WEEKLY COMMENTARY

April 13, 2004

The Relative Value Of Silver

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.)

As I was preparing this article (April 13), the gold and silver markets moved dramatically to the downside. No one should be terribly surprised. The important point is that the dealers succeeded in tricking the brain-dead tech funds again.

There is something I must say about today's dramatic price decline. Kodak and the users didn't use less silver than normal. The miners didn't produce more silver than usual. Nothing in the world of real silver changed - just the price. That's because of the paper games on the COMEX. That's expressly against commodity law.

Further, today's dramatic decline proves, without a doubt, that the commercial dealers are operating as a wolf pack. There is no competition between them to buy back their shorts. They are operating from a predetermined game plan to not break ranks and let the tech funds and other liquidating speculators come to them. It's kind of like watching a pack of killer whales go after baby seals. This is as far removed from free market behavior as possible. Where is the CFTC?

I know that the commercial dealers engineering this sell off do not have real silver, and they are desperate to cover their massive short positions. Once they cover as many shorts as they can, we go up, probably straight up, as the only reason we have dropped so dramatically is to allow them to cover. This is clearly illegal behavior, sanctioned by a questionable organization, the NYMEX, and a malfunctioning government agency, the CFTC.

If history is any guide, this sell-off will be over soon, but may still have some room to run. Once the tech funds are shaken from the long side, and maybe even gone short, the all-clear signal will be apparent. In my opinion, this will be the last all-clear signal in silver that we will see before moving dramatically higher.

Now, on to other matters. The most recent Commitment of Traders (COT) report, for positions held as of April 6, indicates a further shocking increase in historic extreme mismatch in gold, with the dealers holding their largest short position and the technical funds loaded on the long side. While the dealers were heavily short in silver, they haven't changed their position in months. As I indicated previously, it was my sense the dealers were going to engineer a sell-off in gold, in order to induce a liquidation in silver.

The reason I dwell on the COT, especially when it is at historic extremes, is not to tempt anyone to trade silver, as short term traders generally have a very poor overall track record. Besides, most people aren't suited to handle such trading, as it has nothing to do with value and putting time on your side. The reason for my attention to the COT is to try to explain, in advance, why prices may move contrary to the real fundamentals. Let's face it, the fundamentals in silver couldn't possibly be any more bullish than they are, what with a documented, structural deficit staring us in the face. This deficit guarantees shockingly higher prices in time. Guarantees. But because silver is clearly manipulated, it's wise to be aware of that manipulation and how it works. Since we know that the commercial dealers are the ones doing the manipulating in silver, staying alert to their position will help explain sudden moves which benefit them.

What I'm saying is it can be helpful to a long term silver investor to understand and appreciate, if we experience a short term sell-off, just why that sell-off is taking place. It is taking place because the dealers are able to maneuver the tech funds in and out of the market short term, not for free market and sound economic purposes. If we sell-off in gold and silver, it will not be because of some change in the underlying real fundamentals of supply and demand. It will be because the dealers were able to maneuver and manipulate the tech funds out of their long positions, once again. Once again, speculators setting the price of real commodities through paper trading games is illegal.

We don't know if the dealers will succeed in tricking the funds again. What we do know is if they do succeed, it will set up a buying opportunity in silver of extraordinary opportunity. The fundamentals say we are going much, much higher in silver, with or without a sharp sell-off first. It is not possible for everyone, or even for many, to hope to get fancy and to sidestep a potential decline and rebuy after the possible decline. That's a prescription for losing a long term position, something that must be avoided at all costs, as losing one's silver position at this stage of the game, would be the worst thing that could occur.

We appear to be approaching a critical juncture in the silver market from a physical and regulatory perspective. Out of the blue, there appears to be unusual and price-influencing physical silver demands in place. One demand is from a very public source, the Central Fund of Canada, which I've written about previously. The Fund, primarily because of investor demand for the silver component of its gold/silver bullion holdings, has been able to issue more shares and dramatically increase its silver holdings from roughly 7 million ounces at the end of 2001, to just under 12 million at the end of 2002, to just under 20 million ounces at the end of 2003, to over 26 million ounces at the end of March, 2004. In other words, the Funds silver holdings are double what they were 15 months ago, and nearly fourfold in the past 2 and a quarter years. Basically, this is real silver taken off the market forever. It is interesting to note that prior to 2001, there was very little additional silver bought by the fund in its 40 year history. This is a relatively new phenomenon that shows every indication of continuing and accelerating.

What makes this one demand force so interesting at this time, is that the Fund is waiting for delivery for 7.5 million ounces purchased and paid for, but not yet delivered. The Fund doesn't have to wait long for the gold it purchases, but it must wait for silver on a regular basis, usually for months. As a reminder, a commodity in which delivery delays are common, is a commodity, by definition, that is in shortage. I guess that shouldn't be surprising for a commodity in a structural deficit.

The second demand force is from the rumored purchase of an additional 8 million ounces from another Canadian institutional investor. As I've written previously, the rumors come from good sources. Like the Central Fund of Canada, the silver has been purchased, but not delivered. Delays are expected. Together, or separate, these silver deliveries will be hard to meet, in my opinion. They have the potential of disrupting the market if they can't be met.

Whether it's these specific actual delivery demands that break the back of the manipulative shorts may be in question. What's not in question is that in any commodity in a deficit, at some point there will be a delivery demand that can't be met. It's just a matter of time. In the speculation department, I feel these real physical delivery demands are a big deal and the shorts know it. Ironically, I sense that these delivery demands may cause the dealers to maneuver the market down quickly, to induce tech fund liquidation before the delivery demands hit the fan.

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As I was finishing this article, the NYMEX issued a press release, dated April 8, that it had received and was considering a takeover offer from a small private investment firm. This is pretty big news that should be monitored closely. The offer did cause me to study the NYMEX's recent 10K annual report to the Securities and Exchange Commission, dated March 5. I found a very interesting section in this report.

You may recall, on February 16th, in an article titled, "Keeping The Pressure On", I highlighted a press release from the NYMEX that announced that $10 million would be available at all times to reimburse any retail customers damaged by a default. I speculated that this press release concerned a silver delivery default and came about due to pressure that the petition to Eliot Spitzer created. In that article, I explained why I had a much better and fairer solution.

While the President of the NYMEX, J. Robert Collins, is quoted saying in the press release, "we are pleased to be able to offer this additional layer of protection to our already stringent safeguards", the real reason for the announcement is revealed on page 38 of the 10K, filed with the SEC, under Other Matters -

"In February 2004, the Commodity Futures Trading Commission ("CFTC") issued an order requiring, among other things, that the Company (NYMEX/COMEX) establish and maintain a permanent retail customer protection mechanism, supported by a commitment of not less than $10 million, which must be available at all times to reimburse retail customers trading on the Company's exchanges whose original margin might be lost in the default of another customer of their clearing member. Based upon historical patterns, the Company believes that the likelihood of events that would require its performance under this CFTC order is remote. Therefore, the Company has not established, and does not expect in the future to establish, a liability related to this commitment."

Clearly, the NYMEX did not establish this commitment willingly. No matter how "pleased" they said they were, it is obvious that the NYMEX was forced to do this by the CFTC, who, in my opinion, was forced in turn by Eliot Spitzer. It would be interesting to know what the "other things" were in the CFTC's order, but they're not saying. There should be no doubt, in anyone's mind, who has followed this issue that there are things happening behind the scene. Things that promise to lift the yoke of manipulation from the silver market.

While it's clear that the manipulators will fight to stall and drag this out, the handwriting is on the wall - time is not on their side. It is on the side of the long term real silver investor. Whether we get one final tech fund sell-off, or not, the drumbeat of the deficit, new delivery demands and regulatory developments mandate sharply higher prices. The key to successful investing is to buy and hold assets priced too low, while they are still too low. Don't get fancy and let this silver opportunity get away from you.

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Here’s a recent letter I received that was quite interesting:

Ted Butler

Re: Silver Price Manipulation

Dear Mr. Butler:

I have been a long time reader of the revelations regarding the manipulation of the price of silver, which you make available to Investment Rarities, Inc. I can’t tell you how much I have enjoyed reading what you have to write. I never get tired of hearing the arguments you make. I can’t thank you enough for an education which has resulted in several very lucrative silver positions.

I must tell you, I am also very much enjoying watching the unraveling of the shorts. You predicted this event, and in large part, single handedly caused it. At times I am concerned for your safety. You have reason to be very proud of yourself. I can also assure you that there are some of us out here who are extremely proud of you and what you have done. The attention you have brought and the pressure you have created have put the shorts in a position where they simply cannot hammer the price of silver at will any longer, for fear of proving you right.

I signed the petition you originated, and also wrote to the regulators, as they requested and at your suggestion. To date I have not received a reply.

Forgive me if I am out of line for taking the liberty of offering you some novel, persuasive ammunition. Should you choose to develop the idea, and write about it, I do not require any recognition. Use it as you wish, with no conditions from me.

I reviewed a table which shows THE AVERAGE AMOUNTS OF THE ELEMENTS IN EARTH’S CRUST IN GRAMS PER METRIC TON OR PARTS PER MILLION. It is a copy of Table F199 from the HANDBOOK OF CHEMISTRY and PHYSICS, 58^th Edition, 1977-78, published by CRC Press, Inc. 18901 Cranwood Parkway, Cleveland, Ohio 44128.

The argument would go something like this:

1. Doing the arithmetic, there is about 20 times more silver in the earth’s crust than gold. So, why is the price of silver only 1/54^th of the price of gold (down from 1/80^th a year ago), especially in view of silver structural deficits, dwindling supplies of silver, and inelasticity of production capability? You can do the rest, as you do so well.
2. There is about 700 times as much copper in the earth’s crust as silver. So, why is the price of silver only 70 times as much as that of copper? Again, structural deficits, dwindling supplies and production inelasticity apply more strongly to silver than copper. Copper and silver are both industrial metals, so the comparison is closer to apples versus apples, than a comparison to gold. So, the conclusion that the price of silver has been manipulated is inescapable when comparing the price of silver to that of copper.

At some point you have to ask yourself, how do the shorts get out of their positions. It looks to me that they are now manipulating the price of the mining shares, particularly Coeur d’ Alene and Hecla Mining. It appears that they pound the price of these shares for periods of time, even when silver is rising significantly. Obviously there is an accumulation going on if you look at the size of the bids. Then one day when they are loaded up on shares, they cover a portion of their short positions, driving the price of silver up. They also let the price of the shares rise, and start unloading them. The profits from the share sales offset what they give up to get out of their short positions. After unloading their mining shares, they drive the price of the shares back down, and repeat the procedure.

This argument is much tougher to sell, and I really do not think you should try to sell it. The shorts have to have some sort of exit strategy. And, although this is unfair to the mining stock shareholders, the shares will rise over time. Perhaps more significantly, silver is slowly being freed of the manipulation in a somewhat orderly fashion. If, however, you can figure out how to make predictions from the pricing anomalies, I would very much appreciate being copied in on that.

Please feel free to telephone if you have a moment, or would care to discuss this further.

Sincerely,

Jack N.

Attorney from California

First, while I don't do what I do for accolades and attaboys, I must say I am somewhat overwhelmed by the exceptionally kind words from the author of this letter. Those words are greatly appreciated. Second, I hope anyone who feels he has something to add to the general silver knowledge pool speak up, as Jack has.

I'd like to discuss a key point raised in the letter, namely, the relative value of silver, gold and copper, as I think the author raised a very important issue. I don't think one could find two better commodities to compare to silver than gold and copper. Gold, because it's the natural companion to silver as a precious metal, and all that implies. When the average person hears the term precious metals, invariably he thinks gold and silver. Copper is also a terrific comparison to silver due to its geographic production similarities and its broad demographic and GDP-sensitive consumption patterns. Coincidentally, these three commodities are the principal metals traded on the NYMEX/COMEX, the world's largest physical-delivery futures exchange.

The author raises a scientifically valid point, in that one would think that there should be a fairly close relationship between the amount of these minerals deposited in the earth's crust and their respective prices. On this methodology silver should have a current value of $21/oz, since gold is $420/oz and silver is 20 times more plentiful in the earth's crust. Using a copper price of $1.30/lb, and the 700 times that copper is more plentiful in the earth than silver, silver should have a current value of $62/oz.

I'd like to tweak the methodology a bit, but still adhere to the author's main thesis. In order to eliminate any possible dispute as to the validity of the source data (amount of each element in the earth's crust), let's compare the three by a measurement that can't be disputed - the amount of each actually taken from the earth's crust, or world annual mine production. Using round numbers, in metric tons, world mine production for gold is 2500 tons, copper 12 million tons and 18,000 tons for silver.

That means the world takes 7.2 times more silver from the earth than gold. Therefore, if gold was 7.2 times the price of silver, silver would be priced at $58/oz ($420 divided by 7.2). Remember, there is a lot more gold above ground than silver, by a very wide margin, say 3 to 4 billion ounces of gold, compared to 0.5 to 1 billion ounces of silver, so the relative above ground potential inventory of each would support a much higher price than $58/oz for silver. Also, since silver is in a structural deficit, its above ground inventory is shrinking, while gold's is growing.

Copper world annual production is 666 times larger than silver production, not much different than the 700 times more plentiful that copper is more plentiful in the earth's crust, meaning an equivalent value for silver for around $60/oz. Using the metrics of the amounts of each element found below ground and by actual production and current prices for copper and gold, we come to four equivalent price points for silver - $21, $58, $60, and $62 per ounce.

One very interesting comparison is the price of copper relative to gold, using the actual world mine production metric. The world produces 4800 times more copper than gold each year, meaning gold should be 4800 times more expensive than copper. Remarkably, the price relationship between gold and copper is on the money - a ton of gold is worth $13.5 million ($420/oz x 32,151 oz), while a ton of copper is worth $2860 ($1.30/lb x 2200 lb.). Dividing gold's price of $13.5 million by copper's $2860 price per ton, we find gold is 4720 times more expensive than copper.