WEEKLY COMMENTARY

April 5, 2005

SILVER, SILVER, EVERYWHERE

By Theodore Butler

(The following essay was written by silver analyst Theodore Butler. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

The latest Commitment of Traders Report (COT) indicates a continued improvement in silver, on the roughly 50-cent decline in price from the top over the past couple of weeks. The current reading of 55,000 contracts net dealer short position is down around 12,000 contracts from the top. The question is will we get another 5000-contract or so liquidation amid lower prices and a bottom, or does the market bottom here for other reasons. By my calculations, we are at, or soon will be at a great buy point in silver.

In gold, there appears to have been a major reporting error in this week’s report. By my calculations, the dealers’ net short position is misstated by 25,000 contracts. I notified the CFTC but they appear reluctant to delve into the matter. Future reports will determine if there was a reporting error.

It’s no secret that I am an enthusiastic student of the COTs and that I believe they are a reliable guide for short to intermediate price movements. In short, the COTs have been very good to me. But I also believe that the COTs will stop "working" one day, as they are not the ultimate long-term determinant of price; that honor belongs to the law of supply and demand.

Regular readers know that I have long-maintained a number of firm beliefs in silver. One of them is that a market in a physical consumption deficit must eventually result in some type of delivery crunch. Unless sharply higher prices develop and discourage consumption and/or encourage increased production, a deficit must create delivery problems at some point. If widespread shortages and delivery problems develop in silver, nothing could have greater impact on price. Therefore, we are always alert to signs that might signal the start of such delivery problems in silver. Recently, we may have been given new signs of wholesale physical tightening in silver.

If delivery problems and shortages come to silver, they must at some point show up on the COMEX, the most important silver marketplace in the world. Considering its silver pricing power and the fact that the largest known bullion stockpile is held in its licensed warehouses, it is not possible for the COMEX not to be involved in a silver shortage, when the shortage is visible to all. That’s why clues of a silver shortage emanating from the COMEX are closely scrutinized. I think we just got a doozy of a clue.

Tuesday, March 29, was the last trading day for the March 2005 COMEX silver contract, and on that day the March contract expired at a 3-cents per oz premium to the May contract. Although I have read very little comment about it, this is almost unprecedented in silver and is, in my opinion, a very big deal.

When a nearby month trades for more than the next trading month, it is a clear indication of tightness of supply in any commodity. The term for this is backwardation. (I have written a good number of articles on this and have predicted that this must occur someday in silver.) More importantly, when the backwardation involves the spot delivery month the tightness is obviously in deliverable supplies – the real thing.

Let me be clear – the premium of March to May developed because there was an inadequate real supply of silver available at normal price differentials relative to demand. In other words, buyers desiring real silver, right now, had to pay up to get that real silver. And this was no one-day affair. For the last 5 to 10 trading days of the just-expired March contract, there was notable and persistent buying by those seeking to secure immediate real silver. There was urgency to this buying that I had never noticed before in silver.

Who were these urgent buyers of this silver? While there is no way of knowing by name, we can be pretty sure who they were by type. These were, most likely, buyers who needed silver immediately. Not speculators or investors, but users. If you think about that for a moment, you’ll see why I think this could be of profound significance to the silver market. Investors would choose to wait for a silver delivery rather than pay a premium. What difference could it make to an investor to wait a little while? Only users would pay such a premium, because they need the material immediately and are less concerned with price. What makes this so interesting is that it’s the first time I recall silver users turning to the COMEX for immediate delivery silver and paying a noticeable premium. I have long expected such buying.

In addition, these real silver buyers seemed to know the particulars of the COMEX delivery process, namely, that all contracts must be delivered at a specified time near the end of the month. Buyers at the beginning of a delivery month may have to wait until the end of the month for actual delivery, but buyers at the end of the month know their wait won’t be long according to contract specifications.

Lastly, this "buyers motivated by need" scenario was further confirmed by the withdrawal of 2.4 million ounces of silver from the COMEX HSBC warehouse on Friday, April 1. Whereas an investor is normally content to store his silver at the COMEX, a user who needs silver, needs to take it out.

Now let me be careful not to misinterpret what may have taken place. First, we are not talking about massive amounts of silver. Second, there was different silver also brought into COMEX warehouses over the same time period, so the overall total inventories varied little. We are talking about subtle clues to possible physical tightening in silver. If we were talking about massive quantities, that would not be subtle, nor would we be trading around $7. As far as other silver coming into the warehouses at the same time, I think that only confirms the tightness scenario.

Because the COMEX inventories are the largest known bullion inventories in the world, they naturally draw much attention and conjecture. For instance, I witness continuous debate as to the amounts and change in the two categories of COMEX silver inventories, i.e., registered and eligible. I don’t dwell on the specifics of the categories, as it usually evolves into a debate on semantics. But I do understand clearly why there is such a debate and the underlying reason for the debate is important and valid. What people are trying to determine is the amount of silver in the most important COMEX categories. Those categories are the available and unavailable silver.

You won’t find those categories listed on the COMEX or on any other inventory, but that is precisely what we’re all trying to determine. The problem with looking at the COMEX registered and eligible categories, is that there is available and unavailable silver in both registered and eligible. So it seems to me that we should look at it from the perspective of what we’re trying to determine in the first place – how much of the total 100 million ounces in total combined COMEX silver inventories is available at current prices? My sense is not much.

Which brings us back to the silver that was brought into the COMEX, at the same time the buyers that needed the silver, took out silver. The silver that was brought in, I contend, was brought in precisely because the 100 million ounces that was already there was not available. Otherwise, why go to the trouble and expense of bringing in silver if there is available silver just sitting there? Obviously, you wouldn’t do that unless the silver already sitting there was not available. It belonged to someone else who was not interested in parting with it.

You know, this whole discussion on COMEX and other silver inventories and what is available or unavailable reminds of a classic poem I (was forced to) read in high school, about a sailor adrift on a becalmed sea and dying of thirst. It was "The Rhyme of the Ancient Mariner" by Samuel Taylor Coleridge (1772-1834). Here are the relevant passages -