(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.)

Back in October, I wrote an article entitled "The Real Gold/Silver Ratio Part II." In that article, http://www.investmentrarities.com/10-24-06.html, I introduced some new data concerning the relative total market capitalization of above ground gold, compared to silver, over the past 100 years. The purpose of the article was to demonstrate that the gold/silver price ratio was inadequate to fully convey the profound changes between these two precious metals.

I concluded that, due to the extreme rarity of above ground silver bullion compared to gold, silver would almost certainly outperform gold as an investment in the long term. As regular readers know, I have made that point often, starting with my very first article for IRI.

Why do I persist in suggesting a switch from gold to silver? It’s a sensitive issue. Gold holders are devout believers in its merits. I also understand I can be criticized for appearing to badmouth gold. That’s why so few ever raise the issue of substituting silver for gold ownership. I do for several reasons.

I consider myself to be an analyst, I study and weigh all the available data. I am not suggesting selling gold and calling it a day. I am suggesting a switch from gold to silver. A switch is a simultaneous purchase and sale. It doesn’t mean I think gold is going to go down in value. It means that I think silver is going up more than gold is going to go up; much more.

Recently, I have been surprised by a unanimity of opinion among gold analysts that silver will outperform gold. However, there is never a suggestion to switch gold into silver to capture that outperformance. I don’t understand that. To me, the whole purpose of investment is to be positioned in what you think will go up the most. My suggestion of a switch from gold to silver is meant for those who predominantly own gold and don’t have the available funds to buy silver. There’s no need to sell gold in order to buy silver if you have the cash available to buy silver, or if you have other assets that can be sold.

If you think I’m appealing to a narrow potential audience, the facts argue otherwise. The total dollar value of the 5 billion ounces of above ground gold today is close to $3.5 trillion. The one billion ounces of above ground silver bullion have a value of $14 billion. There is 250 times more gold in dollar terms, than silver. That’s trillions versus billions. Very few grasp the significance of this dollar imbalance. As time evolves, more will become aware of this mismatch and, as I will explain, it has profound implications for the price of silver.

Another reason I advocate switching from gold to silver is that it still makes sense at current prices. The gold owner has an advantage in switching now because we still have a low risk, high return opportunity. That’s because gold and silver have generally moved in tandem over the past few years. Silver has mildly outperformed gold. From the dead lows, gold is up 2.75 times in price, while silver is up 3.5 times. Silver has not run away from gold. But it’s just a matter of time until it does, in my opinion, based upon the available facts. Then it will be regret for those who didn’t make the switch. Six months have passed since I wrote the article referenced above. At that time, silver was around $12 and gold near $600, or a 50 to one ratio. Currently, the ratio is still near 50 to one, with gold near $700 and silver near $14. Therefore, the switch can be made at the same price ratio.

Gold is primarily an investment item whose above ground stock accumulates over time, whereas silver is primarily an industrial commodity whose available inventories have been largely disappearing. It is this inventory depletion that accounts for there being more gold in the world than silver. There’s a low physical amount of silver compared to the amount of gold. There’s a high price of gold compared to silver. That creates a difference in value of 250 times. Gold, with greater above ground supply, is valued 250 times more than silver with a smaller supply, and that silver is continuously being used up. These facts are still not widely known.

Gold and silver are uniquely embedded in the world’s history and culture. These metals predate civilization and transcend governments, religions and borders. Almost without exception, what can be said about gold can be said of silver. They are both historical and universal forms of money, stores of value, hedges against depreciating paper currencies and assets that are no one else’s liability. The differences between gold and silver are almost universally unknown. In the last century, silver was demonetized and dishoarded by the world’s governments. That dishoarded silver was industrially consumed or put into a form that made it no longer available. That epic dishoarding and consumption completely up-ended the world’s historical balance of how much above ground silver there was compared to gold.

Silver comes out of the ground in an amount roughly 8 times greater than gold. This has been true for hundreds and thousands of years. Because of this, there used to be many times more above ground silver in to world than gold. But that is not the case any longer. Starting in the middle of the last century, we have been industrially consuming the world’s silver inventories. This has caused the reversal of the relative size of world gold and silver stocks.

Based upon the current price of each, it appears that the world believes there is still many times more silver above ground than gold. Certainly, the world doesn’t believe there is less above ground silver than gold. Perhaps one in a million, or one in ten million, of the world’s 6.5 billion inhabitants know silver is rarer than gold. I think it is reasonable to assume that many more will come to learn this truth in the years ahead, with an enormous impact on price. Rarity is a very basic concept that all people intuitively understand.

The main difference between gold and silver is that you can never have a shortage in gold because it is not industrially consumed. The price of gold can go higher, of course, but not because of a shortage. Silver, precisely because it is an industrial commodity (in addition to being an investment item), must go into a shortage, considering the disappearing inventories. That’s what creates the opportunity in switching from gold to silver. Such a switch has the benefit of low risk, since it’s highly unlikely silver will decline more than gold. It is much more likely that silver will greatly outperform gold, as the world wakes up to these facts. There are signs emerging that a few are beginning to grasp that reality.

New data suggest that a silent investment run may be developing in silver, by deep-pocket institutional investors. Statistics from the US publicly traded Exchange Traded Funds (ETFs) suggest a disproportionate amount of buying in the silver ETF (SLV) relative to buying in the gold ETFs (GLD and IAU).

We are nearing the one-year anniversary of the silver ETF. In that time, 136 million ounces of silver, worth almost $2 billion, have been purchased by the trust. Certainly this is much more silver than any observer predicted, including me. Currently, there are almost 17.5 million ounces, worth $12 billion, in the combined GLD and IAU ETFs. (I am limiting my comparisons to the US ETFs to reduce the variables. Although there are other gold ETFs oversees, the two US versions hold 90%+ of total gold ETF assets).

Therefore, the dollar amount of gold in the combined ETFs is only a little over 6 times the dollar amount of silver held in the (lone) silver ETF. I say "only" because there is 250 times more gold, in dollar terms, than silver in total above ground totals. One would think there would be much more money in the gold ETFs than just 6 times what is in the silver ETF. And if you normalize for the shorter time of existence for the silver ETF compared to the gold ETFs, the comparisons are more dramatic.

One year after the introduction of the big gold ETF, GLD (Nov 2004 to Nov 2005), and including the IAU (Jan 2005 to Nov 2005), these two gold ETFs held a combined 7.7 million ounces of gold, then worth $3.8 billion. Therefore, at the one year anniversary of the respective silver and gold ETFs, there was only 2 times as much gold, in terms of dollar amount, than there was in the silver ETF.

My conclusion from this data is that a disproportionate amount of institutional buying has taken place in the silver ETF relative to the buying in the gold ETFs. Two possible explanations come to mind to account for this disproportionate silver buying. One, some well-informed institutional investors have decided to establish a disciplined position in silver. I use "disciplined" because the buying has been systematic and even. The second explanation has to do with pure index-fund type buying to achieve the proper weightings of silver in the popular commodity indices. This type of buying is also even and systematic. Either explanation would fit with a silent developing "run" on silver by deep pockets.

The buying in the silver ETF, even as disproportionately large as it is compared to gold, does not have the feel of "hot" institutional money. The big "mo-mo" (momentum) hedge fund buying that chases price performance has yet to appear in silver. I think it’s a safe bet to say that it will arrive some day.

The important point is that big institutional money is flowing into silver on a disproportionate basis, as the statistics indicate. It is only a matter of time before this buying causes a disproportionate impact on the price of silver. For me, it’s never been a case of gold not being a good investment, but a case of silver being far superior. If you fit the profile of someone who can take advantage of this opportunity, please don’t let it pass by. Don’t wait for the mo-mo guys to buy first.

As happens periodically, the silver inventory levels at the COMEX-approved warehouses have increased recently. As of this writing, the total silver inventory has climbed to 131 million ounces, up about 11 million ounces over the past few weeks. Invariably, this causes confusion among silver investors, who have trouble reconciling how there can be increasing inventories at a time of perceived tightness or deficits.

COMEX inventories are only one category of total world silver inventories. Of course, they are the most widely observed inventory (along with the silver ETF), so it’s natural for significant changes to bring notice. When there is an increase, everyone wants to know, "where did it come from?" Unfortunately, it is usually not possible to know the answer. I think this is a question that is largely unknowable, so I don’t spend time worrying about it. I prefer to spend time thinking about what is knowable and forming conclusions on that data.

What we do know is that everyday the world collectively takes 1.75 million ounces of silver from the earth. We also know the world consumes more than that amount everyday, well over 2 million ounces (the balance comes from recycling and inventory depletion.) We know that this basic production/consumption structure has existed in the world everyday for more than 60 years. Therefore, we know that any increase in COMEX, or any other reported inventory, is not coming from a surplus or excess of mine production over consumption.

If we know where the silver is not coming from, then we have a much clearer way of determining where it is coming from. If we know it’s not coming from current production, then we know it had to come from past production, namely, previous existing inventories. In other words, any inventory increase in COMEX or any other transparent inventory, had to have come from a non-transparent, or unreported inventory source. As such, any increase in reported inventory came as a result of a decrease in the unreported category. This is not an increase, but merely a transfer.

Of course, such inventory transfers raise other questions. How much is in the unreported category? That is also an unknowable question, but my guess is maybe hundreds of millions of ounces and maybe more. Then again, maybe less, a lot less. In any event, I don’t find it productive to spend time contemplating what I can’t know. And, if there are still substantial unreported silver bullion inventories, that doesn’t mean they are available for sale at near current prices. Only the owners of that silver, if it exists, can answer that. One thing to remember; we are talking about the transfer of millions of ounces of silver, not billions, as could have been the case fifty years ago.

There is one question about the transfer from unreported to the reported category that we could speculate on, namely, why is it taking place? Or more precisely, is this a voluntary or involuntary transfer? I can’t come up with a convincing argument why someone would voluntarily transfer unreported silver to a transparent category. After all, silver has been the same price for the past year, so why move it now, when tightness and shortage are apparent in so many raw materials, and the ETF is gobbling up everything in sight?

I think this silver could be coming in because it is needed to satisfy coming delivery demands in the May contract. But let me cut to the chase and tell you what I really think is happening. Even though I am the only one kicking up a fuss about the big concentrated short position in COMEX silver futures, it is, nevertheless, a very big deal. This short position goes to the very heart of manipulation and commodity law and regulation.

As of the most recent Commitment of Traders Report, the 4 or less largest traders on the COMEX are net short the equivalent of 145 days of global mine production, or over 253 million ounces. This is outrageous and stands out like a sore thumb. No other commodity comes within a country mile of having such a concentrated short position. The regulators, both on the exchange and in government know how serious this problem is. It is my feeling that the increase in COMEX inventories may be related to this concentrated short position. The regulators are pressing the shorts to justify their obscenely large position by showing they own more real silver than they’ve shown in the past.

If I am correct, and the spotlight is finally being shined on the big shorts, that could be very bad news for them and very good news for all silver investors. Bringing in a few million ounces of silver is not going to make the problem of the concentrated short position go away. It has to be resolved, and that resolution will be to the great benefit of those who hold physical. In the meantime, increases in COMEX inventories should be welcomed, not feared, as every single ounce that comes into the light, is one less ounce held in the darkness.

In 1982 a close friend passed away. He owned a company that sold energy saving products. His family came to me and asked if I’d buy the business from them. After a brief investigation, I paid them $200,000 for the company. After a year, I could see that my acquisition was going nowhere fast. The new company was losing money. I began to worry about the $500,000 inventory loan at the bank that we had assumed.

I put a two-inch ad in the business section of the newspaper offering the business for sale. Right away we had a nibble. Two young guys called and wanted a meeting. They both had newly minted MBAs and, apparently, one of them had just inherited a million dollars. As we discussed the company for sale, I could see they were overconfident and opinionated. Almost immediately they knew more than me. After a few days of investigating, they went for the deal. On the day of closing they gave me $200,000 and, best of all, they went to the bank and wrote out a check that paid off the loan. I was overjoyed.

We had a brief meeting and I gave them some advice on running their new company. They almost sneered in my face. They weren’t interested in learning anything from me. They assured me they knew exactly how to run things. I’d never seen two more arrogant, self-assured individuals. As they went out the door, I could tell they were giggling inside at my stupidity for selling them such a plum. Eleven months later they filed bankruptcy.

Their arrogant pride proved fatal to the business they bought. They failed because their egos were out of control. In fact, they probably never would have bought the business if they weren’t so cocksure. I cite this example to illustrate how easily a lack of humility can ruin you. C. S. Lewis wrote that pride was the greatest sin. Perhaps that’s true, but, without a doubt, pride is the greatest danger in your financial affairs.

We all have some degree of ego. Usually, success in life causes our pride to swell. Financial statements and egos often grow apace. However, too much self-importance inevitably meets with a painful leveling experience. Pride cometh before a fall. This certainly applies to investing where the humble approach works best. One dangerous aspect of a large ego is that the person who has it can’t recognize it in themselves. Only years later do they come to realize they once were overly prideful.

Futures trading in silver offers a classic example of pridefulness. It’s a known fact that 90% of amateurs or small traders lose money in futures. They are up against big trading firms, dealers and banks. Nevertheless, they keep trying. It can only be ego that makes them think they can outsmart the rest of the market. High leverage means they are up against the big boys, on a shoestring. That’s mighty egotistical. One West Coast firm had thousands of margin calls in the most recent silver downturn. Their clients lost a lot of money. Hopefully, they gained enough humility that they won’t try it again.

You are bordering on arrogance when you think you can beat the futures market. Furthermore, you have to be pretty egotistical to think you can pick a few junior silver stocks and hit a home run. The world is full of large egos who are trying to make a big score in stocks. Unfortunately, only one mining company in a hundred that has a silver claim will ever prove out. Other types of silver investments, such as SLV funds, undermine your patience. You think you’re smart enough to time your way to big profits, but premature selling will invariably limit your gains. These funds are too easy to sell, and a small gain inevitably proves too tempting.

Owning physical silver is a more modest, conservative and humble way to go. Fortunately, this humble approach offers the greatest opportunity for gains and the least risk. By purchasing actual physical silver, and taking it into your possession, you put yourself in the best position to capitalize on a rise in the silver price. By owning it outright, you are far more likely to continue holding for the time period necessary to maximize profits. Too much ego drives the other silver investments where so many investors think they can beat the odds or repeal human nature. Humility is your greatest asset in money making and pride your greatest enemy. Use the humble approach with silver and give yourself the best chance to prosper.

The amazing thing about silver is how few people know about it. If they knew the facts, I believe they would buy as much silver as they could. In silver you have an ageless precious metal with an intrinsic value still selling at close to historic lows, when adjusted for inflation. This tangible asset stands outside the paper monetary system. It has universal demand by people around the world who value it because it’s scarce and precious.

Silver became money on its merits before there was such a thing as industrial development. Then, fifty years ago industrial uses for silver literally exploded and the above ground supply, that was once used for money, began to disappear and rapidly became depleted. Silver is an asset that’s absolutely indispensable for modern civilization. You have large industries where silver is so necessary they will fail without it. You have all the substitutes for silver being too expensive to replace it.

You have new investment buying to go along with the aggressive industrial demand from Asia. You have a world supply that’s been dramatically drawn down and depleted. You have a gap every year between what’s produced and what’s used. You have a crucial metal with less of it left to be mined from the earth than any other major metal. You have the price of silver trading close to the cost of mining it, a bullish factor for a commodity.

On top of all this, you have a shocking amount of silver sold short. You have a large quantity of silver leased out that hasn’t been returned because the silver has been consumed. You have silver sold forward by mining companies who haven’t produced it yet. You have silver certificates for huge quantities of silver in the hands of investors who believe the silver is there when it probably isn’t. You also have large financial entities who have sold more silver on paper than exists in known stocks. You have a growing awareness that this opportunity in silver exists. This recognition has profound consequences for the future as more and more people act on what may be the most bullish set of circumstances to ever exist.

Ted Butler says, "On the first real price rise, the owners of the tiny remaining silver inventory will realize simultaneously just how valuable their property is, and will do what people have done for the entirety of human existence – they will hold their property tighter than ever before, or demand an ever-escalating price. And it will come rapidly. That is the silver window that is about to shut tight for perhaps another 30 or 40 years."

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Sincerely,

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