WEEKLY COMMENTARY

May 15, 2002

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THE HEART OF THE MATTER

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.)

On April 30, 2002, the CPM Group (www.cpmgroup.com) released its annual silver survey of supply and demand worldwide. For the twelfth consecutive year, CPM reported that the silver market operated in a deficit between current production and consumption with the amount of the deficit amounting to 83.8 million ounces for 2001. Furthermore, it projected a deficit of almost 122 million ounces for the year 2002. Despite this deficit, silver prices fell 12.4% in 2001 to $4.38/oz, from $5 in 2000.

I ask you to take a few minutes to read over again that opening paragraph. It still may not seem that strange, or unusual, to you, as we have seen such reports from CPM and Gold Fields Mineral Services and other statistical compilers for more than a decade. But I would submit, that the first paragraph is impossible. It can not be. You can’t have a deficit (shortage) and have falling prices. It would not matter if the most respected and knowledgeable economist in the world wrote that first paragraph, nor what the commodity was - it would be impossible. Yes, the first paragraph is ridiculous and impossible in a free market.

I'm going to make this article very short, because I don't want you so much to read my words, as use your head. I want you to think, instead of read. If you understand the significance of the first paragraph, you will understand all there is to know about silver. You will know more than do 99% of the participants in the silver market, including professionals who have dealt in silver for years. Use your common sense, and don’t get sidetracked from what your common sense tells you. In a free market it’s impossible to have a deficit in a commodity without also having higher prices. It can't happen. It would violate the very basics of supply and demand. It would be as if the sun started to orbit the earth. Perhaps you could have a deficit for a few days or weeks, without higher prices, but certainly not for a year, or a decade. Here's why - a commodity deficit means greater consumption than current production. It means eating up more than is being produced. Consumption must equal total "supply" since you can't consume more than the supply or consume that which does not exist. So something must supplement current production to balance the equation. That something is always previously produced, existing inventories.

The only way, in a free market, you can draw existing inventories away from those who own them is with the incentive of higher prices. You must make them an offer they can't refuse. This is the essence of the law of supply and demand. As higher prices draw out existing inventory, those same high prices encourage more new production and discourage consumption, until production and consumption balance, and the cycle plays out to the downside, as production begins to exceed consumption. We expect our kids to learn these economic fundamentals in school.

But, we have had a long-term deficit in silver without higher prices. How can that be, if I claim it’s impossible? There's only one way - silver is not in a free market. To be sure, it might be possible that CPM, or GFMS, or any of the other compilers of silver statistics are wrong about a deficit. But I don't think that's the case, as we have witnessed long term declines in recorded inventories of silver, which confirms the existence of a deficit. We are left with one conclusion, that silver is not in a free market. In fact, the combination of low prices and a commodity deficit that we have today could only occur if the market was rigged or manipulated. In fact, low prices and a deficit are clear proof that the silver market is rigged or manipulated. That’s because a deficit in a commodity is the most bullish circumstance possible. If you buy a commodity in a deficit you are guaranteed the opportunity of making a profit, because a deficit guarantees a higher price at some point. We may not know how high a price may go, or how long a higher price may last, but I can make the absolute statement that a commodity deficit must create higher prices, until the deficit is corrected. Normally a commodity deficit is a very short term occurrence, because the certainty of higher prices works quickly to balance the equation, by increasing production and decreasing consumption.

Here's another point I'd like you to think about. Some people have said that because the deficit in silver in 2001 was smaller than the deficit the preceding year, that somehow that is bearish and would account for the lower prices year over year. I say that is preposterous. A deficit is a state or condition, like life or death or like pregnancy. You're either in that state, or you're not in that state. How much, or little, you are in that state is moot. A deficit of 84 million ounces in silver isn't less bullish than a 120 million-ounce deficit. It may sound like it, but as long you are in any kind of major deficit, you have a maximum state of bullishness.

So what happened with silver? What happened that its price can go down, and stay down, in spite of being in the most bullish state possible? What happened is clear - it got hit with the powerful 1-2 punch of leasing and paper short-selling. Silver is rigged and manipulated almost beyond belief. Why do you think I keep lashing out at the COMEX and the CFTC about this ongoing manipulation? Why do you think they never come back with substantive denials to my allegations? Because they know, full well, that in a free market a deficit should result in sharply higher prices. That a verified decade-long deficit has not resulted in higher prices, can only mean one thing - the silver market isn't a free market and that’s contrary to basic law and common sense.

Now some people may look at my interpretation of the reported and documented deficit in silver (documented by the concurrent decline in reported inventories), and conclude that, indeed, this is the most bullish condition possible in any commodity. But those same people may look at my allegations of manipulation, and be turned off by the thought of dealing in a manipulated market. To me, it would be a big mistake for someone not to load the boat with silver because it is manipulated. That's because it is this very manipulation, or price rig-job, that has created this wonderful opportunity and should send you running to buy all you can. I don’t mean paper contracts, or partial money down deals, but real, honest to goodness, cash on the barrel head silver. The only reason you can buy real silver at these prices is precisely because there is a manipulation.

But what if the manipulation continues longer than we want it to? After all, it has continued for over 15 years, who's to say it can't continue for years more? This is a legitimate point. Certainly, no one has made big returns on real silver anytime recently. Only prophets can tell you when something might happen, analysts can't. So where do I get off telling folks to run and buy real silver right now? To run and buy it like this is your last chance? Please allow me to explain.

I'm assuming that the readers are using investment funds and silver is not being bought with rent money or funds that have to be replaced short term. If you have ample investment funds, silver isn't the only asset you own. (However, if you don't have sufficient investment funds to permit diversification, and only could invest in one thing, I would only own silver). What do we want from our investments if we admit up front that only prophets know when something will occur? Well, number one on the list of investment "wants", would be preservation of capital. Any sound investment should not contain a great risk of loss. On this score, silver measures up. Because the manipulation has depressed the price to such low levels, the risk to the downside has been wrung out. At these prices, you just can't lose big. You may have to be patient, but in today's incredibly low interest rate environment, that’s not terribly painful.

The next "want" on any investment wish list, would be the chance for significant gains. After all, why shoot for mediocre gains? Once again, because of the ongoing manipulation, silver measures up. Minimal expectations would be a double or triple, but I see gains way beyond that. Remember we're talking about a commodity that traded more than ten times current prices, 20 years ago. Today, after decades of deficits have eliminated billions of ounces of inventories from the time that silver traded at $50 per ounce, there is no big supply to prevent that price level from being exceeded. Silver has all the potential bang you could ever want for your investment buck. Enough bang to handily compensate for any amount of patience that may be required.

What a potent combination - extremely low risk and shockingly high potential profit. It almost doesn't get any better. But wait - I'm not finished. It is not just this wildly favorable risk/reward ratio that has me imploring you to run to buy real silver now, although that would be more than sufficient justification. It is something much more than that. It is the manipulation itself. The very same thing that has created this unbelievable opportunity is telegraphing another ultra-clear message. Like a deficit, or a surplus, or life or death, or pregnancy, a manipulation is a state. The silver market is either in the state of manipulation or not. The degree of manipulation does not matter. If you believe, like I do, that the silver is a heavily manipulated market, you must consider what happens when the manipulation ends.

To be sure, all manipulations must end. There is no other way. Manipulations, by very definition, are an altered and artificial state. To manipulate anything is to do something that is unnatural. A silver price of $4.50/oz, given known statistical data, is unnatural. It is not a question of whether the silver manipulation will end, as we know it must. It is even not a question of knowing when it will end, because we know that question is unknowable (although I will note that I am personally trying to do everything I can to bring that day closer). What I can say is that the silver manipulation will end, and when it does, it will be sudden and violent. Overnight. In a heartbeat. When enough silver is no longer available for the industrial users the explosion will occur because they must have silver at any price or they will not be around. That's why you must run to buy silver, right now. Because you won't get a second chance, at these price levels, once the manipulation ends. It will suddenly be too late.

Here we have a vital commodity operating in the state of deficit, for more than a decade. You will never find a more bullish condition than a commodity in a deficit. Never. The statistics in the first paragraph are not my statistics, although they are confirmed by the evaporation of reported silver inventories worldwide, including those of the US Government. The COMEX and CFTC are fumbling and stalling over clear and obvious questions regarding manipulation. This is not a sustainable situation. The price of silver will reflect these realities in a flash. In such a circumstance, it is better to be way early, than one day too late. Don't wait for price confirmation to the upside. Buy real silver now.