WEEKLY COMMENTARY

May 10, 2005

$5 Silver Returns

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.)

For several years, I had the very good fortune to have been able to write many articles that laid out my case in urging people to buy silver at $5 and less. Many thousands of readers had the good sense to heed that urging and follow that advice. Looking back, there should be no regrets, save not buying more. Certainly, I do not regret the enthusiasm in my message.

The single greatest feature to buying silver below $5 then, was the extreme low risk of significant loss of investment capital. This is the very first rule of investment success; do not lose your capital. The second great rule of investment success is to remember rule number one. It was this very low risk of major capital loss that fortified me. Knowing that no one could get hurt by buying real silver on a fully paid for basis, let me sleep at night. The most important thing I would want to avoid was having even one person get hurt financially by following my research. Hurting many thousands would be unbearable.

I am convinced that $5 silver is a thing of the past. I know that we were below $5 as recently as a year and a half ago. I know that we were below $5 for many years. I know that it wasn’t that long ago that many people proclaimed we would never even get above $5 silver. Even knowing all this, I am convinced we will never trade below the $5 mark in silver in our collective lifetimes. And please be sure – I would not make such a statement that, we would never trade below a price actually witnessed a year and a half ago, about any other commodity. Just silver. Please allow me to explain.

Silver is special among all commodities. It is the only commodity to be in a structural consumption deficit. This deficit stretches back 60 years. This structural deficit has gone on for so long, that we have reached the point where a surplus production year or two, not that one is apparent, won’t really matter. World silver inventories have been so severely and irreparably depleted, that they will never be realistically replenished, regardless of price.

Let me repeat that – no matter how high the price may go in the future, the world will never restore silver inventories by more than a percent or two, of what existed 60 years ago. Sixty years ago, the world had 10 billion ounces more in above ground silver than it does today. It is hard for me to conceive, no matter what the price, or the number of years required, how the world could add even one or two hundred million ounces to above ground inventories. Not with the growing new industrial uses and hundreds of millions and billions of new prospective world consumers.

It is the continued deficit and the cumulative damage from the deficit, whenever the deficit is reversed, that is the principal guarantor against sub $5 silver, but, almost unbelievably, the deficit is not the sole guarantor. The sudden and unexpected increase in the mining and refining cost of producing an ounce of silver presents an additional formidable obstacle to former silver prices. And forget sub $5 silver prices, it is hard to imagine silver staying below $7 for long.

As recent mining company earnings reports clearly indicated, the primary silver producers can’t make money at $7 and higher silver prices. Due to increased energy, equipment and other costs, mining and refining costs have increased some 40% in just the past two years. While this is decidedly bad news for the miners and refiners, it is a gift to the real silver investor. It means that $7 today is the equivalent to the $5 silver that will never return.

While no one can turn back the clock, and allow us a "do-over" or an opportunity to decide on the basis of hindsight, I sincerely believe that the new and unforeseen increase in the costs of mining and refining silver is just that. Think about it – while everyone was worried about photography, and increased by-product mining from base metals and continued dumping from China, one incredibly new and unexpected bullish factor slapped us right in the face. It suddenly cost a helluva lot more to produce an ounce of silver.

This is a very real second chance to capture the extraordinary low risk of the $5 silver of yesteryear. One of the truest findings I have learned over the past 30 years, came from a very astute analyst long ago – buying a precious metal below its cost of production is foolproof. In terms of real risk, the effects of the deficit on inventories and the sharply higher cost of production makes $7 silver today the same as $5 years ago.

As all-important as low risk is to any investment and the preservation of investment capital, we must also strive for growth of capital. Otherwise, our finances become too defensive. Sometimes, preservation of capital can still leave us behind in the lifelong struggle to maintain and increase future purchasing power.

That’s what makes silver an ideal investment, the single best in my book; precisely because it not only has superb low-risk characteristics, but also explosive profit potential. In fact, I can’t even imagine another investment item that has the latent get up and go as silver. Whereas the supply/demand fundamentals already in place in silver dictate that it’s only a matter of time before silver doubles, triples, or moves five or ten fold in price, it’s hard to conceive of another item having close to that potential in even the most extreme and unexpected circumstances. Try naming any other investment items that you feel sure will double or triple or move ten fold from current levels.

Remember, I’m not talking about some special new world or financial events developing in silver before it explodes in price; the stage and conditions are already set. The cake is baked. The rocket is on the launch pad; we are merely awaiting certain ignition. In reality, the only development needed to launch silver is an end to the 20-year manipulation, something that history guarantees will occur.

Importantly, the very same reason that has already proven conclusively that silver has been ultra-low risk also mandates its great profit potential – the deficit. Month in, month out, year in, year out, decade in, decade out, the world has consumed more silver than it has produced. The price is still below the cost of production. That is all you need to know in order to make a long-term investment in silver.

One criticism I hear is that I say the same thing, over and over. I accept this criticism, as it is completely correct. Of course, I also think I’ve introduced more new facts and different perspectives about silver, and am responsible for thousands of people learning about silver, but, basically, I do say the same thing. I admit it. But how could it be otherwise? I intentionally choose to write about one item. Mine is primarily a long-term analysis for an industrial commodity in a flagrant structural deficit. The long-term supply and demand fundamentals of any industrial commodity change as abruptly as a super tanker changes its direction. If I flip-flopped on silver, there would be something flawed with my analysis.

The primary difference between the low risk and high profit potential in silver, even though both are defined by the deficit and shrinking inventories, is one of timing. Timing should not matter to the risk aspect of any investment. If it does, you have the wrong investment or your analysis is wrong. Timing has not mattered in the risk in silver. The only time silver has sold off sharply is after it had risen sharply. There is nothing unusual about that. Just don’t buy it after it has risen sharply. Buy it before it has risen sharply. The passage of time itself does not increase the risk in silver. It reduces the risk.

Timing does seem to matter more on the profit side of the equation, in that the profit won’t be realized immediately. Risk should be risk, regardless of timing, but the profit will come only in due time. Of course, you don’t know when the market will respond to the fundamentals and overcome the manipulation and explode. It will happen, but no one knows when. No one can know when.

Since it is not possible to know when the silver (or any) market will reflect the real supply/demand fundamentals in the price, you must mentally prepare yourself accordingly. You must condition yourself to blot out the day-to-day movements. About the only thing you can do constructively concerning day-to-day activities is look for signs that either confirm or refute your basic premise in silver. I’m not talking about reading bearish stories after the price declines, or bullish stories after a price rise. That’s nonsense and unproductive. I’m talking about the continual flow of real facts; do they mesh with your understanding or not?

Let me try to bring you up to date on what I see as the real flow of facts and how it relates to my premise in silver. Please keep in mind that these facts change constantly and may be woefully out of date by the time this printed form reaches you. My basic premise in silver is that because of the structural consumption deficit, we must have a delivery problem at some point. That deliver problem must involve the COMEX, as that is the principal silver exchange in the world. When that delivery problem is apparent, the world will quickly recognize just how manipulated and undervalued silver had been, and will rectify both the manipulation and the under valuation simultaneously.

I see some new and exciting signs that indicate that the inevitable delivery problem on the COMEX may be upon us shortly. If you remember, when we concluded the recently expired March contract, the market recorded a premium in the March contract of 3 cents to the May silver contract. This was almost unprecedented and reflected a clear tightness in the physical market. It appeared to be users clamoring for the spot March and subsequent warehouse movements confirmed this appearance.

Now, the May contract is demonstrating its own tightness. Only ten days into the delivery month, we are actually more advanced compared to the expired super-tight March contract at corresponding times. The spreads are tighter in the May contract, there is more remaining for delivery and there is more new user buying of the May, than took place in the March contract at this time of the delivery month. Additionally, the move to tightness has suddenly impacted all the trading months in COMEX silver, something that never happened in the March.

Additionally, as predicted last week, we have seen a spectacular improvement in the Commitment of Traders structure in silver. The improvement was even better than I expected, as the 20,000 net contract decline in the dealer short position was double what I forecast. The brain dead tech funds were lured onto the short side in impressive numbers. This current structure almost guarantees a rally, with the only unknown as the extent of the rally. That will be determined by how aggressive the dealers sell short on that rally. As always, this rally should be handled as the "big one", until and unless we see evidence of the usual dealer short selling.