarters and half dollars that are now outstanding. We will make another billion before we halt production. And they will be used side-by-side with our new coins.
Since the life of a silver coin is about 25 years, we expect our traditional silver coins to be with us in large numbers for a long, long time.
If anybody has any idea of hoarding our silver coins, let me say this. Treasury has a lot of silver on hand, and it can be, and it will be used to keep the price of silver in line with its value in our present silver coin. There will be no profit in holding them out of circulation for the value of their silver content."
President Johnson and his economic team at the Treasury Department were eventually proven remarkably correct but also incorrect. They were correct that the demand for silver would soon deplete US inventories. They were dead wrong in their expectation that the US Government could hold down silver prices and prevent investors from making a profit. In just a few years, most silver coins were removed from circulation. In less than 15 years, the price of silver rose from $1.29 (at the time of the President’s speech) to more than $50 in early-1980.
In 1959, six years prior to the speech, the US Treasury Department held approximately 2.1 billion ounces in silver bullion inventories plus 1.3 billion ounces in circulating coinage, for a total of 3.4 billion ounces. By 1971, through a combination of bullion sales and new coinage, the Treasury held only 170 million ounces of silver bullion. Most silver coins were removed by investors from circulation, and eventually melted into bullion. Over this 12-year period, more than 3.2 billion ounces of silver were transferred from the US Government to the private sector. Around 94% of what the government controlled was gone.
1959 would also be the last year that the US Government was a buyer of silver, until 2001, when it began buying silver for its coin programs. In 1959, when the US Government held 3.4 billion ounces of silver, the US population was approximately 180 million. That means the Government held almost 19 ounces of silver, for every man, woman and child in the nation. Today it holds none. This also means that the US Government can never be a physical silver seller again unless it buys silver first.
Here’s a statistic that is stunning and troublesome at the same time. In 1959, there were about 5 billion ounces of silver physically held on US soil. This includes the 3.4 billion of government holdings plus privately held silver. That includes hundreds of millions of ounces of silver objects that would be melted in the early 1980’s. Today there are no more than 300 million ounces held on US soil, including all the 118 million ounces in COMEX-approved warehouses. The 400 million ounces in ETFs are held outside the US. If my numbers are accurate (as I believe them to be), the amount of physical silver held on US soil is down 94% in 50 years.
In 1959, there were about 9 billion ounces of silver bullion-equivalent in the world (half of that in the US. With a world population of 3 billion, there was a per-capita amount of 3 ounces for each of the world’s citizens. Today, 50 years later, there is a per capita amount of silver of 0.15 of an ounce remaining (1 billion ounces divided by 6.8 billion population). That is not a misprint. The per-capita amount of silver bullion in the world has declined by 95% over the past 50 years.
By way of comparison, the per-capita amount of gold bullion equivalent in the world has remained remarkably stable at around three-quarters of an ounce per person, for more than 100 years. In 1900, there were around 1 billion ounces of gold versus a world population of 1.5 billion. In 1959, there were about 2.3 billion ounces of gold against a world population of 3 billion. Today there are roughly 5 billion gold ounces and 6.8 billion people.
I make these comparisons with gold to provide a legitimate perspective. Gold and silver are the perfect items to compare. I make the comparison to show how undervalued silver is, not that gold is overvalued. In spite of evidence of manipulation, gold has done what it has been expected to do - it has kept pace with inflation, money and population growth. That’s proven by its price increase over the past 50 years. Since 1959, gold has increased in price more than 25-fold ($35 to $900). It’s a much different story in silver. Yes, silver has increased in price by more than 15-fold in 50 years ($.90 to $14), but that’s only half the story. The other half is that 90% of the silver in the world has been vaporized over that time or put into forms that may not be recoverable, no matter what the price. Nevertheless, the price of gold rose from 30 times the price of silver to 60 times today. Only two reasons can account for this - a manipulation in silver and a global unawareness of these facts. I guarantee you that both reasons will be terminated in time.
The US Government and other nations around the world removed silver from coinage because there wasn’t enough silver available. President Johnson’s words are crystal clear. They knew they couldn’t keep issuing coins pegged at an artificially low price (1.29). They were correct. But what no one knew 50 years ago was that even if the world stopped using silver as money, we would still run out of silver because of industrial demand. Even the investors in the 1960’s who took down a portion of the US Government 3 billion + ounces didn’t buy silver with an eye towards the day when silver inventories would be depleted by industrial consumption.
The investors in the 1960’s who bought the silver from the government did so because it was a no-lose proposition. Those who removed silver coins from circulation knew that the face value of the coins provided a floor, making silver coins a no-risk proposition. Intuitively, investors also knew that silver prices were artificially depressed by government sales. They also knew this silver dumping had to end at some point. When it did, prices rose and those early investors did what made sense: they took profits and sold. The silver that was taken out of circulation from the US Government was in turn taken away from early investors. Whereas many billions of ounces of silver existed in the world 50 years ago, maybe 10% remains today.
No longer can the US Government (or any other) dump massive amounts of silver on the market. Let’s face it - back then, the US Government was openly manipulating and controlling the price of silver, by selling at fixed prices. When they ran out of silver to sell, the manipulation and control ended in a flash and prices exploded. Today the manipulation is different. A government-protected entity, most likely JPMorgan, sells paper silver contracts at artificially depressed prices. I contend that this abhorrent paper manipulation will vanish in a flash at some point, just like as the governments’ physical manipulation ended 50 years ago. Only this time the impact on the market and the rewards to investors will be greater because there is so little silver remaining.
Back then, the US Government was the world’s largest silver seller. Today, the Government is a large buyer, perhaps the largest in the world, through the American Eagle and Commemorative silver programs. This year, the US Mint is on pace to produce and sell over 30 million ounces of Silver Eagles and other silver coins. Because the Government holds no silver and must buy on the open market, this makes the Mint a very large consumer. Incredibly, just this buying by the Mint alone uses up 80% of what the US produces in a year, as the world’s eighth largest silver producing country.
It’s not just that the world no longer has billions of silver ounces, or that the world economy and population demand more silver than ever before. It’s not just the fact that most of the new technologies require silver’s unique qualities. It’s not just that the paper manipulation on the COMEX is becoming more apparent and less feared. There is something else that runs through my head when I contemplate President Johnson’s words and look at what took place over the past half-century.
The 1960’s were a simpler time. Communication and knowledge didn’t travel then, as it does now. It won’t take long for the world to focus on the silver story, once prices begin to reflect its true value. Fifty years ago, we had a small fraction of the investment money in existence today. We didn’t have the concentrated pools of investment money looking for a home (hedge funds and sovereign wealth funds). We didn’t have the surge of stimulative money being created as we do today. It’s likely we will have a great price explosion as these facts become known. Remember, it’s not about the facts turning in silver’s favor. That already exists. It’s about enough investors becoming educated to the facts. Then today’s fabulous buying point will be gone forever.
By James Cook
Years ago I had a partner. He went to bed one night and never woke up. At age 48 his heart stopped. Bernie and I had started Investment Rarities in 1973. In 1975 we split up, but stayed friends. Bernie was a first class economic thinker. I remember he would often say, "Jimmy, someday bread will be a dollar a loaf." I would giggle at such an outlandish claim. More seriously, he would intone a forecast for the future of the country. "Jimmy, we’re going to hit the gutter."
I have often wrestled with that thought, hoping that it wouldn’t be so. Now I wake in the night and see it clearly. We are going to hit the gutter. The nation is nearly ruined, well on it’s way to bankruptcy and there is no possibility of changing directions. We are going to go broke. Make that a guiding thought for your future. It you suspect your country is going bankrupt, you can at least play some defense. Let me say it again; this nation, the greatest country in the world, the United States of America, is going to go broke. It’s not treason, it’s not heresy, it’s not malevolence or wishful thinking. It’s a sad but inevitable conclusion predicated on the sorry economic events of our time.
Last week the newspaper chronicled further erosion in the financial condition of Social Security and Medicare. Expenditures for the latter are running wild. Free health care is a financial back-breaker. The numbers only worsen, they never improve. Virtually all subsidies, entitlements and social programs are running away. There’s no way to stop these soaring costs, short of national bankruptcy. If a politician had the guts to curb or abolish a single program he’d be lynched. Rather, our current leaders want more entitlements and fatter budgets for existing social programs. Throw in wars and stimulus and you have an unmanageable deficit that must be covered by currency debasement.
Last week I got a check from the government for $250. This handout went to millions of people of retirement age. It basically adds to the government deficit. No country has ever done anything like this before, and there’s much more free money to come. This is the economic school of hocus-pocus and legerdemain. Make up a bunch of checks, send them out and borrow the money to cover them, or just print it up. When your government has to create billions for economic stimulus or to cover out of control spending on open-ended military and social programs you eventually ruin the integrity of your currency.
The dollar is the world’s reserve currency. It gives us special privileges. It’s value has held up no matter how much of it we printed and exchanged for foreign goods. That’s going to change. As we inflate the world with dollars, they are going to lose popularity. There’s too many of them. Eventually, the dollar’s reserve status will end. When it does, we’ll be unable sell our bonds to foreigners to finance the government’s debt and all the dollars out there in in the world will come back to us, either sold off or exchanged. As the dollar sinks, inflation will roar. In a flash hyperinflation will set in and the dollar will be doomed. It could happen now, or it could happen after the next credit-induced boom and bust. Inevitably it will happen. Remember this, no country has ever been privileged to have a paper reserve currency. Reserves were always gold and silver. We’ve abused this privilege. So much of our paper exists outside the U.S., it adds to the certainty of runaway inflation when the dollars reserve status ends and dollar holders dump. As its role as the world’s reserve currency once helped the dollar, so it will reinforce the doom of the dollar.
First comes runaway inflation, then inevitably a depression. There is no defense against depression when your currency fails. A worthless dollar can no longer be used to bail out failing banks and bankrupt businesses. There’s no stimulus left. The government is out of bullets, the treasury broke, and the Federal Reserve impotent. All the economic sins of the past come home to roost. For awhile, it will be far worse than the dirty thirties. In effect we will have hit the gutter. But, life goes on. What happens next is the subject of a book I’m planning to write. Watch a couple of horror films so you can handle it.

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