WEEKLY COMMENTARY

February 21, 2006

Hit With The Stupid Stick Again

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.)

The biggest advantage of being an independent analyst is not having to worry about disturbing relationships which don’t exist. If I see something that I think is dumb, I can say it is dumb. Of course, that doesn’t mean my opinion can’t be wrong, just that I’m relatively free of conflict to reach that opinion.

I started writing on the Internet, almost ten years ago, about a financial practice, precious metals leasing and forward selling, that I labeled as being as dumb as dirt. In addition to being dumb, the practice, which involved the dumping of huge quantities of physical gold and silver on the market under the guise of legitimate hedging, was also manipulative to prices. http://www.butlerresearch.com/dumb_and_dumber.html

With the benefit of hindsight, it is easy to see that the practice had a pronounced influence on the price of gold and silver, first pushing prices to historic low points and then allowing prices to rise when the dumping stopped. The practice was as manipulative as it gets.

What made this leasing/forward selling so dumb? Well, in the case of the mining companies which participated, like Barrick Gold, Placer Dome and AngloGold, in addition to initially lowering the price of what they produced, it left them in the position of being liable for potentially hundreds of millions, if not billions, of dollars in losses if the price of gold rose high enough. Which is precisely what happened.

Generating a loss isn’t necessarily dumb, but if you are given clear warning on how to avoid such losses and still persist in the folly, that is pretty dumb. To this day, billions of dollars of open losses from these stupid forward sales still haunt these companies. The managements responsible for loss of shareholder wealth should be drawn and quartered.

I genuinely believed that the rocket scientists on Wall Street had hit the peak of stupidity when they concocted precious metals leasing/forward selling. I have come to realize that I was wrong. They’ve actually come up with something dumber.

I have tried to remain somewhat neutral on the pending Silver ETF proposed by Barclays and awaiting approval by the SEC. I look forward to seeing the matter resolved, approval or rejection. Either outcome will confirm much of what I have written about silver. While a couple of my articles were listed on the SEC web site, I did not submit them nor request they be submitted. I wanted to stay out of the fray. Now that the comment period is over and the SEC is no longer soliciting comments, I’d like to get something off my chest.

This proposed silver ETF, as well as any ETF on any commodity, is as dumb as a bag of rocks. Sure, it will make the price explode, and precisely for that aspect virtually all silver investors, including me, look upon it favorably. Suddenly take away a big chunk of any commodity’s supply and there will be a big impact on price. That’s elementary. But there is more to the story than that.

An analyst is supposed to judge and evaluate something objectively, to consider all the facts and circumstances. If he sees something wrong, he should say so. Analysis is not a popularity contest. I see something very wrong with commodity ETFs. I don’t think they have been properly evaluated.

My main objection with commodity ETFs is that, in addition to artificially altering supply and demand, they turn legitimate commodity law and regulation on its head. The main thrust of commodity law is to prevent concentrated speculative buying and selling from artificially influencing prices. This primary premise and intent of commodity law is obliterated by the concentrated buying (and selling someday) that a commodity ETF insures. It’s as if someone sat down and devised an idea that would upend all the safeguards and regulations against manipulation that have taken many decades to develop. Think I’m kidding? Please hear me out.

Commodity ETFs destroy the very concept of commodity regulation. One of the most basic tools that the Commodity Futures Trading Commission (CFTC) employs to safeguard against manipulation is its Large Trader Reporting Program http://www.cftc.gov/opa/backgrounder/opa-ltrs.htm This program mandates that traders must report their trades and any affiliated trades in every commodity over a certain number of contracts. In gold the threshold is 200 contracts (equivalent to 20,000 ounces) and in silver the threshold is 150 contracts (750,000 ounces). If you hold more than these quantities, long or short, you must provide detailed information about yourself and any related affiliates and associates and report daily any changes in your positions as long as you remain over these threshold levels. (This information is used in the Commitment of Traders Report.)

In the existing gold ETFs, as well as the proposed silver ETF, there are no reporting or disclosure requirements. Any entity could hold as many equivalent ounces of metal in an ETF, whether ten times or a hundred times Large Trader Reprting levels, and effectively evade any and all disclosure requirements. Additionally, there is zero protection against entities banding together for the express purpose of manipulation. These are clear sidesteps around and evasion of existing commodity law. It’s as if commodity law is intentionally being undermined by the creation of commodity ETFs.

Over twenty-five years ago, the weight of commodity law came to bear on the Hunt Brothers in the most famous manipulation of them all, the great silver manipulation. The basis of the manipulation was the related and concentrated buying and resultant price pressure brought on the price of silver. The proposed Barclays silver ETF promises to legitimize the very acts which the US Government succeeded in prosecuting. Talk about irony.

I know, perhaps better than anyone, that silver prices have been manipulated for a very long time. But I don’t think two wrongs make it permissible to overcome one manipulation with another. The silver manipulation will end. I question if the means justifies the end, if it involves a different manipulation.

What I am taken back about is the lack of free market voices who will proclaim the commodity ETFs to be just what they are – gimmicks and devices that facilitate concentrated buying and selling and manipulation. Sure the ETFs make it easy to buy and hold metals, where they couldn’t be bought before. They also make it easier to evade commodity law and manipulate the price. Is this the government’s intent?

Where the heck is the CFTC and where do they stand on this issue? The very heart of commodity law is being threatened and they are flitting around the world giving useless speeches on useless topics. To my knowledge, the CFTC has yet to utter word one on either the gold ETFs in existence or on the proposed silver ETF.

I know the silver ETF is being portrayed as some type of epic struggle between the silver investor against the Silver Users Association. That’s nonsense. Sure, the SUA is against the silver ETF. But it is opposed to the ETF for precisely the same reason silver investors are for it, namely, it will cause the price to explode. So, in essence there is agreement on how little silver there is available. I’ve always thought that the SUA should be prosecuted and punished by the government for anti-trust reasons, but not for proclaiming and confirming just how rare silver has become.