WEEKLY COMMENTARY

May 24, 2004

China Controls Silver

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.)

First, a quick word on the Commitments of Traders (COT) - it’s spectacular. The latest COT shows the total COMEX dealer net short position in silver has been reduced by 33,000 futures contracts (165 million ounces) on the wolf pack engineered sell-off, from over $8/oz. Gold's COTs show a breathtaking reduction of 140,000 contracts on the engineered $50 decline. The brain-dead tech funds served as the accommodating patsies, once again. Now the decks appear to have been cleared for a liftoff to a powerful rally.

I hope there is not the slightest doubt in anyone's mind as to why we sold off so sharply. This downward move occurred for one reason and one reason only - to allow the dealers to cover as many of their short positions as possible. The good news is that they did in spades. As such, the market structure now allows for a rally of significant proportions. The mother of buy signals in silver is alive and well. Gold and copper look poised for a dramatic up move as well.

My analysis of the silver market revolves principally around using the published statistics and facts issued by the most accepted sources, and then using that data to reach my own conclusions. While I admit that my conclusions are generally at odds with most conventional analysts, very rarely will you hear me dispute the underlying facts and statistics published by industry professionals and insiders. Please keep that in mind in the following discussion.

As you know, there has been significant information recently on the flow of silver from the government of China's central bank, the People's Bank of China (PBOC). The leading silver statistical research organizations, GFMS and CPM, both report on the amount of the sales of government owned silver by the PBOC, acknowledging that it is this silver that principally satisfied the deficit since 1999. Even the CFTC, in their recent 9 page response denying a silver manipulation, confirmed GFMS' statement that China sold large quantities of government owned silver.

On page 5 of the recently released 2003 annual report from Pan American Silver (whose chairman is the recent past president of the Silver Institute), the company states that more than 300 million ounces of silver have been sold from official Chinese government holdings since 1999. I accept and believe to be true all these statements from these industry insiders. What I don't accept is the nonchalance and ho-hum reaction to this government selling by China. Clearly this selling is dumping, in addition to being manipulative to silver prices. Without this official government selling from China, the silver would have had to come from free market inventories, and only at sharply higher prices. In effect, the Chinese central bank is controlling and determining the price of silver.

But there is no legitimate economic explanation for the Chinese government to participate in the manipulation of silver. Only uneconomic explanations are plausible. While I don't want to dwell on all the uneconomic possibilities, I will say that I don't think their selling of silver is completely understood by them, certainly not at the highest levels of government. I think it is highly likely that the People’s Bank of China has been hoodwinked into selling their silver, much as the US Government was tricked into disposing of its silver stockpile over the past 60 years. Tricking governments out of silver is a recurring historical fact.

The sad fact is that due to China's certain long term economic growth, it won't be long until it must import silver at any price for industrial consumption. Having sold silver for the past five years at under $5/oz, it would not surprise me to see China pay 10 and 20 times that amount to buy in the future. And I'm sure that China is being used by the silver wolf pack at the COMEX, to give their short sales quasi-legitimacy.

But one day soon, China will sell government silver no more, either because they run out, or wake up to the deception that has been foisted on them. When that occurs, there will be no way to meet the deficit, except from free market supplies at shockingly higher prices. The enclosed letter should be self-explanatory.

May 25, 2004

The Honorable Zhou Xiaochuan

Governor

The People's Bank of China

No. 32 Chengfang Street

Xi Cheng District

Beijing, China

Post Code 100800

Dear Governor Xiaochuan:

I write to alert you to a grave economic harm that threatens not only the citizens of your nation, but also many world citizens. The harm comes from the damage to the world's silver producers and consumers caused by your Bank's policy of selling or leasing official government silver inventories.

For many years, the silver market has operated in a structural deficit, with consumption outpacing production, necessitating the draw down of world inventories in order to balance. According to respected international research firms, and confirmed by leading silver industry officials, and even the US Commodity Futures Trading Commission, your Bank has provided the vast majority of the inventories satisfying the silver deficit. It has been reported that your bank has sold or leased more than 300 million ounces of silver, since 1999.

Without the silver selling/leasing from your Bank, silver prices would have been much higher, since there were no other inventories available to be sold at the very depressed prices of the past five years. In fact, the People's Bank of China's selling has been below the world marginal cost of production, and has harmed producers of silver. This selling appears to meet the criteria for being classified as dumping.

Ironically, since silver is such a vital industrial material, it is likely that your country will, at some point, be buying silver for many times the price you are selling it at. I can think of no legitimate economic reason for your country to dispose of a valuable asset that was accumulated over many hundreds of years, in such a manner.

There is no doubt in my mind that your country was tricked into selling your silver at depressed prices, much like my country, the US, was also deceived into dumping billions of ounces. I know that your Bank's silver sales were not done with your full knowledge or approval. For the sake of your citizens I hope you still have a good amount of their silver remaining, unlike the US, which has none left.

If you investigate this matter, I'm sure you will find large international financial institutions behind the fire sale of your country's silver. I think you will perform a great service to your citizens if you look into and then terminate the unnecessary and uneconomic disposal of one of your country's most valuable assets, at give-away prices.

Respectfully yours,