WEEKLY COMMENTARY

May 17, 2004

A Silver Buy And The CFTC's Response

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.)

This was quite an eventful week for silver news. First, the Silver Institute released its annual silver survey, covering the world supply/demand situation for 2003. Allow me to give you a quick summary. The world consumed, for the 15th consecutive year, more silver than it produced, necessitating the draw down of existing inventories by 72 million ounces. More than 1.5 billion ounces have been taken from world inventories and consumed over the past 15 years to satisfy the structural deficit.

We have 1.5 billion ounces of silver less in world inventories than we had 15 years ago. We have 10 billion ounces less silver in world inventories than we had 60 years ago. We have less silver in world inventories than we have had in hundreds of years, precisely at the time of greatest demand. Interestingly, even with a falloff in photography demand, the deficit in 2003 was greater than the deficit the year before. Remember that, the next time someone tells you that falling silver photographic demand is a big negative. How negative can it be, if the deficit actually grew?

And here's another thing to remember - even if this was the very first year of the silver deficit, and not the 15th or 60th consecutive annual deficit, that would be a significant milestone, as having a commodity deficit is the most bullish condition possible in any commodity. Whether for one year, 15, or 60 years.

The second big story this week was the surprise announcement by the major silver resource company, Silver Standard Resources (SSRI), that they had purchased almost 2 million ounces of physical silver, deploying approximately 20% of their corporate cash. The CEO of SSRI, Robert Quartermain, is to be congratulated by silver investors everywhere for his intelligent and courageous decision. Quite simply, this was the right thing to do, at the right time, and Mr. Quartermain deserves accolades for having the guts to do it. Well done, Mr. Quartermain.

In addition to being in the very best interests of its shareholders, this move by SSRI could have a profoundly favorable impact on the silver market, for a number of reasons. One, it is a stunning endorsement that silver is grossly undervalued by one of the silver industry's most important people. Quartermain is a pro, with long experience in developing silver resources all over the world. For his company to take the unusual step of buying silver, at this time, demonstrates to all just how cheap is the silver price compared to its supply/demand fundamentals. It's one thing for mining executives to say the price of silver should go up, but quite another to back those words with actions.

Two, the reaction by silver investors, SSRI shareholders and shareholders of other silver companies has been almost unanimous in their approval of SSRI's purchase. These investors know that this is a good deal. SSRI did it the right way, paying cash for real silver, and won't have to worry about margin calls. This is a sane and intelligent move, a welcome departure from the idiotic short selling at low prices by a lot of metal companies, that has been universally loathed by shareholders. Truly, it is about time that someone from the mining industry stood up to the manipulators. Hopefully, SSRI's move will force other silver companies to speak out as to where they stand on the issue. This is an issue very important to shareholders. If you are a shareholder, you should not sit by and wait for your company to speak out. It's important for all silver companies to state their intentions on this issue.

Another powerful advantage of Silver Standard's purchase is the very real pressure it puts on the manipulative short sellers. These shorts, as you know, can sell unlimited quantities of paper short contracts, but it is much harder for them to deliver real silver. I'd estimate this new 2 million ounce delivery demand for real silver, when added to the already known delayed deliveries, is causing big trouble for the shorts,. In the end, it will be the inability to deliver physical silver that will terminate the manipulation, as is required by the law of supply and demand. .

Silver Standard confirmed what silver investors know to be true - that given the merits of sitting on a pile of cash in the current environment, investing a portion in real silver makes sense. Most of the large silver companies have extremely large cash hoards, as a result of recent stock offerings, that have little chance of being deployed for many years. Rather than sit with unproductive cash, investing a portion in silver is a true win-win situation. Also, SSRI's action finally resolved a great mystery to me - why wouldn't the miners stand up to the manipulators?

The final major story this week was the publication of the long-awaited response from the Commodity Futures Trading Commission (CFTC) to the hundreds of letters and e-mails they received on the public's allegation of manipulation in the COMEX silver market. (cftc.gov) The response took three months and was nine pages long.

As predicted, the Commission's response denied that any manipulation existed in silver and took a bit of a personal swipe at me, also expected. First, some general comments about their response, followed by a look at some of their more serious misrepresentations and omissions. Certainly, not all of which the Commission wrote was incorrect, and I must tell you, this was one of the most bullish documents I have ever read about silver. As such, and while I know that was not their intent, I will conclude with why I think the CFTC is telling you to buy real silver now.

It is important to remember that the purpose of writing to the CFTC was not in the expectation that they would suddenly do an about-face and confront the silver manipulation. There was no real chance of that occurring, as the consequences to the commercial dealers would be too severe. In spite of the Commission's recital of all the manipulations they've dealt with, they left out an important qualifier, namely, that they have never busted up a manipulation in progress. It's not something they are capable of doing, in my opinion. They have moved against every manipulation in their history, only after those manipulations have died a natural death and have been exposed to all. Whether it was Sumitomo in copper, the Hunts in silver, or Enron and the other energy companies recently, history shows that the manipulation has been terminated and the damage has been done by the time the CFTC arrived on the scene.

The purpose of everyone writing in was to leave no wiggle room later for them to say, "we didn't know." Also, in the inevitable legal proceedings that will take place after the silver manipulation is exposed and known to all, putting the CFTC so clearly on notice will aid in exacting justice, both civil and criminal. Make no mistake, the CFTC, and in turn, the manipulators, were put on notice. You can tell that in the respectful and sincere tone adopted by the CFTC in their response.

There was good reason for their respectful tone. They received more public comment on this issue, than any in their history. Having seen a good number of the over 500 letters and comments they said they received, I know the CFTC was rattled by the sheer number and high quality of your letters. They knew they had a potential public relations nightmare on their hands, and did not want to trip alienate anyone by the tone of their response. In spite of that extremely respectful tone, most folks can see what they really said or didn't say. I am continually amazed at how well educated people have become on this silver issue.

I'm going to spare you a blow-by-blow of the entire nine page document, and concentrate on the CFTC's more serious misrepresentations. The most obvious was their claim that they saw no plausible motive for a silver manipulation. This had to be particularly cruel for all of those who suffered financial damage in the latest manipulative sell-off. In fact, as I have tried to do over the years, you can trace the motive for the manipulation in the CFTC's own weekly Commitments of Traders Report (COT). These reports clearly document the cumulative billions of dollars the dealers have stolen through control, bid-rigging and collusion. Pure greed is the motive. The CFTC's refusal to see the obvious was insulting.

Another major misrepresentation by the CFTC was their omission of any attempt for a free market explanation for how we could have a structural deficit in silver for so long. They tried to evade the issue and the question I have raised so often, by noting that inventories must have been much larger 15-20 years ago, than originally thought (by GFMS and other statistical services.) While this is obviously and technically true, it still doesn't address the question of what motivated the inventory sellers. I say, clearly, that the motivation was manipulative in nature and based upon the fraudulent practice of metal leasing. The CFTC doesn't even mention leasing and avoids the intent of my question completely. No big surprise there, as there is no legitimate free market explanation for how inventories can be dramatically drawn down in anything, without a corresponding sharp rise in price.

It is interesting to note that the CFTC confirms that it is dumping by the Red Chinese government that is primarily responsible for filling the current deficit. Official government dumping from treasury holdings, below the marginal cost of production is not a free market hallmark. It would not surprise me, at all, if the Chinese government is behind the current manipulation in silver, and are using the commercials as surrogates. I plan to write about this issue soon.

The next serious misrepresentation by the CFTC was the twisting of the facts regarding the size of the net and gross short position on the COMEX. Here, the CFTC is intentionally and cleverly deceptive, as they always have been on this issue. If you read all my prior writings on this issue, you will see I am very careful to compare the COMEX short position to world production and total world visible inventories. It is the largest naked short position in history. You will note, in the Commission's response, they refuse to contradict my clear statement. Instead, they shift the discussion to the short position compared to exchange warehouse stocks. I have been actively involved in commodity futures for well over 30 years, and I know it is common place for the short position of a commodity to exceed warehouse stocks, so I would never make that comparison. And I also know that when compared to other commodities, the silver short position doesn't look unusual, until you compare all to world production. I state unequivocally (and the CFTC hasn't and can't dispute this) that the COMEX silver short position is unique among all commodities in that it is the only commodity to have a short position, very often, that is larger than world production and total known world inventories.

This, obviously, leads to the next misrepresentation by the CFTC, namely, the size of the known, or identified, world silver bullion inventories. The CFTC states, quoting GFMS, that total identifiable world bullion stocks at 671 million ounces at the end of 2003. (I love the precision of this number, down to the last one million ounces). The CFTC or GFMS can identify this 671 million ounces, like I can fly by flapping my arms. This is the very same issue I raised last week, in asking Ross Beaty to identify that which he claimed was identifiable (the same GFMS bogus inventory figures). Don't get me wrong, I think there may be unknown silver inventories of this size. But I know there are not known inventories of this size.

In the table comparing silver to other industrial commodities, the CFTC's intent is to show silver as having large inventories when compared to the others. What was not included in the table was reference to gold, the most obvious comparison of all. After all, while people write and consider the gold/silver ratio continuously, I have never heard of active discussion on the silver/zinc ratio, or the silver/aluminum ratio, or the silver/tin ratio. Silver, being a precious metal like gold, is held by many as an investment. Zinc, tin, aluminum, copper are not precious metals and are not held as such. If the CFTC had been truthful, and included gold in that comparison, silver inventories wouldn't have looked so large at half a year's consumption, as gold would have shown 30 years of inventories. This was a statistical sleight of hand by the Commission, leaving out the most obvious comparison, as it would disprove exactly what they were trying to prove. Shame on them.

As to the claim that the CFTC has evidence that all the dealers' short positions are not naked, but are backed by silver and bona fide hedging agreements, I note with interest that no evidence was presented. We are told to just trust them. I prefer to trust, but verify. We will know if this is true or not with the passage of time. What I do know now is that claims of hedging agreements, bogus or not, are not an excuse to control a market. Even if an entity controlled a large amount of real silver, that would not bestow upon that entity the right to control the price by false claims of hedging. The proof that no real hedging is taking place is the frequent and synchronized trading by the commercials These commercials are speculating to the point of controlling the market. It's as far away from legitimate hedging as it gets.

Finally, the CFTC summarily dismissed the very constructive solutions offered as to position limits and shorts having warehouse receipts on first delivery day, writing, in essence, that the COMEX was doing fine and there was no problem. Time will tell. I will tell you that their assertion that there has never been a silver delivery default in NYMEX/COMEX history is only technically correct. The NYMEX had a flat-out delivery default and closure of a major market in the Maine Potato debacle, as well as near defaults in platinum and palladium. The COMEX, in turn, suffered a clearing member default in the Volume Investors affair. The CFTC picked the wrong exchange to hold up as an example of default purity.

While they did not mention me by name, there should be no doubt who they were referring to when they wrote to be careful of analysts who speak in half-truths and total fabrications and to check their motives. I am reminded of the saying that if you can't attack the message, attack the messenger. I expect more attacks in the future. If anyone is aware of any half-truths or total fabrications I have ever written, please let me know, and I will acknowledge and correct them promptly. Certainly, I didn't see any specifics from the CFTC, just innuendoes.

They are correct, however, in that you should always consider the motives of anyone who urges you to invest in anything, as I urge people to invest in real silver. Although I have done so in the past, please allow me to restate my motives for writing about silver. My primary motive, for almost 20 years, has been to end the silver manipulation. This should be clear and is documented. Even the CFTC confirms this. About three and a half years ago, I began writing for Investment Rarities as an independent analyst. It was at that point that I began to urge people to buy real silver as an investment, as a secondary motivation. This looked like a no-conflict circumstance to me. It still does. I receive a flat fee, no commissions of any type, for what I write. I contend that what I wrote before my association with Investment Rarities is essentially the same as what I write now.

Now please let me tell you why the CFTC's response was such an incredibly bullish silver document. Basically, they confirmed the same case I have continuously presented. They acknowledge the structural deficit for 15 years. They acknowledge that silver inventories have been drawn down by more than 1.5 billion ounces over the past decade and a half. They acknowledge that the continued inventory draw downs are what is balancing the market.

They acknowledge that we are down to a half-year's worth of silver inventories, as compared to annual consumption. What they are not saying is that 60 years ago, we had over 11.5 years of silver inventories (10 billion ounces divided by current annual consumption of 860 million oz). 95% of world silver inventories have been consumed over the past 60 years. Using the CFTC's own quoted source data, they are saying we had more than 2.5 years' worth of silver in inventory 15 years ago. Think about that - 11.5 years inventory 60 years ago, down to 2.5 years inventory 15 years ago, and now we're down to roughly 0.5 years inventory. And still dropping, thanks to the ongoing deficit.

The CFTC acknowledges, on page 4, the reason why production deficits haven't resulted in higher prices is because of the high level of former stocks. They say, "Had these stocks not been available, silver prices surely would have risen higher." I ask you to think about that. We know these stocks are no longer available, as they are consumed and gone. Even the CFTC acknowledges that. With the continued deficit, and it appears to be increasing, rather than decreasing, is not the CFTC saying silver prices will surely rise in the future? I'm not looking to play word games here, I am just looking at what the CFTC is writing. Long term, continuous deficits, evaporated world inventories, on a path for certain higher prices if the deficit continues. Is this not my long term message?

I want to share with you something from my own experience, that I have never written about before. In fact, I doubt if any current employees of the CFTC would be aware of what I'm going to say, unless they've retrieved internal documents dating back to the mid 1980's. When I began my campaign to end the silver manipulation, the numerous and continuous denials from the CFTC back then were always that I was wrong because the silver market was in surplus. I knew the silver market wasn't in surplus, based upon my own research, but the statistical services reported a surplus and the CFTC always hid behind that argument.

I want to tell you just how remarkable it is to me to read this latest response from the CFTC, in which they openly acknowledge the long term structural deficit and dramatic draw down in inventories, compared to all their early responses indicating a surplus. It's not just that my early research was right in calculating the market was in a serious developing deficit, but something much more remarkable. I've always stated that the silver market is manipulated because its price does not respond to real, free market forces. When I compare the early responses from the CFTC, which claimed the silver market was in surplus, to this latest response which clearly acknowledges the giant deficit, I am struck with the unavoidable conclusion that the CFTC will always say no manipulation, no matter what. Remember, according to the law of supply and demand, there can be no greater price influence on a commodity than whether it's in a surplus or a deficit. Apparently, the economists at the CFTC are looking at a different law of supply and demand than I am.