TED BUTLER COMMENTARY

April 3, 2007

THE EXCELLENCE OF SILVER

(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.)

I write today about investments in general. But I want to make it clear that I am not intending to offer personal financial advice on how anyone should invest. You can’t offer anyone specific financial advice unless you are familiar with their personal financial situation. That may sound contradictory, since I have been an outspoken advocate for the merits of silver, but I don’t see it as contradictory. I observe the silver market closely, offer my analysis and opinion and back up what I write with factual data. After that, the individual must decide.

It’s no secret that we live in an increasingly complicated world. In financial matters, data and opinion change at warp speed. This has led to short-term thinking and investing with many newsletters and services dispensing advice to encourage this trend. Lately, I wake up to an imaginary million-dollar short-term trading contest on financial TV.

The thought of making enormous short-term profits is quite appealing. So is the thought of becoming a movie celebrity. The odds of consistent success in short-term trading are comparable to becoming a celebrity. I’m not saying it can’t be done, just that the majority can’t do it. This is coming from someone with a commodity futures trading background. Long-term investing offers the best chance for success. That leads us to the best choices for long-term investing. What’s best to buy and hold for a long while.

There are only a few basic asset classes from which to choose. Those are debt (bonds and other interest bearing instruments), equity (stocks and mutual funds), real estate and all others. The other category includes gold, silver, commodities, natural resources and things like art and collectibles. This article is intended for those investors who choose to decide for themselves what to invest in and wish to stay in control of their investments, rather than cede the control to someone else. This requires a certain amount of investigation, comparison, and reflection. The best way to do that is through listening to what others say or write and acting on what makes the most common sense.

Let’s look at the big asset classes and how they have done over the past 5 years, and are likely to do in the future. How an asset performed in the past is not necessarily a guarantee of how it will perform in the future. Examining the reasons for past performance is, however, a legitimate methodology for looking ahead. It’s hard to know where you are going if you don’t know where you’ve been.

I find myself confused by the stock market’s performance as time goes on. The S&P is up from the lows of 4 years ago (by almost 80%), but still lower than the highs of 7 years ago. So performance is mixed. More importantly, the prospective outlook is mixed. Analysts appear to be all over the spectrum on future economic and investment trends.

The debt market, both on the long and short end of the yield curve is about where interest rates have been over the past 10 years. There have been no great fortunes made in bonds, but interest payments have been consistent. For income derived from mortgage obligations, however, the recent news does not appear to be good. I am not anti-bonds, but I don’t see how the average investor will get wealthy holding them. In real estate, the performance was good, until the past year or two. Now, storm clouds have rolled in, courtesy of easy credit and excessive borrowing. When an asset looks like a bubble that has burst, its prospects won’t look good for a while. It’s hard to come up with anything positive to say about real estate as an investment because it’s currently over-owned and over-leveraged.

That leaves the "all other" class, which includes natural resources, industrial commodities and precious metals, including gold and silver. Not only has this asset class had the best performance of all assets over the past five years, the reasons behind that performance strongly suggest a continuation of this out-performance. Insatiable demand from China, and other fast growing economies, has driven the large price increases in natural resources. This demand is rooted in the quest to improve living standards. While there are no guarantees, a slowdown in the US economy might not derail that quest. Among major asset classes, natural resources still seem to have momentum and appear likely to outperform debt, equity and real estate.

An Easy Choice

If you conclude, as I have, that natural resources are the preferred asset class for the long-term, where is the best play likely to be? For me, silver is the head and shoulders favorite. It is the easy choice. Here’s why.

Price. While silver has outperformed equity, debt, real estate and gold over the past 5 years, it has under performed other natural resources. Copper, nickel, zinc and uranium went up more. As a value-investor, the price lag of silver to other industrial items is an inducement to buy. The items that outperformed silver went up for the same reason – stronger than anticipated demand. Silver shares this industrial demand, so the fact that it has lagged the others on a price basis creates the opportunity to buy a bargain. At some point in the future, silver’s price will greatly outperform everything else. However, that is not the case today, and it’s a big advantage for buying silver at this time.

History. Almost 65 years of consumption that exceeds production has decimated world silver inventories. These inventories took thousands of years to accumulate. For the most part, they are gone forever. The current price of silver does not reflect this to any significant degree. No other commodity has ever experienced this phenomenon to this extent.

The closest possible example is uranium, where decommissioned nuclear warheads coming to market allowed uranium consumption to exceed production for 20 years. The distortion in the law of supply and demand is now clearly being reflected in the price of uranium, which is up more than 12 times from its low point, and may be headed much higher. Since the situation in silver inventories is more extreme, it is reasonable to assume a minimum 12-fold increase from the low in silver, bringing a price of $50+.

Another major difference is that uranium is a "new" commodity, in that it has only seen increased demand since the beginning of the nuclear age in the middle of the last century. Therefore, it is reasonable to assume that new resources will be found and developed. Silver is an "old" commodity, in that it has been in demand since the dawn of civilization, thousands of years ago. Therefore it is reasonable to assume that giant new silver discoveries will be fewer and less rich. It is unlikely we will discover a new Comstock Lode.

Duality. Silver stands alone as the only practical investment vehicle that is both an industrial commodity and a precious metal. This places silver on a very unique pedestal. Few potential silver buyers recognize just how powerful this will be to the price. No other industrial commodity can experience broad-based retail and institutional investment buying. Silver already has, and will continue to see, such buying. Investors aren’t stupid. Not only will more and more of them come to learn the real silver story, the infrastructure and investment vehicles already exist to accommodate new investors. The trick is to position yourself before the masses arrive.

In the eyes of the world, only gold compares to silver as an investment. Maybe one in a thousand investors recognizes that silver is more rare than gold above ground. This is not a secret that can be hidden forever. When it becomes more obvious (through silver’s outperforming price action), expect fireworks as it collectively dawns on the world how little silver is available. Remember, based upon how much the above ground gold is worth ($2.5 trillion) to how much all the above ground silver is worth ($13 billion), gold investors are likely to recognize the rarity of silver before other investors. Gold investors are pretty sharp and will move quicker than others to jump on silver. If just one-tenth of one percent of the value of above ground gold moved into silver, that would come to $2.5 billion dollars, or about 200 million ounces of silver at $13/oz. That’s much more than total COMEX inventories.

Gold buyers anticipate the dollar will decline and see this as a good reason to buy precious metals, because as the supply of dollars is inflated, the value of metals is also inflated. The supply of paper currencies has been inflated much faster than the long-term 2% annual increase in the above ground stock of gold. This is the essence of the case for gold as an inflation hedge. But that’s even a better reason to choose silver over gold, as silver’s above ground stock has actually decreased by more than 90% over the past 65 years.

I’ve always called silver the good news metal because it doesn’t need bad news to go up in price. Others look to precious metals as insurance, which I understand. But even if you anticipate bad news ahead and desire an investment that can thrive in bad times, the fact that there is such a scarcity of silver, in total dollar terms, should make silver a better insurance policy.

The Bombshell. If there is one thing that separates silver from any other asset class, or any other item in any asset class, it is the presence of an unprecedented concentrated short position in COMEX silver futures. It is the existence of this concentrated short position that will, at some point, launch the silver price to the heavens. This short position has grown so large, and is held by so few entities, that it no longer matters how it will be resolved. It must be resolved and, whether that resolution involves default or buying by short covering, it will have the same bullish impact on price.

You don’t have to look any further than the concentrated COMEX short position as to why silver has not outperformed every other commodity. Just as it explains price under performance (if a triple can be classified as underperformance), it is telling you why there must be overperformance in the future. At some point, the price of silver must accelerate upward to price levels that are truly shocking.