TED BUTLER COMMENTARY

May 30, 2006

Facts and Speculation

(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

Usually, I much prefer to write about silver on a long-term basis, as I am convinced that is the only real way the average investor can hope to succeed. Leveraged, short-term trading is not suitable for most investors. Fortunately, the long-term supply/demand fundamentals in silver look as promising today as they were before the price of silver doubled and tripled. Furthermore, as an analyst, it is generally safer and easier to stick to the long view.

But the long view, while safer and easier, can sometimes seem repetitive (even if it is profitable). So when new developments appear that augment the long-term case, they require attention. There are some recent developments in silver that hold great potential for influencing the price in the short term, and I’d like to comment on them. I’ll try to be objective and speak about the facts first, and then speculate a bit as to what the facts may portend.

The first new development is the noticeable recent draw down in COMEX silver inventories. In just over a week and a half, more than 12 million ounces were removed from the COMEX approved warehouses, mostly from the HSBC facility. This represents 10 percent of total COMEX silver inventories, leaving a total of 110 million ounces. I don’t recall that much silver being removed in such a short period of time before. The removal comes after a particular heavy month of deliveries for the just expired May COMEX silver contract.

Of course, these facts don’t tell us who took the silver out and for what purpose. To know this would be priceless. For these answers, we can only speculate. Here’s my speculation. It was a single entity, not a speculator because the regulators would question it, nor a user because the quantities are too large and the removal would work against a user’s interest. I think the silver is being removed to be sent to London for the ETF. If I am correct it is obviously very bullish, as it would mean there is not enough available silver in London. You don’t ship many thousands of miles if you have the merchandise locally.

Another new development is the leveling off, and reduction, in the actual silver holdings of the silver ETF (SLV). From a peak of 73 million ounces, there has been a reduction to 69.5 million ounces in the trust. Many have been quick to conclude that this indicates a saturation of demand for silver and that the reduction in holdings indicates liquidation by early buyers. These explanations are possible, but they are speculations, not certainties. There are other possibilities that could explain the reductions.

In my opinion, it is more likely that the reduction in silver holdings in the ETF is as a result of withdrawal of physical silver from the trust. This can be affected at any time by an Authorized Participant, simply by turning in shares in basket amounts (50,000 share or 500,000 ounce amounts) and backing up a truck and removing the silver. In fact, this may be the most efficient manner to secure industry-size and grade quantities of silver on a moment’s notice. This would sidestep the delay that can be experienced at the COMEX, where the seller has more to say about the when, where and what of deliveries. This idea had been previously advanced to me by Carl Loeb, who coined the phrase, "Death Star" to describe the silver ETF.

Further, Loeb has also privately pointed out that the ability to withdraw physical silver at any time from the ETF creates the possibility that someone could continue to accumulate a significant quantity of silver, and by removing it from the ETF along the way, create the appearance that there was no new buying. In case you were not aware of it, this is exactly how major financial entities, including hedge funds, send out false market signals to obscure their real actions.

Additionally, the ability to short shares in the silver ETF, by either the sponsor or others, can delay the buying of real silver, in spite of real new buying of shares. I don’t see anything wrong with this, necessarily, as long as the shorted shares are repurchased fairly quickly and the shorting is strictly used as a temporary inventory management and procurement tool. It would definitely not be right if the short position in SLV grew to a large and permanent position, strictly for the purpose of avoiding the purchase of real silver.

In any event, this speculation concerning what may really be behind the flow of silver to the ETF is intended to demonstrate that there are more explanations possible than the ones that first come to mind. I’m inclined to question the explanations suggesting a cooling of investment demand for silver, because that is contrary to other objective measures of silver investment demand. For instance, Silver American Eagle sales from the US Mint are running at all-time record levels for the first 5 months of this year, while gold sales, while respectable, are nowhere near record levels.

The CFTC Consoles the SUA.

In a somewhat related matter, Commissioner Hatfield spoke to the Silver Users Association (SUA) last week. I urge you to read the speech, as I think it was important http://www.cftc.gov/opa/speeches06/opahatfield-4.htm Assuming I won’t unduly influence what you think was the real message; please allow me to offer what I think that message was.

These are the very first public comments, to my knowledge, made by the CFTC about the silver ETF. I find it remarkable that the CFTC has been able to avoid public comment on such an important issue for so long. I don’t even recall the CFTC ever commenting on the gold ETFs, and they’ve been trading for more than a year and a half. The CFTC sounds miffed that the SEC left them out of the ETF decision. This sentiment is shared, I’m sure, by the SUA. I’ve long felt the SUA had the CFTC in their back pocket. Apparently, the SEC is not in that same pocket.

It’s possible that this speech was a CFTC warning to the SUA that they could not expect help from the CFTC in silver matters any longer. The SUA is now on its own. The concluding remarks concerning the threat to the nationalization of silver mines in Latin America should have sent the SUA rushing to buy silver. All in all, it was a very bullish speech for silver, in my opinion.

I must tell you that it is beyond strange to read how the CFTC and SUA talk about silver today, compared to a couple of years ago. Formerly, it was always "there’s plenty of silver, yada, yada, yada." Now, it’s a different tune completely. I suppose I should be grateful that the CFTC is waking up, but I’m not.