WEEKLY COMMENTARY

May 24, 2005

All In

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.)

The most recent Commitment of Traders Report (COT) confirmed the continued powerfully bullish market structure in COMEX silver. For three weeks running, the dealers have maintained their lowest net short position in years, as the tech funds have abandoned the long side and have rushed to the short side in silver. As such, the downside remains limited, and the upside wide open.

While such a constructive silver COT configuration is all one should need to be aggressively long in silver, at any time, the biggest new development has been in the dramatic improvement in the COT structures of related markets, like gold, copper and the dollar. In fact, in addition to the strongly bullish structure in silver, the COTs of these other markets are also in their most bullish configurations in years. And, as bullish as the COTs are in gold, I still maintain that the gold structure is much better than reported, when adjusted for the large and uncommon non-tech fund long position in the non-commercial category.

Unless one believes that the tech funds have somehow come to realize that they have been the patsies and have now tricked the dealers into getting more long and less short than the dealers have been in years, it would appear that the tech funds will once again have their heads handed to them, when we rally in silver, gold and copper, and sell-off in the dollar. The only real question is how much pain the dealers inflict on the tech funds when these funds rush to cover their short positions.

It should be remembered, of course, that the COTs are not a timing device, but more of a directional indicator. As such, we must allow sufficient time for them to work. Just like in tossing horseshoes or hand grenades, close enough in the COTs counts more than pinpoint accuracy. Right now we are structured favorably enough in all the COTs, so as to be "all in" in silver. We may get more favorably configured amid lower prices, but the bigger risk is in missing the coming upside move.

Here’s a quick update on the May COMEX silver delivery situation. The day after last week’s article, the bulk of the then remaining 2000-contract open interest were delivered, as expected. The one real lesson that I think should be learned from the May delivery situation was the apparent unwillingness or difficulty experienced by the shorts in making actual delivery. As it is, there are still 200 contracts open, which represents one million ounces, with only two days until last trading day.

Once again, there is no legitimate economic reason for a short not to deliver as soon as they possibly can, save they don’t have the material. About the best thing one can say about the May COMEX silver delivery is that it is nowhere near as extreme as the May COMEX copper delivery, where there are over 2000 contracts open with the same two trading days remaining. Interestingly, this number of contracts in copper is more than all the total copper in COMEX warehouses, something I have never seen before. This is a very extreme and unusual circumstance. I don’t know what conclusion to reach other than copper is, obviously, very tight and that the management of the COMEX doesn’t seem quite on top of the situation in allowing such a development.

BUTLER IN BARRON’S

The following article appeared in the May 9 issue of Barron’s:

PICTURE THAT!

Digital photos might not sink silver

By Jim Hawe

Ever since Sony unveiled its mavica digital camera in 1981, the prevailing opinion has been that the silver market would fall on hard times as consumers ditch their clunky old film cameras for the exciting new world of digital photography.

But according to recent market studies, a very different picture is developing for silver, one in which traditional and digital photography will likely coexist for years to come, with digital both hurting and contributing to silver demand.

According to a J.P. Morgan report, the photo industry gobbled up 6,428 metric tons of silver in 2002, but demand from this sector is expected to come to only 5,492 metric tons in 2005 as the digital-camera boom takes its toll.

Ted Butler, Florida-based independent silver market analyst, avers that the worst may be over for the metal. He argues traditional silver-halide-based photography will be around for some time, as costly digital applications fail to make big inroads in the high-growth, heavily populated countries like India and China.

Keep in mind that digital-camera users typically use personal computers, printers, battery packs, memory cards and other accessories to produce photos. This can run to hundreds, if not thousands, of dollars, while a disposable will only set you back about $10.

Butler also believes the markets for digital cameras in developed countries could become quickly saturated. One sign: According to Japan’s Camera and Imaging Products Association, Japanese digital-camera exports fell in February for the first time, slipping 0.9% from a year earlier, to 3.29 million units.

A surprising development in the digital boom is the fact that many shutterbugs are taking their prized digital snapshots to processing shops to have them reproduced on glossy, high-quality photography paper, which is loaded with silver.

Digital images printed on plain paper tend to fade and can become easily damaged by moisture. A lot of people are not willing to take these risks with their wedding photos or pictures of the new baby.

Photofinishing News, a market research and publishing group, just completed an extensive report projecting photographic demand for silver through 2010. While this group expects a gradual slide in the number of prints from film cameras, it expects this drop to be offset by a rise in prints of digitally captured images.

While the drop in the number of film rolls being used cuts into silver demand, it also takes a chunk out of supply, as less silver is being recycled from these rolls. "The key point to bear in mind is that photography is a double-edged sword and structural changes affect both demand and supply," says the J.P. Morgan report. "This originates in a large portion of traditional film supply being sourced from recycling and recent trends indicate that while demand from the photography sector has declined, scrap supply from recycled film and flakes has declined simultaneously."

Butler believes this idea of digital photography dooming silver has shifted the focus away from the many compelling reasons why investors might want to add a silver lining to their portfolios.

"There is the continuing market deficit, which is the most bullish condition possible for any commodity," he said, adding silver has the largest short position among speculators of any item in the history in the Commodity Futures Trading Commission’s weekly commitment of traders report. Those bears eventually will have to buy the silver contracts they sold.

The average spot silver price jumped from $4.80 an ounce in 2003 to $6.90 an ounce in 2004, roughly the same time the digital-camera market was exploding. "That’s the craziest thing," says Butler.

J.P. Morgan forecasts an average silver price of $7.10 an ounce in 2005, noting that "the price rally which started in 2003 was a justified price correction that more accurately reflects silver’s fundamental market balance." July Comex silver settled Friday at $6.96 an ounce.

The present risk/reward scenario "looks great!" Butler asserts. "It’s hard for me to see how someone can be hurt with silver right here and how very good things can happen to someone with a long-term perspective," he says, adding that any big move under $7 should be seen as a good time to "load the boat!"