WEEKLY COMMENTARY

February 28, 2006

CONFIRMATION

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.)

Almost two months ago, I wrote about Barrick Gold’s large gold short position and growing hedge book losses, before their quarterly and year-end report was issued - "Lessons Learned?" http://www.investmentrarities.com/01-03-06.html I anticipated large derivatives losses.

On February 22, Barrick did report their earnings and no word of loss appeared in any of the dozens of news reports that covered the story of what is now the largest gold miner in the world. Instead, Barrick reported a quarterly profit of $175 million. Many people wrote me, asking how I could be so wrong. It’s no fun for an analyst to be accused of being wrong. Especially when not only you are not wrong, but were right on the money.

While Barrick did report $175 million in quarterly profits, they did not report quarterly losses on their precious metals short position of 3 times that amount, or $500 million. They did not report a total open loss of over $2.8 billion on their short gold position. Well, Barrick did report these losses, just as I anticipated, but they reported them in such a manner, buried so deep and hidden in the footnotes, that the average person wouldn’t see them in a million years. That’s why people thought I was wrong, when I was spot on.

This isn’t a question of me being right or wrong, this is a question of integrity. Not mine, but Barrick’s and all other companies who report on their derivatives results. (For the record, I have not, do not and probably never will have a position of any type, long or short, in Barrick or any other company I have written about, and I am not intending to give specific investment advice. I am writing about such issues in the much broader context of how they influence metals’ prices and how financial statements are constructed.)

I think it is very wrong for Barrick to attempt to hide their derivatives position from clear view. Because I have been following and writing on this issue for so many years, I know where to look in the earnings report for real story, but I admit, the information is not easy to find. And please keep in mind – there have been clear edicts from the Financial Accounting Standards Board (FASB) dictating how derivatives must be accounted for. If it were not for these clear FASB rulings, I get the feeling we’d never know the true story.

For the record, here is the combined Barrick Gold (including the recently acquired Placer Dome) short position in fixed-price gold contracts. As of Dec 31, 2005, the total short gold position was 20 million ounces, with an open loss of just over $4 billion, based upon a $513 gold price. Since December 31, the company has covered 1.5 million ounces, including 1 million ounces of gold calls bought back by Placer for a realized loss of $222 million ($222 per ounce). Therefore, the company has 18.5 million ounces of gold shorts still open.

The $4 billion dollar open loss at year-end is the largest in history, to my knowledge. It is more money than Barrick ever made in its existence. It is equal to two full years of production. I would not make these statements if I did not believe them to be true. I am not out to embarrass myself or write false words. I will retract them if they can be shown to be untrue.

My point was not to attack Barrick, as I have no financial interest in what they do, but to show existing trading practices can result in unexpected consequences, much like the outsized COMEX silver short position. I wrote about gold "hedging" for years before these avoidable billions of dollars of losses occurred, just like I’ve written about the manipulative and dangerous level of silver short selling.

Another one of my prime contentions was recently confirmed. As long-time readers know, I have maintained that there is much more available above ground gold in the world than silver. I made this finding in the very first article I wrote for Investment Rarities, Inc. over five years ago http://www.investmentrarities.com/11-13-00.html

The confirmation came from the archenemy of higher silver prices, the Silver Users Association (SUA), in one of their petitions to the Securities and Exchange Commission (SEC) to kill the Silver ETF. The SUA offered research and documentation from the CPM Group showing that there was 4 times the amount of gold above ground (3 billion ounces) than silver (750 million ounces). The SUA was trying to show how much more disruptive a silver ETF would be than the gold ETFs.

While I would have preferred a citation from a different source than the SUA, I doubt that we will ever see anyone refute, with documentation, the assertion that silver is more rare than gold. Let me assure you – this is an important acknowledgement. Sure, the SUA only has its own self- interest in mind, but in promoting that interest, it is confirming a major unknown in the investing world, namely, just how rare silver has become.

It is just how unknown that silver is rarer than gold that makes this fact so powerful for silver investors. I think it is the most important long-term fact in silver. As it becomes more widely known in the years ahead, and it will, it is hard to underestimate the influence it will exert on the investors of the world.

Remember, nothing has to change in the physical realm in order for the force of the impact to be felt, just that more people have to become aware of a simple fact. In fact, not only does nothing have to change in the real world of physical commodities to establish the fact that silver is more rare than gold, but absolutely nothing can change in the decades ahead to change this fact. Let me restate that – never, or at least never in the lifetime of anyone reading these words today, will there ever be more silver above ground than gold.

I know that is an outrageous statement, but how could there ever be more silver than gold in the future? The only way that could possibly occur would be if the world began to produce giant annual mining surpluses of silver and continued those surpluses for decades. This, for a commodity that hasn’t produced a single annual mining surplus in the past 60 years. Even if the world produced an annual 100 million ounce surplus (a build in inventories) for 50 consecutive years, the amount of above ground silver would just equal above ground gold at that time. And it would take such extraordinary high silver prices for that to be accomplished, that I would love to be wrong in my assertion.

Now that it appears that my contention about silver’s rarity is being confirmed, I have heard the argument that rarity alone does not determine value. I don’t buy that, especially when it comes to a comparison of gold and silver. There are a number of reasons behind my thinking.

For one thing, at the very heart of gold’s perceived value is the very issue of rarity. Listen to the argument of any gold bug (many of which are good friends). Whether they look at gold as money, or insurance or the ultimate store of value, what they are really saying is gold is rare, that there isn’t much of it to go around. I emphatically agree; gold is rare. That is why it sells for hundreds of dollars per ounce. My only point is the simple fact that silver is more rare than gold. Draw your own conclusions.

Another point I would make that the comparison between gold and silver is not a loose one. If any two things ever went together in peoples’ minds, like love and marriage, horse and carriage, salt and pepper, it has to be gold and silver. No two other commodities hold, or have held, a closer pairing than gold and silver. They are natural and elemental companions, known to all people for all time.

The most important point I would make is that while these most natural of elemental companions are known to all people of our world, very few of the world’s citizens actually realize just which one is the most rare. If it were possible to poll everyone in the world, I’m sure that 99.9% would think that gold is more rare than silver. They would hold that opinion because gold is so much more expensive than silver and not for any other reason. Their opinion would be at odds with the facts. Therein lies the great opportunity for silver investors.

In a prior article (that I can’t even place, at this point) I remember writing about an exercise in which a typical second grade class was given the facts about two very similar commodities, without revealing the actual names of the two items. One was utilitarian, essential for modern technologies and living, the other was a luxury and non-essential. The essential one was being used up and there was less of it every day, the luxury item was accumulating. There was a lot less of the essential one, compared to the non-essential item. The class had to decide which one cost 60 times the price of the other.