(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.)

Most men treasure personal reputation as their most valuable possession. I know I do. With reputation comes responsibility, especially if you put your words in print for a wide audience. The last thing I want to do is write something that would cause damage to the reader, particularly in financial matters. You don’t get a positive reputation by tearing other people down, or by making unsubstantiated claims, or by stealing someone else’s thoughts. You earn it by introducing ideas that help people.

Lately, I have been thinking once again about investment pool accounts and certificate programs for unallocated silver (and other precious metals). My new thoughts lead me to believe that, at some point, it must end in disaster for both the buyers and issuers of these programs. I will try to explain why and convince you, to the best of my ability, to get out of these programs now.

What is a silver pool account or a certificate program for unallocated silver? In simple terms, these are purely paper promises or bookkeeping-only entries that are sold as an alternative to owning the specifically-earmarked real silver of segregated or allocated type accounts. Most people who buy this paper form of silver are not aware that there is no specific silver backing up these accounts, only a promise of some type by the issuer. If a problem develops either in the silver market (a shortage) or with the issuer (insolvency) the buyer could end up high and dry. The buyer pays full cash value for the silver, yet may not get the silver or the value of the silver.

I consider pool accounts and certificate programs with no serial numbers of bars on a par with the great failed experiment of leasing and forward selling of gold and silver by mining companies. Long-time readers may know that this was this issue that prompted me to first write on the Internet, 10 years ago. To my knowledge, I was the first to write of the stupidity and manipulative effect of leasing. One great thing about the Internet and the printed word is the time record created.

For newer readers, leasing transactions failed because they didn’t pass the test of common sense. Great quantities of physical central bank gold and silver were dumped on the market through leasing. This artificially depressed the price (to below $300 on gold). The mining companies obligated themselves to pay back years of production at those depressed prices. It was an accident waiting to happen when the price rose and the transactions were unwound. Leasing participants were too concerned about transaction fees and cheap financing to step back and look at the big picture. They convinced themselves they were hedging, even though legitimate hedging never involves the physical short sale of a commodity, or obligates years of production.

The disaster did occur, as it had to. Gold prices rose when the dumping stopped and gold was bought back (the silver has yet to be bought back). The cumulative losses, to date in gold from this wacky experiment are in the tens of billions of dollars, and there is still a significant portion left to be closed out. That’s tens of billions of dollars in losses from an idea that shouldn’t have passed muster.

Although it seems clear in hindsight just what a mistake this forward selling was at the time, it was an accepted practice that no one spoke against. I have a confession. Back when I publicly started writing about leasing, Barrick Gold and others involved in this nutty practice, I would sometimes wait for the process server to knock on my door with libel lawsuit papers. (Yes, there have been many days I’ve waited for COMEX related papers, as well.)

What does leasing/forward selling have to do with pool accounts and unallocated silver storage? Quite a lot. For starters, they both sound good, until you think about what’s really involved. A transaction must be examined from the perspective of all parties to see if it makes sense, or even if it is legitimate. For the buyers of silver (or gold) in a pool or unallocated account, the great allure is that it is cheaper and easier than buying real silver. Cheap and easy are powerful incentives, and, all things being equal, they win every time. And in today’s modern world, technology enables us to do many things cheaper and easier (like e-mail and securities trading), so we’re not always suspicious of things cheap and easy.

Are all things equal between pool accounts and owning the real thing? Do you save enough to justify it? I don’t think so. (The real thing is actual metal segregated and held in your name by a large and reputable third party. That’s generally not the dealer you bought the metal from. In the case of 1000-ounce bars, professional storage identifies them by serial numbers.)

In the typical pool account or certificate program, the buyer incurs a very small sales charge and zero storage charges. Your common sense should tell you that this is only likely if there is insufficient or no real silver being purchased. Zero storage charges generally equal zero real silver. So the trade-off for the buyer is that no real silver exists. There may be statements given by the issuer that there is real silver backing the pool or certificate account, but no specific proof. Further, there is usually a provision that the buyer can get real silver if he is willing to pay an additional charge. This provides further evidence to the buyer that no real silver backs a pool or an unallocated certificate account.

What about looking at these transactions from the issuers’ perspective? What’s in it for them? Well, certainly not commissions or storage fees. Only the sales agent makes a commission. But these are for-profit organizations. They are in business to make money. How do they make money, if they don’t charge storage fees? They make it on the float, or the use of the buyers’ money. That’s the only way they can make any real money. The issuer puts the buyers’ money in an account earning interest or into the business. If these accounts are not fully backed up, or backed up at all, with real metal, the financial strength of the issuer becomes the predominate factor. In other words, it is not real metal that backs up these accounts, but the financial strength of the issuers themselves. Make no mistake – these pool and unallocated certificate accounts are, in large part, unsecured obligations of the issuing entity.

Now, some people who are aware of these circumstances claim they are content doing business this way, because there have been no known problems to date. I can understand that, but things can change and how could you know if they did? Others would say the Perth Mint also offers a guarantee from the provincial government. I understand that as well, but real metal holders don’t need a government guarantee, because unencumbered metal is an asset that is no one else’s liability. A pool account or an unallocated certificate account, by definition, turns an asset that is no one’s liability into an asset that is someone’s liability.

In no way am I attempting to malign anyone’s reputations. On the contrary, I am trying to save them and their customers great potential harm and heartache. My motivation in writing about leasing/forward selling ten years ago was to alert all participants to the inherent flaws in those transactions. By not heeding my warnings, the mining industry went on to lose tens of billions of dollars that would have enriched their shareholders.

My motivation today is similar. The worst thing that could happen to a silver investor is to have bought at the right time and then discovered, too late, that he held the wrong form of silver. I am convinced that silver in pool accounts and unallocated certificates are the worst form of silver, and it is highly likely, if not near certain, that they will end badly for all involved. That’s because the issuers are at risk in a price rise. As the price rises, the buyers are calculating their profits and the issuers their losses. But, the issuers have to actually pay out the losses as buyers sell at a profit or convert their pool accounts or certificates to real metal. There is no daily margin requirement, to my knowledge. As long as it is only a few buyers selling out, or if there are new buyers coming in, the cash outlays by the issuers may be minimal. As long as pool investors think silver is a buy or hold they will not cash out and require the issuer to pay out cash. This can allow an issuer’s financial condition to deteriorate as the price rises. The only real issue becomes when is this likely to reach a tipping point? The obvious, if imprecise, answer is when the price is high enough to cause people to sell while no new buyers appear.

What I’ve just described could result in a classic Ponzi scheme, in which old investors are paid out with new investor money. The scheme can only last until new investors stop investing. Then it collapses. Do I think that any of the pool issuers intentionally set out to construct a Ponzi scheme? No! Just like I didn’t think that Barrick Gold would intentionally deprive their shareholders of many billions of dollars because their foolish forward sales. Just as I don’t think someone at the COMEX woke up one day with the bright idea to intentionally manipulate the silver market with concentrated short sales. The way things work in the real world is that unintended consequences develop when people take questionable actions without thinking things through.

Pool accounts and unallocated silver certificates are a bad idea. They create unacceptable trade-offs. It costs a small amount of money to store and insure real silver. You can’t do it for free. You can store non-existent silver for free, but that’s a bad idea. Compounding the problem is the lack of public information. I’ve read various annual reports, and I am concerned with the lack of financial detail and their reliance on leased metal. Pool operators are often private companies and financial data is not available. Worse still is the lack of regulatory oversight. If you think there’s a problem with the silver ETF, you can at least petition the SEC, or Barclays, a public company. The CFTC may sidestep complaints about the COMEX, but at least they have to go on record. Who oversees the pool accounts and certificate issuers?

Investors should rid themselves of these pool and unallocated accounts while they can. There are too many good alternatives for holding real silver. Also, a deployment out of non-existent silver to real silver will help the price. The issuers should stop dealing in these potentially ruinous financial concoctions, which are not central to their basic business. It may prove temporarily painful but, in the long run, it will save these businesses. Ten years ago, very few envisioned what damage leasing and forward selling would do to the miners. Years from now, I think the same thing will be said about pool and unallocated silver accounts.

Thirty years ago, to the month, I took my small coin collection to the bank and sat waiting quietly outside the bank president’s office. I needed money to keep Investment Rarities going. I’d started the company in 1972 with a partner. We’d had a few good months in 1974 when silver ran up to $6.40 an ounce. However, 1975 was tough sledding and our money ran out in the fall. My partner left the company and sold his stock back to us for pennies. I was alone with two secretaries and the bills were piling up. The secretaries had to be paid and the rent was overdue. I was worried about the phones getting cut off and I hadn’t taken a salary in months.

Finally, Cecil the bank Prez waived me into his office. I spread the coins out on his desk. "What are they worth?" he asked. "About $7,000," I replied. He looked at me wearily and sighed. "OK, I’ll give you $6,000 on them, but they better be worth that much, Cook."

That was a great day for me and the company. I could make payroll and pay the rent. Now, however, I had no reserves. I had to do something fast to survive. Gold and silver were dead, but I managed to take on a line of wood-burning stoves and began to sell them. The first energy crisis was in the news and wood burning made a mild comeback as a heating source. In the next few months we sold enough of these heavy steel stoves to keep the doors open. Eventually, gold and silver revived.

Since then, especially in the late 1980s and early 1990s, I’ve been in even tighter squeezes. For years we hung by our fingernails. No one expected us to last in the face of one severe financial crisis after another. Yet, we survived. I learned that no matter how bleak the outlook, or how desperate the situation, there was always a way out, always a solution, if you looked for it hard enough. I also learned there is a power in the universe that is there for you to use to help you get through any adversity or difficulty in life. This understanding is in itself a greater reward than all the earthly treasure I have struggled to pile up.

It’s pretty simple as to why the price of an asset falls in value. Demand diminishes. Recently, prices have fallen for residential real estate because demand slowed way down while inventories of homes for sale continued to grow. While visiting Florida recently the newspapers were full of stories about falling prices for condos and houses. A few builders were in trouble, and speculators who were multiple buyers of condos were taking their lumps.

The formula for consistent profits in any asset is unrelenting demand. Investment demand can be fickle. We saw that in the 2000 NASDAQ decline, the 1980 farmland crash and periodic busts in commercial real estate. Industrial demand, which differs from investment demand, can be steadier and more reliable. However, industrial demand can fall off too and commodities such as copper and zinc can decline and languish. The demand for silver can also decline if industrial production becomes impacted by a major recession.

However, the demand for silver appears to be the steadiest and strongest of any industrial commodity. There are several principal reasons.

1. Multiple new uses for silver.
2. Widespread use in hundreds of crucially important applications.
3. Overall growth in worldwide applications.
4. Phenomenal growth in Asian demand for appliances, autos, photography, plastics and construction causing silver demand to explode.
5. Used in such small amounts per industrial application that it won’t be readily replaced at higher prices.
6. Production increases from mining have long lead times. Higher prices won’t change this.
7. Increased awareness of a potential silver shortage causes all interested parties to hold more closely.
8. Awareness of potential shortage causes industries to hoard the metal.

You can’t get many more solid demand factors piled on top of one another than this. Demand should be strong for years to come, with no let up. A depression could diminish demand, but in that environment everything loses value. Silver would likely lose less than other assets because demand is worldwide and basic to modern civilization.

Not long ago I discussed this powerful demand with analyst Ted Butler. I asked what he thought the price of silver should really be, taking all these demand factors into consideration. He didn’t want to answer. I kept at him and asked, "What if the market was totally free of the paper transactions that hold down silver and traded solely on the supply and demand for physical silver, what would the price be?" He replied, "It would be over $100 an ounce, but don’t quote me."

Okay, so I’m no good at keeping secrets. Sorry Ted. It’s just too important a conclusion to keep under wraps. When the world’s foremost silver analyst thinks in these numbers, it’s quite dramatic. If you buy physical silver and hold it for the long term, the ongoing industrial demand should work to your great advantage. I just can’t think of anything better to own in the new global economy.

If I am even close to being correct in my assessment of silver, you are being presented with something that is actually beyond a lifetime opportunity. This is an opportunity that has been many hundreds of years developing. That we are alive and in position to actually take financial advantage of this great change is almost beyond comprehension. The transition from a manipulated market to a free market is the most dramatic change possible. To catch that transition properly positioned can create a lifetime of wealth. The one sure way to guarantee you are properly positioned is with real silver. The vast majority of the world’s investors will necessarily be blind to this opportunity because they are unaware of the great dynamics in force. If you open your eyes to the real facts, and act while there is time to act, you will see the future and reap the rewards.

When the price of silver began to rise in the early 1960s, people began to hang on to the coinage because it was 90% silver. The government tried to combat this hoarding by minting much larger quantities of silver coins. Instead of the usual 300 million new dimes in a year, they struck two and a quarter billion dimes in 1964. Instead of a hundred million quarters, they struck well over a billion. Instead of the 25 million half dollars they struck in 1960, they minted over 425 million Kennedy Halves in 1964. It didn’t work. The silver coins were grabbed up and began to disappear from circulation. The country was running out of coinage.

In 1965, the U.S. Mint dropped silver from the coinage and came out with a copper-nickel substitute. Subsequently, silver coinage totally disappeared from circulation. Over the years, a lot of these coins went into the melting pot and supplied industry with silver. Nobody knows how many are left. When demand is high, they take on a premium over their silver value. It’s possible that this premium can grow with higher prices.

Recently, I’ve been revisiting the idea that people should keep a supply of these silver coins on hand in case of a monetary breakdown. I never placed much stock in that

idea. However, with the possibility of worsening inflation and other economic problems, it may make sense to have a $1,000 face value bag at home for each family member. The primary reason to buy silver is to make a profit. A second reason is to hedge against inflation, or some other crisis. A final reason may be that if unbacked paper money begins to lose value too fast, you may need an

alternative. Yes, it sounds like a remote possibility, but it’s still worth having some silver coins around just in case.

Silver coin bags are one of the best ways to own silver. With the Silver Users Association confirming that silver is much scarcer than most people thought, silver coin bags may come under buying pressure and there may be far fewer than anyone thinks. Certainly the supply is not endless and you should buy them while they are still available at today’s price. You get 10,000 dimes, 4,000 quarters, or 2,000 half dollars in a bag that weighs 56 pounds and contains 715 ounces of silver. You can also buy uncirculated bags that contain 725 ounces of silver. We ship them by registered mail in half-bag lots, each in a plastic bucket that weighs a manageable 28 pounds. We mark them "machine parts" to maintain privacy.

Call us now at 1-800-328-1860 and buy some bags of silver coins. We don’t think you can go wrong owning these bags of silver.

All Rights Reserved © 2002 Investment Rarities, Inc.
For Web Site Questions Contact the Web Master
Disclaimer