TED BUTLER COMMENTARY

April 22, 2008

THEN AND NOW

(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.)

Recently, the price of silver has been at levels not witnessed since 1980, some 28 years ago. That’s a pretty good chunk of time. For instance, 28 years ago, half the world’s 6.5 billion population had yet to be born. On a personal basis, it was almost half a lifetime ago for me. How old were you and what were you doing in 1980?

In 1980, I was a commodity broker for Drexel Burnham in Miami, recently re-married with three young children. I had been a broker for almost 8 years by then, starting at Merrill Lynch in 1972. I considered myself fully experienced, having lived through the great commodity boom of the 1970’s. I was proficient and consistently ranked near the top in Drexel’s broker rankings. I handled a large volume of all types of commodity transactions, including silver. In fact, I handled the largest single retail brokerage transaction in Drexel history, a tax straddle involving many thousands of silver futures contracts. In addition, I handled a wide variety of silver transactions for myself (including taking delivery). I had clients like Izzy, who later developed into a good friend and mentor. The vast majority of my clients were profitable.

I recount my background during the time of the great run up to over $50 and subsequent collapse in the price of silver to make that point. Even though I probably knew more about silver on a short-term basis and transacted numerous silver trades, I really didn’t know anything about silver. That’s right - I was clueless as to the real silver story, even though I was actively involved in it. I didn’t come to learn anything important about silver until I forced myself to step back and really think about it.

The purpose of this article is to help you decide for yourself if silver is still the great investment opportunity I believe it to be. I see some major fundamental differences between silver in 1980 and today. I think it is those differences which should make you want to buy and hold silver more than ever before. In no particular order of importance, let’s consider those differences.

1. There is a lot less world silver inventory today than there was in 1980; billions of ounces less. In very broad terms, there were close to 4 billion ounces of available world silver inventories in 1980. Over the next 28 years, because of the silver deficit, roughly 3 billion ounces (a little over 100 million ounces annually) were removed from inventories and industrially consumed or put into a form that prevented it from coming back to the market, except at extraordinary high prices. In other words, 75% of world silver inventories were consumed over the past 28 years, leaving us with one billion ounces remaining.

On a per capita basis, the reduction in world silver inventories is even more dramatic, because the population of the world grew by almost 50% over that time span. In 1980, there was almost one full ounce of silver inventory for every person on the face of the earth. Today, only a small fraction, 15% of an ounce, remains. Stated differently, in 1980 there was six times the per capita amount of silver inventory than there is today. On that basis alone (and forgetting inflation adjustment), the price of silver today should be six times higher than the price in 1980.

Where did all the all the silver inventory depletion come from? A good amount came from the great silver melt, in which people sold silver-containing objects in response to the high prices then. Much more came from central banks who disposed of long-held silver inventories in what was a cock-eyed leasing scheme. As those inventories no longer exist, central banks are done dumping silver.

2. In 1980, there were long lines of people selling silver objects of all kinds, in response to the then-high price. There are no long lines today, even though we are revisiting those prices. There were months-long refinery backlogs then, as so much silver awaited melting. There is no melt backlog today.

In fact, even though prices are at levels last seen 28 years ago, there has been tightness and even shortages of investment silver. In 1980 it was the opposite. Today, the retail buyers are more aggressive. Back then the sellers were more aggressive. The public viewed the price of silver as overvalued back then. As it turned out, that proved correct for more than two decades. Today, the public views silver as undervalued because they are buying and not selling. I think the public is correct.

3. The changes in real supply and demand favor silver today, much more than in 1980. With consumable commodities such as energy, industrial metals and agricultural products, there is tightness. With its lean inventories silver is no different. Yes, we mine more silver today than we mined in 1980, but we have increased production of every other commodity as well. The trade-off is that we consume much more silver than we did back then.

The major themes are obvious - more people, more world economic growth and the highest levels of economic activity in history. Couple that with increasingly hard to find sources of supplies. The economic expansion of Brazil, Russia, India and China, along with all others in the developing world did not exist in 1980. It is a force today that’s seemingly impossible to derail. The demand for raw materials will never revisit 1980. We are in a different world of commodity demand.

One key difference unique to silver was that it operated in a continuous deficit for the 28 years from 1980 (and as far back as 1940). We are just starting to react to the growing supply/demand tightness in all commodities. The "payback" from the effects of the unique deficit consumption pattern in silver will one day shock the world. We consumed the silver both above and below ground. It’s mostly used up and gone. Industry needs almost a billion ounces of silver a year and it isn’t going to be there.

One important difference between 1980 and today in all commodities is the shocking rise in the cost of production. In metals, the cost of opening new mines and the overall declining grade of ores are much different from what prevailed in 1980. This has been, and will continue to be, a tailwind to higher commodity prices. Nowhere is this more true than in silver.

4. The last time we were at current prices, in 1980, the move to dishoarding had begun. In addition to the great silver melt, net investment selling, reinforced by a long-term decline in prices, took hold. This investment ice age would last in silver for almost 20 years. It was a commonly observed fact of life that silver was the absolute worst performing investment asset of all for two decades.

Contrast that lack of investment and terrible price performance with what exists today. There have been very few investment items that have performed better than silver for the past few years. More importantly, the resurgence of investment buying in silver has been nothing short of dramatic.

In addition to a rebirth of retail investment buying, the likes of which has never been seen, institutional silver buying via the ETFs has unleashed a force never even contemplated in 1980. In less than 2 years, more than 200 million ounces of silver have been bought by three new silver ETFs. As institutional investors, and others, come to learn the real silver story, investment buying can be expected to continue and intensify.

While there has been a broad awakening as to the merits of commodity investment in general, silver is the only industrial commodity, which allows both the smallest and largest investor alike to buy it directly in its real form. You can’t do that practically with any other consumable commodity. In this day and age of dubious finance, owning an investment that can’t suffer a counterparty default (when held in the proper form) is very comforting to all investors.

5. The main issue is the subject of concentration, which is defined as a large and dominating position held by a few traders.

There are some concentration issues that are strikingly similar today to what existed in 1980. There’s also big differences. The similarities include a very large concentrated short position. To my knowledge, there was no Commitment of Trader (COT) concentration data back then, but published reports at the time confirmed a few large insider silver traders, led by Mocatta Metals, dominated the short side of the market. Large and concentrated as the short side may have been back then, I am certain it is very much larger and more concentrated today.

What was different was a large concentration on the long side, in the form of the Hunt Brothers and their close associates. Today there is no hint, from the published data, that any concentrated long position exists. Therein, lies a very bullish factor for silver.

Because there was a long concentration back then, the exchange-insider concentrated shorts, aided and abetted by regulators from the CFTC, were successful in changing the rules midstream and kicking the legs out from under the concentrated longs. Let me be clear here - I’m not saying that the concentrated longs (the Hunts) were innocent of manipulating the price of silver to artificially high price levels, I’m just saying the concentrated shorts were not as pure as the driven snow either. In any event the shorts, due to their connections, prevailed.

But because there is no concentrated long position today in COMEX silver futures, only an historic concentrated short position, the insider midstream rule changes won’t work as they did in 1980. There is no big speculative silver "villain" whose legs can be kicked out from under him.

In the face of high prices today, if the regulators closed the COMEX, or ordered liquidation only, or allowed the COMEX to default on the physical delivery requirement of the silver futures contract, it would be different. Instead of the price plummeting, as it did in 1980, the price of silver would explode to the heavens. Why? In 1980, the price of silver was manipulated higher (in spite of the concentrated short crooks). When the manipulation was terminated, the price naturally plummeted. The price always moves violently in the opposite direction of how it was manipulated, when that manipulation ends. Since the price of silver today has been manipulatively depressed, the inevitable termination of the current manipulation must have prices explode.

More importantly, any suspension of the normal contractual physical delivery mechanism of COMEX silver futures contracts, would set off a worldwide rush for physical silver at precisely the same time the key device of the manipulation, the ability to short in unlimited quantities, would be destroyed. Investors and industrial users would rush to buy real silver and the crooked shorts would be unable to sell short into real physical buying. The days of selling short more silver than is available in the world would be over, suddenly and forever.

It is the very real prospect of this development that behooves those who intend to buy real silver, for investment or consumption, to not delay. It is better to be way early in laying in real silver, than to be a day late. That this prospect exists today, and did not in 1980, is bullish beyond words.

6. The emergence and existence of numerous silver pool, unallocated and certificate accounts currently, didn’t exist in 1980. While there have always been cases throughout history where fraud and deception have occurred, the widespread practice of selling unbacked silver investment accounts is a phenomenon that developed after 1980. As I have previously written, my estimate of the cumulative total amount of the non-existent silver represented in these accounts is more than two billion ounces.

While investment in real silver was virtually non-existent for the 20 years after 1980, there was still plenty of investment in paper (fake), silver in pool, unallocated and certificate accounts which don’t publish serial numbers of the 1000 oz bars held. The buying of fake paper silver since 1980 diverted important money away from real silver and what would have been the beneficial impact on price. That trend may be ending. The holders and investors in such accounts are starting to get the message about the dangers that such accounts hold for their financial well being. For their sake, I hope they get the message and act promptly and accordingly. As it becomes obvious what the real nature of these accounts is about, it is reasonable to expect that existing holders will get out of paper silver and into real silver. Additionally, it is hard to imagine new investors buying fake silver in the future, when real silver is just as easy. This is a bullish factor that did not exist in 1980.

7. In 1980, the major precious metals (gold, silver, platinum and palladium) made historic highs. Today, all but silver have exceeded those highs. In addition, all industrial metals have recently exceeded their historical price highs by very wide margins. The same can be said of most major energy and agricultural commodities. Only silver is far below its historic price highs.

As a result, silver is cheap, relative to almost every other commodity. Relative cheapness is the first analytical test for a long-term value investor. If a prospective asset can’t be called cheap on a relative basis, a true value investor won’t be interested in that asset. All the other attributes that may concern an asset don’t matter a whit, if that asset isn’t cheap. Silver wasn’t cheap in 1980. Today, it’s the cheapest asset around.

Our then and now exercise works with gold as well. As always, my hope and expectation is for gold to rise in price. Gold is more akin to silver than any other asset around. It shares many similarities with the silver comparisons, such as an obscenely concentrated COMEX short position (in percentage terms). This suggests gold should, and will, be priced higher in the future. Rapidly rising production costs suggest the same, as does the emergence of real gold buying (via ETFs) and the cessation of the fraud of fake gold pool, unallocated and certificate accounts. In short, gold has a lot going for it.

But compared to silver, there is no contest. Whereas there was slightly more silver above ground than gold in 1980, there is much less silver today. That’s due to the nature of silver’s industrial consumption profile compared to gold’s consumption centered on jewelry and investment. In 1980, there was more than 3 billion ounces of gold above ground, compared to almost 4 billion ounces of silver. But 28 years of mine production and the lack of destruction via industrial consumption added almost 2 billion ounces of gold to above ground supplies, while the deficit in silver drew down available above ground silver stocks to perhaps one billion.

Over the next 28 years, gold should add another two billion more ounces minimum to above ground supplies, while it appears impossible for silver to add even one single ounce. In fact, based upon expected future demand, it’s likely that silvers above ground inventories will decline. For all practical purposes we are close to full depletion currently.

On a per capita basis, the comparison between gold and silver is stark. In dollar terms, there is approximately $700 worth of gold above ground for every man, woman and child in the world. There is $2.70 worth of silver per person. You decide for yourself how many investors are aware of this and which item has the best chance for dramatic upward revaluation.

Due to a more extreme price manipulation in silver, gold has recorded decisive new (nominal) price highs, while silver remains at only a third of its price extreme of 28 years ago. All things considered, this has created a value investor’s dream come true. I doubt that even one out of every million of the earth’s inhabitants are aware that silver is more rare than gold and how little silver remains per person. With the passage of time and the rapid development of global communications, I am sure many more will learn of these facts.

I don’t think it should be terribly surprising that it was in silver, and not in gold, that we experienced a retail shortage for the first time in history. Or that it was in silver in which the US Mint could not keep up with demand for Eagle bullion coins. Or that a more noticeable increase in melt response to higher prices has occurred first in gold and not in silver. Or that there have been continuous delays in getting silver, not gold, delivered into funds. All these occurrences appear to be consistent with the findings that silver is undervalued compared with gold and less plentiful. Heck, what isn’t silver undervalued against?

I have been a staunch advocate of silver for years as it languished below $5 an ounce. The price has gone up almost four times and yet the bullish factors haven’t changed very much. It strikes me as odd that the broad array of facts and comparisons still suggest that silver is extremely undervalued and capable of a price jolt to the upside that will shock many. There may come a day when that can no longer be said, but that’s not the case today. Please think carefully about the case I’ve made. I hope you also can see the enormous opportunity that has become clear to me.