TED BUTLER COMMENTARY

March 13, 2007

BACK TO THE FUTURE REVISITED

This article was written a number of weeks ago and has been distributed to IRI clients.

(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.)

Choosing which previously written articles are better than others is a difficult task for an author. It’s much easier for a reader. Many people have told me that they particularly enjoyed an article I wrote exactly six years ago, titled "Back To The Future." http://www.investmentrarities.com/02-27-01.html In fact, just the other day, Jim Cook, from IRI, asked me specifically if I could write an article just like it. I asked him how I could write what I already wrote, and left it at that.

In truth, I wish I could write that article again, not so much because it was good (I’m not that vain), but because I think I was able to convey the long-term investment merits of silver clearly. Certainly, anyone following the advice contained therein would have profited tremendously. After all, silver was under $4.50 at that time (gold was under $270). But none of us can turn the clock back, and it is hard to imagine such low prices in the future. But just because those prices are a fond memory, does that mean the long-term investment merits for silver are also a thing of the past?

Just this morning, a headline in the local paper resonated with me, and sparked this follow-up. For those who may not have read the original article, I compared the value of silver to the value of raw land 50 years ago. I gave many similarities between the two, including availability, low price and holding costs, the long term nature of each, and how both were overlooked by the majority of investors, raw land 50 years ago and silver at the time (2001). I compared the price between the two and concluded that silver was undervalued, and strongly implied silver was valued like raw land was valued 50 years ago.

The headline that caught my attention today wasn’t specifically referring to raw land, but real estate in general. The headline in the Palm Beach Post stated, "Real Estate’s New Dirty Word: Inventory. Investors exit once-hot market, taking sales with them and leaving homes vacant." I realize that real estate is a local market in many ways, and that this particular headline would not apply to every area of the country. But it does apply to many formerly hot areas and I ask your indulgence in order to make some new comparisons with silver. The whole point is to attempt to put things in perspective.

Like silver and other natural resources, real estate prices boomed over the past six years or so, until the past year or two. In fact, real estate began its run a couple of years before prices started climbing in silver and other industrial commodities. But, there were a number of important differences between the price rise in silver and the rise of real estate. That’s the very point of this article, namely, that while the original essay pointed to the similarities between silver and raw land of 50 years ago, this article is intended to show the differences in the silver rise compared to the rise we’ve seen in real estate prices.

There was a much higher "quality" and sustainability to the rise in silver than there was in the price rise in real estate in general. Please understand that my main intent is not to make the case that silver is a better investment than real estate or any other asset. I believe that to be the case, but my intent today is to analyze what were the reasons for the price rise in silver and real estate and for you to use that information to decide for yourself. In no particular order of importance, let’s see if we can identify the key differences in the nature of the price rise in silver versus real estate.

First, the real estate price rise took place with what had to be the maximum amount of public participation. Not only did you have to be living in a cave to be unaware of the rise in real estate prices, it was hard for the average citizen to not become involved in some way. Most often this was through mortgage refinancing to take advantage of higher home values and lower interest rates. In silver, the opposite situation was true. Only a very small percentage of the public could tell you the current price of silver, or what it’s needed and used for. Only a tiny fraction of that small percentage owns any type of silver. The point here is highlighting the old investment axiom that the biggest opportunities are found in the most under-owned assets. It’s hard for everybody to get rich by all doing the same thing.

Second, the nature of the public participation in the real estate price rise was principally on borrowed money, including the current fiasco de jour, sub prime mortgages. It wasn’t that long ago that most people had a goal of owning their home debt-free and to throw a mortgage-burning party. I haven’t been invited to any mortgage-burning parties recently, nor have I run across many folks buying properties for full cash payment. Everywhere I look, the new rule seems to be maximum extraction of home equity. While I have strong personal feelings about what this trend portends for the financial future of the average family, the point today is that most of the real estate buying has been fueled with borrowed money.

Contrast that to silver, where, away from the futures market, most buying has been on a cash basis. And even in the leveraged futures market, the big buyers have been a few technical hedge funds, not the public. And I have yet to run across a silver investor who has extracted equity from physical silver holdings by borrowing against them. This eliminates potential silver sales from over-leveraged investors being drained by high interest-related carrying costs. Simply put, real estate is usually bought on the chit, whereas silver has been purchased for cash on the barrel. The difference in the quality and strength of these two types of buying should be obvious.

Next, the run up to the top in real estate prices took on the emotion and frenzy of a true bubble. Ordinary people were buying for no other reason than the price was rising, which created a self-fulfilling cycle. Nothing else mattered, except that prices were rising and you were missing the boat by not jumping on board. Flipper was no longer a dolphin, but a type of real estate speculator. And as long as you were going to make a profit why stop at buying one property speculation at a time, the more the merrier. This led to a speculative frenzy, which is what today’s newspaper headline, was all about. The real estate market has a two-pronged problem: the sudden disappearance of speculative buyers and the glut of inventory to be absorbed, particularly vacant properties that generate never-ending expense drains.

Now compare that situation to silver. Aside from the recurring problem of tech fund buying followed by liquidation, there is little evidence of widespread public speculative buying in silver. There are no infomercials late at night pitching get rich quick seminars by buying silver, yet. Even though silver matched or outperformed even the hottest real estate markets over the past few years price wise, there is no "vacant" or unwanted silver inventory. Any silver investor who wishes to sell, can sell. I’m not trying to be cute here, as I know there are material differences between real estate and a precious/industrial metal. My point is that, unlike real estate, there is no evidence of widespread public speculation in silver. In fact, it seems hard to imagine, given collective human behavior, that there won’t be widespread public silver speculation at some point, and at much higher prices

Furthermore, there is no evidence of a build up in silver inventory for sale. Yes, there has been a rearrangement of previously owned silver inventory by many retail and institutional investors, but that suggests a movement of metal to more diversified and stronger hands. Overall world silver inventories have not increased, but decreased, since 2001 thanks to the silver deficit. Even if the silver structural deficit is now a thing of the past, as I suspect, that points to a balance in the supply and demand, which means inventories remaining unchanged. The only way inventories of silver could grow at this point is with sustained surpluses being generated. With industrial and investment demand apparently growing faster than production and recycling, it is hard to imagine inventory growth.

Simply put, the run up in real estate prices has resulted in a glut of vacant and other inventory for sale, while the run up in silver prices has created no obvious unwanted inventory. It follows, almost without saying that unwanted inventory creates downward price pressure. No unwanted and excess inventory, no downward price pressure. That is not to say that silver will not, and cannot, go down in price, just that it won’t be from real inventory liquidation. Paper inventory liquidation on the futures market is a separate and temporary issue.

I’m not intending to offer an opinion on the long-term merits of the real estate market, as that is not my field. But, I can’t overlook that the demographics of world population and economic growth would seem to favor silver, very much a vital world resource, over the domestic real estate market. It is a lot easier to see how continued growth in China and India would benefit silver compared to how it might benefit the domestic housing market.

My intent is to highlight the differences in the nature of the forces making up the respective price rises in silver and real estate, for the purpose of helping you decide the relative quality of the price moves of each. There are price rises, and then there are price rises. Price rises built on universal participation, on borrowed money, and based on the mob frenzy that rising prices will continue forever, have foundations of quicksand. Price rises built on very limited public participation, with little borrowed money, and based on legitimate supply/demand fundamentals, have a sound foundation.