Weekly Commentary

WEEKLY COMMENTARY

March 19, 2002

THE COMING SILVER EXPLOSION

AN IN-DEPTH INTERVIEW WITH SILVER
ANALYST THEODORE BUTLER

It’s our opinion that silver analyst, Theodore Butler has more knowledge about silver and the silver markets than anyone else on the planet. That’s a big claim. Nevertheless, we have presented difficult questions to him time and again to which he has responded with expertise. We have confronted him with various arguments that dispute his theories about silver and he has always demolished them. I personally believe that he’s right and that's why my company continues to forcefully present his dramatic case for silver. We recently conducted the following interview.

Q.        You and I have both written to the Commodity Futures Trading Commission (CFTC) recently to complain about the large short sales by a few bullion dealers. Can you explain your case?

A.        My case is simple - enormous, concentrated and uneconomic paper short sales on the COMEX have kept the price of silver artificially depressed for years. What makes matters worse, the silver paper short sales have become so extreme and obvious, it's clear to me that this selling is for one purpose only - to keep the price of silver cheap. It's manipulation in its purest form.

Q.        Short sales are a means to sell silver on paper. It's silver you don't have. You sell a futures contract and later you buy it back, or cover. Is that correct?

A.        Yes. I'm not against short sales. They are part and parcel of every futures market transaction. The futures markets could not exist without short sales. The basic definition of a futures contract is that one party is short and the other is long.

Q. There’s also a delivery component isn’t there?

A.        Yes, a short sale is an agreement to deliver a certain quantity of silver, or if you don’t deliver, to cover, or buy back the contract before expiration. A long (or buyer) agrees to accept delivery of silver, or sell out his contract before expiration. That’s the opposite of the short.

Q.        It sounds like everything gets balanced by expiration.

A.        Everything is not balanced by expiration, because 90+% of all futures contracts are "rolled-over", or extended when the expiration becomes due. So, there really is no true expiration. But much more importantly, of all the regulated commodities, only in COMEX silver is the total short position larger than what could possibly be satisfied by real delivery.

Q.        Explain?

A.        I mean that the short position in COMEX silver, in futures and call option contracts, is larger than all known silver bullion inventories in the world. The short position is also greater than all the silver that could be mined in the world in a year. This situation has never existed in any other regulated commodity. This situation has existed continuously in COMEX silver for the entire time I allege that silver has been manipulated, for the past 15+ years. In fact, this is the reason (plus leasing) that silver has been manipulated.

Q.        Can you put it into numbers?

A.        Well, as of today, March 15, there were roughly 120,000 silver futures and call options contracts open on the COMEX. That's equal to 600 million ounces of silver. World mine production is less than that, and there are no more than 125 million ounces of documented silver bullion inventories in the world.

Q.        Compare that to gold.

A.        Today, COMEX gold open interest is around 265,000 contracts in futures and calls, or 26.5 million ounces of gold That’s less than one-third of world mine production. That’s less than one per cent of known bullion inventories of three billion ounces. If gold was the same as silver there would be nine billion ounces short. What a joke. This sick situation does not exist in any other commodity.

Q. Why do you call it sick?

A.        Because it should be impossible to have a short position bigger than what exists or could be produced. Think about it. Let me go one step further. This is all the proof that anyone would ever need to know that silver is manipulated. This large short position would be impossible in any other item, commodity or otherwise. And how the COMEX and CFTC can sit by and ignore this aberration is beyond me.

Q.        I can accept the comparison to world production, but isn't there more than 125 million ounces of silver in the world?

A.        Of course there is more silver than that. But I use verified inventory, because that allows a scientific, objective comparison to other commodities. Apples to apples. Also, the COMEX contract calls for a very specific form of silver bullion. While there is much more silver in the world than 125 million ounces, how much is available and in either good delivery form, or that could be converted to good delivery form? I mean, I hear these stories about billions of ounces in India, for instance. But what form is it in, jewelry? And its ownership is spread among hundreds of millions of people. And even in 1980, when silver hit $50, there was no big Indian silver dumping. It's just silly to think that Indian silver backs the COMEX short sellers.

Q.        But isn't there a long for every short? Doesn't that balance out things?

A.        The longs are different from the shorts. They have different responsibilities. Just because there's a long for every short, doesn't mean a market can't be manipulated. Let's face it - we have had many instances of manipulation over the years, and in every case, there was always a long for every short. That didn't necessarily preclude manipulation. Try as you may to justify it, it's one of those things that sounds logical until you think about it further. There is no logical economic backing to the excessive COMEX silver short position. And frankly, it's even worse than I've described so far.

Q.        In what way?

A.        Not only is the short position in COMEX silver bigger than any short position has ever been, or could ever be, it doesn't even appear to be the real producers who are doing the selling. For example, just today, Pan American Silver, reported their earnings; or, I should say, their lack of earnings. They reported a loss. Same as Coeur d'Alene, Hecla and every other primary silver miner I'm familiar with. The reason given for the losses, just like the reason for the bankruptcy of Sunshine Mining is the low price of silver. None of these companies can make a profit because the price of silver is too low. Not surprisingly, none of these companies are selling silver short on the COMEX, although they, as producers, would be considered to be the logical sellers. That's because the COMEX and all futures markets exist for the purpose of allowing real producers and consumers to hedge. That is the economic purpose and justification as to why we even have futures markets. To allow hedging.

Q.        You say the price of silver is too low for producers to profit and the producers aren't selling or hedging on the COMEX. So if the real producers, the natural hedgers aren't selling short on the COMEX, who is?

A.        The speculators. You have to be one or the other. You are either a hedger or a speculator. If the hedgers aren't selling, then for sure, the speculators are. And that makes the short selling on the COMEX that much worse.

Q.        Why is that worse?

A.        Because then there is no economic justification for the short position on the COMEX at all. Look, I can show that the COMEX silver short position is the biggest short position in history. Now, I can show it is being done by speculators, and not real producers. It is illegal beyond question.

Q.        Illegal?

A.        Absolutely. The main purpose of commodity law is to prevent manipulation. The economic justification for futures trading is to allow hedging. The speculators on the COMEX have driven the price of silver so low, that the producers not only can't hedge, they can't even show a profit, or stay in business. The main premise of commodity law is that the real producers and consumers of a commodity should set the price of the commodity, not speculators. In Comex silver, the short selling speculators run the show. And that's flat-out illegal. How the miners sit by silently and allow this to happen is beyond me. They act as if everything's just fine.

Q.        What about the CFTC and COMEX? Don't they see this problem?

A.        Jim, I read your letters to the CFTC and their response, just as you have read mine to them and the COMEX. In addition to taking three months to answer you, did you feel they even addressed the issue fairly?

Q.        Well, no.

A.        I don't know why the COMEX and CFTC won't address this issue and fix the problem. It is plain as day. And it's disgraceful.

Q.        Do you know who the big speculators are?

A.        Mostly the dealers, but sometimes the technical hedge funds. Right now, it's the dealers, although the dealers are trying to lure the hedge funds onto the short side.. For the new Commitment of Traders report issued today, the concentrated net short position of the 4 or less traders has increased to over 181 million ounces, a recent record and thoroughly obscene naked short position. If there are 4 traders, and not less, that means they hold an average of over 45 million ounces net short, each. Just to put that number, 181 million ounces, into perspective, that's equal to the entire silver mining output of the most silver-prolific continent in the world - North America. 4 or less speculative traders are short what every silver mine in Mexico, the US, and Canada produce in a year. It's totally crazy. With that kind of short selling, it's a wonder the price isn't two dollars.

Q.        But who are these big speculators?

A.        We can only guess, because the CFTC keeps that secret, although I am trying to get that changed. The likely candidates are Goldman Sachs, AIG, JP Morgan Chase, Bank of Nova Scotia, HSBC - the usual group of suspects. The ones I have publicly accused of being involved in this unsavory enterprise. Certainly none of them is coming forward to admit to being one of these 4 or less traders. While the CFTC will undoubtedly hide behind the law preserving these traders identity, it is a selective enforcement of the law. The CFTC ignores the laws on manipulation and speculative position limits. We are in a new day and age of transparency in the markets, and there is no reason that any trader holding a net short or long position in any market of 5% or more, should not be publicly identified. Just like the SEC makes anyone with a 5% holding of any stock publicly disclose the position.

Q.        So futures trading in silver has changed from producers and users hedging to big speculators trading?

A.        Absolutely. Contrary to every concept of futures trading, the speculators have pushed the real producers and consumers aside, as far as price-influence goes. The lunatics are running the asylum.

Q.        They control the market?

A.        Without a doubt. These dealer/speculators and hedge fund/speculators deal in amounts much larger than the real producers and consumers, who are basically absent from the COMEX. It's like having the front line of the St. Louis Rams against the local high school team. It isn't even close. How could it be? These well-financed dealers are swinging around obscene amounts of paper silver. That's what sets the price.

Q.        What's really going on with these short sellers? What do you think they are up to? Is it any more than trying to profit?

A.        I can only guess here. Like most things, the silver manipulation started out small. I won't say innocently, but small. I think the dealers realized many years ago, that by buying, or selling a few more contracts, they could influence the price. They could set off stops. They could force liquidation. They could "goose" the market. What at first may have been normal market-making (taking the other side of any trade) became complete dominance and manipulation.

Q. Can they continue to control the market?

A. Like any process, there are always unintended consequences. In silver it’s the requirement that they short more and more contracts and they become a larger and larger percentage of the short side. That's why 4 or less of them are net short all the silver produced in North America. Once the dealers went down this path, there was no turning back.

Q. So they are going to maintain the upper hand?

A. I don’t think so. Silver is a worldwide commodity. By putting its price artificially low for so long, another unintended consequence is to attract outside investors to the low price. Jim, your customers aren't the only ones awakening to the merits of buying silver at these prices. The more the dealers and other speculators sell short, the more outside investors (like Warren Buffett) see a historic opportunity. The increased and concentrated dealer short selling keeps the price low, as long as there’s silver to supply the deficit. The minute the dealers can't short sell more, or there’s no more silver coming in from leasing, the self-fulfilling process stops. We explode. And considering how noticeable the concentrated COMEX short selling is becoming, it's hard to imagine it having a very long life.

Q. But, isn’t it also true that some hedge funds and speculators are increasing their silver holding? With gold edging up and a lot of people looking more favorably at silver, couldn’t this offset the short sales of the big four you mention and push silver up?

A. Sure, the big shorters could get overrun. Or, the dealers may succeed in getting the funds to go short on lower prices and transfer the short position “hot potato” to them. But, because of the structural deficit, whomever is short when we get to the moment of truth, is going to have a very big problem.

Q. We could have a short squeeze couldn’t we?

A. Not could, we WILL have a short squeeze. In fact, we will have the biggest short squeeze in history, because we have the biggest short position ever. The only thing we didn’t know is who will be squeezed or when. Of course, to those who own silver outright, it doesn’t matter who gets caught short. But for sure, someone will get caught short.

Q. What would silver be priced at without these short sales?

A. That's a tough one. If we never had these excessive short sales over the past 15-20 years, and no one ever thought up the stupid practice of metal leasing, that means the law of supply and demand would have been functioning freely for the past two decades. In that case, I'd guess somewhere between 15 and 30 dollars per ounce, depending upon how widely recognized silver had become as an investment and depleted vital resource.

R. Low prices do damage to the supply don’t they?

A. Yes. Because of the artificial low price created by short selling and leasing, we have consumed far more silver than we would have otherwise. There has been no consumption constraints, resource conservation or the new production that a free market price would have provided, so all bets are off.

Q. What price can rectify 20 years of manipulation?

A.        A shockingly high price- $50 or $100, or maybe much, much more in a price spike. This is a worldwide commodity. I don't know how people around the world will behave once the real story on silver comes out, and they start to recognize how vital this material is, and how little there is left. If they behave as emotionally as the professional investors and speculators did in the dot-com bubble, my price assumptions will prove low. We all know higher prices make people want to buy items more than low prices. I can tell you this - once this silver price juggernaut gets rolling, it will not be stopped until it runs its natural course. There will be no government, not the US or anyone else, who will be able to put out the silver fire, once it starts burning, because there are no government inventories left. The silver conflagration will have to burn itself out.

Q.        How about giving us a "way-out" silver prediction, you haven't previously written about?

A.        I've been concerned that the US Mint has become very closed-mouthed about the amount of silver they have remaining for their coin programs, and when they will commence buying silver. That will be the first time since before WW II, that the US is a buyer of silver. I think this could be a market-moving event. I know a lot of people say it is discounted in the market already, and what difference does it make, since the Mint needs only 1% of total world silver consumption for its programs. I disagree. First off, the proper comparison is to total supply, not demand, and the amount, 10-12 million ounces is closer to 1.5 to 2%. That demand could easily grow to a much bigger amount, as the Mint produces its silver Eagles to meet demand. There are very few users in the world that consume what the Mint will consume, maybe five or ten.

Q. I thought the U.S. running out of silver was old news?

A. No, I think it will still be a shock when people understand that for the first time in over 200 years, the US is flat out of silver. The real kicker could be that the Mint would cease production of new silver Eagles, which would undoubtedly cause premiums on previously issued Eagles to jump. It would also confirm to the whole world that the US is officially out of silver. Either way, it makes silver look attractive, and may explain why silver Eagle sales have been strong.

Q.        You mentioned leasing. That's a process where an organization that holds a large amount of silver leases it out to get an interest rate on their silver. The ones who pay the interest sell the silver and use the proceeds for their own purposes.

A.        This is the key to understanding silver. And it's the one thing people have trouble understanding, because it's also one of those things that sounds all right on the surface. But once you dig into what metal leasing is all about, it's something else entirely. When you really analyze leasing, when you pick it apart objectively, you will see it is something that is not only stupid but manipulative. What appears to be a simple and innocent way for a central bank to gain interest on a fallow asset, and a great way for a borrower to get access to cheap funds, is really a perversion. I keep saying it's not a lease, it's a sale, because the collateral is destroyed or sold, and can't be paid back. More importantly, the metal is dumped on the market, depressing the price.

Q.        How much of this kind of silver can there be left?

A.        Boy, that's the billion dollar question. No one, certainly not me, knows for sure, except those who have been leasing the silver, such as the Philippine Central Bank. But, there has been over a billion ounces already loaned out, and dumped on the market, by my estimates, so we do know they're a billion ounces light from where they started.

Q.        The lease rate has gone up and down recently. What's it mean?

A.        Just to keep it simple, high lease rates mean a tightness in the wholesale physical market, low rates means there is no availability problem at the moment. The important thing to keep in mind about lease rates, is that because these are short-term vehicles, mostly 30 days, the rates can change abruptly from day to day. When we get a problem in the lease market, as evidenced by high lease rates, it comes suddenly, without warning. For an investor, waiting for lease rates as an buy signal, can cause you to miss the market.

Q.        What about coin melts and other sources of silver?

A.        Since there appears to be premiums on all silver coins, I can't imagine there is a coin melt presently under way. As far as investors selling silver, I would think you would be in a better position than me to answer that question. Do you see widespread investor silver liquidation?

Q.        No, but I'm trying to get to the bottom of where this silver is coming from? Every month we need 10 million ounces above and beyond what comes from mining and scrap recovery. That's a lot of physical silver. I feel like I'm missing something.

A.        Jim, I know how you, and anyone who has looked at the silver situation must feel. You sit there studying statistics and facts that show a structural deficit and disappearing inventories, yet the price doesn't reflect that. So, naturally, you get frustrated and begin to question if the facts are correct, or is the low price telling you the real story and the facts are wrong.

Q.                Well, where do you think it’s coming from?

A.        What you're asking, is what I asked myself a million times more than 15 years ago. Where is the material coming from to satisfy the deficit? I knew that the uneconomic and excessive short sales on the COMEX were artificially depressing and manipulating the price of silver. And I tried to do something about it. I wrote and called and complained to the COMEX, the CFTC, Congress, state governments, corporations. I have enough letters for ten books. But, I couldn't answer where the silver was coming from to satisfy the deficit. I knew how the price was kept down, through massive short selling, but I couldn't figure out how the mandatory inventory liquidation was taking place, to make up for the short fall, with such low prices. Driving the price down was one thing - keeping it down with continued supplies was something else. I gave up. That's right - I quit. I withdrew from the investment business in 1988 (I had been in it since 1971, when I became a commodity broker for Merrill Lynch), because I couldn't figure out where the silver was coming from. There were other things that influenced my decision, of course, but you have my word that not figuring out where the silver was coming from, at such low prices was number one by far. I went into hibernation. So, I have respect and understanding for you and anyone else who is frustrated by the continued low price and deficit. You don't know what frustration is, until you grasp what my frustration was.

The good news is that even though it took a terrible toll on my personal life for ten years, I finally figured out where the silver was coming from in 1995 - leasing. You don't have to look anyplace else for where the silver is coming from to satisfy the deficit. The answer is leasing, leasing, and leasing. And it will be over soon, because it is so stupid and manipulative. And has created the buying opportunity of ten lifetimes.

Q.        Are you dead certain you are on the right track with this? When things don't happen right away, people begin to doubt your argument and become skeptical. How do we know you are right?

A.        You'll only know if I'm right or not with the benefit of hindsight. I'm an analyst, but I'm also human, so I can be wrong. I'm wrong as far as timing goes, because I thought silver would explode long ago. Nevertheless, I have no doubt that my views on silver are correct. I have been very careful in what I tell folks. I don’t exaggerate the facts. I tell them that the best way to buy silver is on a fully paid for, physical basis. That way, timing doesn't matter. There are sexier ways to buy silver, including stocks, and employing leverage, but no surer way than unencumbered real silver. And as I've told you before, Jim, I don't want folks buying silver just because I say so. I give reasons, lots and lots of reasons, all based upon publicly available data. I don’t think I’m wrong, but everyone has to examine my argument and decide for themselves.

Q.        People think they can make more money in stocks and mutual funds in a slightly improved economy than with silver. What do you think?

A.        Maybe they can, I don't know. I don't like badmouthing something I'm not sure of. I'd rather be positive, and stick to what I know. . I've studied silver as intensely as I believe is possible. An improved economy makes silver a sure thing, in my opinion. The production and consumption statistics make it clear there’s a tremendous silver shortage that will be there no matter what the economy does. People tend to buy more silver during inflation than deflation. But it doesn’t matter. The price must rise in the most dramatic and explosive fashion to bring the market into balance. To me, this outcome is a given.

Q.        Are you saying that silver is the best thing in the world to own?

A.        If there's something better, I'm all ears and eyes, but I'm not aware of it. I am aware of silver. I'm aware of how vital it is to modern life. I'm aware that it is captive to demographics; the more people, the more silver needed. I'm aware everyone in the world knows what it is, and may be a potential buyer. I'm aware we've used up all of history's inventories. I'm aware that its future production is complicated by its byproduct nature. I'm aware it has the largest short position ever seen in anything, and how this will fuel a price explosion, by itself. I'm aware it can't go bankrupt or worthless. I'm aware that it's current cheap price has wrung the risk out of owning it. I'm aware that it's the best candidate for a grand slam home run I've ever come across.

Thank you.