WEEKLY COMMENTARY

June 14, 2005

INTERVIEW WITH SILVER ANALYST

THEODORE BUTLER

Theodore (Ted) Butler must certainly be the foremost silver analyst of our time. Not only is he a pioneering thinker on the subject of silver, he is also way ahead of the curve with what’s happening in the silver market. Many of his ideas are original and new. It’s no exaggeration to say that almost everything you see other people write about silver today comes from Ted Butler.

Back in 1972 I was selling $1,000 face value bags of silver coins for $1,100. The downside risk was $100 a bag. Eight years later they were $35,000 a bag. During that period I became friends with Jerome Smith, the brilliant author of "Silver Profits in the Seventies" (1970s). His bullish analysis of silver influenced the Hunt Brothers, who were instrumental in the price of silver reaching $50 an ounce in 1980.

Jerome Smith expected silver to explode upward once again in the 1980s, but it didn’t happen. No one could explain why until Ted Butler began to reveal the inner workings of the silver market. He concluded that large banking and trading companies had a stranglehold on silver. They were making a lot of money by frequently knocking the price down. He showed exactly how they did it and how they continue to do so to this very day. His brilliant analysis sparked a revival of interest in silver and, in our opinion, was instrumental in the recent price rise of the metal.

His primary contention today is that the price of silver has been artificially suppressed. When it finally breaks free, it will seek a much higher level. Mr. Butler has gone on record as saying, "Nothing in the world has the potential to multiply your net worth like silver." We conducted the following interview with Mr. Butler via telephone conversations and email.

Before we proceed, it’s necessary to say that Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.

Cook: The Silver Institute just came out with their World Silver Survey 2005. They say, "The silver price in 2004 staged a dramatic rally, rising a robust 36%…. This stunning price increase performance reflects fundamental changes in silver supply/demand balance." Would you agree?

Butler: Well, there are aspects to this report that I agree with and disagree with. I agree that the price went up the amount quoted, but I would hardly call that price rise dramatic or stunning. Not with what silver has going for it.

Cook: Were there fundamental changes in supply and demand as they say?

Butler: No. In fact, I strongly disagree that there were many changes in the silver supply/demand balance at all. The remarkable thing is how the fundamentals were basically the same as they’ve been for decades.

Cook: The price rise last year doesn’t come close to fulfilling your predictions, does it?

Butler: Not even close. The fact is that the primary silver producers, who are the chief sponsors of this survey, still can’t turn a profit, in spite of the "stunning and dramatic" price increase. Some stunning price increase that doesn’t even meet the cost of primary production. It makes you wonder what these silver producers are thinking.

Cook: What do you mean?

Butler: I mean here we have this incredibly unusual circumstance of a commodity in a deficit for many years, with the price still below the cost of production, and the tone of this report is that everything is hunky-dory and how nice it is that the price went up. I think these silver miners are living in a dream world.

Cook: At what price do the miners start to be profitable?

Butler: Somewhere above $7.00. That’s why any price decline to that level or below should be bought.

Cook: Any chance we could be stuck in this $7.00 range for a long time?

Butler: Not for long. As I’ve conveyed recently, the market structure suggests a dramatic resolution before long.

Cook: What do you make of the recent delivery delays on COMEX silver? You have pointed out that in the past they made deliveries on the first day or two.

Butler: It is to the seller’s advantage to deliver right away, to capture the use of the proceeds. Delaying only denies the seller the use of the funds. When delivery is delayed, as it has been in silver and copper, that is proof of tightness in physical supply. This is basic. It should make you want to rush out and buy that commodity.

Cook: If there is continued tightness in COMEX silver, how is this going to unfold?

Butler: Just the way it has been unfolding. Delayed and difficult deliveries on the COMEX and elsewhere, and rising premiums.

Cook: The World Silver Survey claims that the shortage or deficit between supply and demand is only 22 million ounces. Do you agree?

Butler: No. This whole report is a hodge-podge of inconsistencies. You must remember that GFMS does this report the way most people do their tax returns. They decide on the bottom line first and work backwards to prove what was decided initially.

Cook: They point out that this is the 16th year of deficits. If there was a similar deficit in oil, or corn, or copper, wouldn't the law of supply and demand make the price go higher?

Butler: Of course. This is the most basic of economic principles and, in silver, it’s a development never seen in any commodity ever before. The silver miners in the Silver Institute should be screaming their heads off that something is very wrong in the silver market. It shouldn’t just be me. And you are correct. If there weren't games being played, the price would be much higher.

Cook: Well, what do you think the actual deficit is?

Butler: Somewhere between 50 and 100 million ounces.

Cook: In a nutshell, what’s holding down the price of silver?

Butler: Unrestricted paper short selling, primarily on the COMEX, and central bank dumping and leasing, primarily from Red China.

Cook: Why would a big silver user like China be dumping silver?

Butler: Not for any legitimate economic purpose that I can think of. It’s probably for stupidity, or bribery, or controlled markets. This is official government silver that is being sold, not just current production. Even the Silver Institute acknowledges that.

Cook: If the Chinese dumping is satisfying the deficit you talk about, then it’s not a deficit, is it?

Butler: In commodities, the term deficit is used when consumption exceeds production, necessitating a draw down of inventories. Of course, there must be a balance in the sense that you can't consume that which doesn't physically exist. But if you are consuming inventories to make up for insufficient production, that is a deficit.

The important point is that Chinese dumping of official government holdings is what is satisfying the deficit, not free market inventory liquidation in response to higher prices. This Chinese dumping is against every precept of the free market. What I can’t understand is how the Silver Institute can calmly report that the Red Chinese government is dumping official inventories and not do anything about it.

Cook: Like what?

Butler: Let’s face it, these Chinese stockpile sales have single-handedly satisfied the deficit for almost six years. In other words, without this Chinese dumping, the silver price would have been much higher, and the Silver Institute can’t connect the dots.

Cook: What should they have done?

Butler: If this Chinese dumping had taken place in any other commodity from lumber, to steel, to anything, the producers in those industries would be all over that dumping, like white on rice. Only in silver do the producers sponsor a report that proves the dumping and then they do nothing about it.

Cook: Tell us what they should do?

Butler: What other producers do. They should go to the government and their World Trade Organization (WTO) and labor to end unfair trade practices.

Cook: The World Silver Survey sounds a note of authority on their supply and demand figures. I’ve seen that getting accurate numbers on production and usage figures from around the globe seems daunting. Actually, these figures could be only guesswork or purposely falsified. Don’t you think there’s more secrecy than openness in determining the real supply and demand numbers for silver?

Butler: This is one of my pet peeves. When you read this report, you can’t help but come away with the feeling that it is authoritative, given the precision of the numbers. There is never any rounding, every number ends with a fraction or decimal point. That’s preposterous. Not one of the numbers recorded could be independently verified and documented. How the heck could one rinky-dink London outfit know everything from what farmers are doing in India to what the central bank in China is selling to what investors are buying? This report is written with an agenda in mind.

Cook: What’s that?

Butler: The Silver Institute is not just comprised of miners. Users are members and they have a different agenda. That’s why the survey is so middle of the road, and doesn’t rock the boat. It stays away from controversy. The fundamental question of silver market manipulating is never addressed. The manipulation is like a dead body lying on the floor of a fancy cocktail party and people are stepping over it and discussing the quality of the wine being served.

Cook: Let’s change the subject. You’ve claimed that the silver shorts are trapped. How will they extricate themselves?

Butler: Only a price resolution to the upside can remedy the overall short position, and it will probably be dramatic.

Cook: How will this play out on the COMEX?

Butler: No one can know exactly what will occur or when, but we can speak in broader terms. A commodity in a deficit, with a price below the primary cost of production and with shrinking inventories will only be resolved with much higher prices. The shorts could be squeezed.

Cook: Will exchange officials likely intercede in a big short squeeze?

Butler: Maybe. Certainly history would suggest so. But there has been a widespread education about silver and the COMEX as a result of the Internet and your private mailings, and any intercessions by the COMEX to stop a silver price rally will be under more intense scrutiny than ever before.

Cook: Won’t there be a hue and cry from owners of actual silver?

Butler: I would hope so, and not just by real silver owners. I would hope that all believers in the free market would object to any heavy-handed attempts to protect the silver shorts and punish the longs. But the owners of real silver will be in the best position of all.

Cook: How so?

Butler: The COMEX can only change rules that apply to their paper contracts. They have absolutely no say in anything physical.

Cook: Let’s go back to the World Silver Survey. You’ve been about the only one on earth to say that digital photography wasn’t going to kill silver. Their report says China experienced a 6% growth in traditional photography. Isn’t that something you expected in Asia?

Butler: Sure. The price difference between a $2 disposable film camera (in Asia) and a thousand-dollar-plus digital setup argues that the film version will not disappear any time soon.

Cook: The Silver Survey claims that fabrication demand was 836 million ounces last year. Throw in demand from investors and total demand could be a billion ounces. That’s a lot of silver. Do you agree with these numbers?

Butler: I generally agree with those numbers, but not that the Silver Institute knows the numbers with pinpoint accuracy. The important point is that silver demand is economically sensitive and more will be used as the world economy grows, particularly in Asia.

Cook: What about an increased supply of silver?

Butler: Of the three sources of supply – mining, scrap recycling and inventory liquidation – I see real constraints in the last two. Too many new uses of silver are non-recyclable and you can only liquidate so much from rapidly depleting inventories. It’s not even a question of price.

Cook: At what price do you see more silver mining production?

Butler: Even if silver were to jump to double digits next week, it would still take years to bring new mine production on stream. And, let me make a prediction about all the new silver production that’s being counted on over the next few years, mostly from South America. I see real problems from increases in taxes and royalties.

Cook: What about local opposition on environmental or nationalistic grounds?

Butler: Yes, it’s surprising how many countries show symptoms of this, including Chile, Peru, Bolivia and Argentina. We’re going to need more silver production, but I have a sense all that’s needed and expected won’t be forthcoming.

Cook: Do you ever again visualize a big coin and silverware melt like in 1980?

Butler: I just don’t see that big melt being repeated. But, as I always say, even if I’m wrong, it can only come at sky-high prices, so who cares. Let’s get to those higher prices and we can talk about how wrong I was.

Cook: What do you think an equilibrium price of silver would be if we had a totally free market? In other words, what should the price be?

Butler: I’m not a soothsayer, just an analyst. I think it would be well into the double digits. Two years ago, would anyone have thought that crude oil would have leveled off at $50, or copper at a $1.50? We don’t have to decide what equilibrium price will be – the market will tell us. It will be a lot higher than current prices.

Cook: You’ve pointed out recently that the equilibrium price is moving higher all the time.

Butler: Yes, the price will only go higher as energy and other cost pressures increase, and we must find silver in remote places where mining is more difficult.

Cook: What kind of price could we see over the short term if there’s a short squeeze and a lot of silver that’s held in storage accounts turns out not to be there?

Butler: That’s the real wild card and where we could see crazy prices because that could trip off a fear-driven market panic. There’s no way to logically and systematically predict price in those circumstances. It would be every short seller for himself.

Cook: Couldn’t that also set off a buying panic among industrial users?

Butler: Absolutely, and then Katie bar the door.

Cook: Since you wrote about these silver storage certificates several people have contacted us about the inability of their brokerage firm or dealer to produce serial numbers or any proof that the bars exist. How can these firms come out on this type of transaction?

Butler: That’s their problem and I don’t care what happens to them. I only care about those buying silver because of my writing. To them I say, make sure your stored silver bars have serial numbers and weight.

Cook: You have written a lot about the Commitment of Traders Report (COT). Quite a few people have picked up on this, haven’t they?

Butler: You must remember that the COTs of all the markets have been followed by people for years. In the old days, the analysis centered around the small trader being wrong and the large speculator being correct. It’s true my analysis of metals concerning the dealers and the tech funds has recently gained in popularity. I’m generally happy for this, as it does tend to confirm the legitimacy of the analysis.

Cook: I don’t think you get enough credit for this, do you?

Butler: I’m a little surprised how many writers forget where they learned this analysis in the first place.

Cook: Will this greater following of the COTs render it less viable as a timing mechanism?

Butler: Yes, that’s already happening.

Cook: There’s been renewed talk of a silver ETF, or Exchange Traded Fund, like gold. What’s your take?

Butler: Great if it happens, but don’t hold your breath. Assuming that a silver ETF would require the purchase of many millions of ounces of real silver, it’s hard for me to conceive of where that silver would come from at current prices. As I said, I’ll believe it when I see it.

Cook: People have a lot of choices as to where to put their money nowadays. Real estate seems to be getting all the attention. Could you compare silver to other areas for people’s money?

Butler: Before I attempt to answer that question, I would like to state that I am not trying to be anyone’s financial advisor. I’m not interested in passing judgment on what people should or shouldn’t buy. I put forth my opinions on silver and try to substantiate them with fact and reasoned speculation. The key to successful investment is value and vision. It seems simple to me. You should deploy your capital to the most undervalued assets you can find. Undervaluation means low risk and the chance for great profit as the asset moved to overvaluation. I’m no real estate analyst, but I’m not aware of any strong arguments that real estate is undervalued. However, there’s a strong case that silver is undervalued.

Cook: Do you think silver is superior to anything else?

Butler: Yes. That won’t be the case forever, but it is right now.

Cook: What percentage of a person’s net worth should be in silver?

Butler: It depends upon the person. Once you know the silver story, the percentage will take care of itself. For some people, it’s over 100%.

Cook: How is that possible?

Butler: Leverage of borrowing.

Cook: I thought you didn’t encourage that?

Butler: That’s true, but the more someone studies silver, it becomes a natural reaction. Some people are going to take more risks than others.

Cook: Why do you think that actual physical silver ownership is the best way to go?

Butler: Because it is the only certain way of insuring that you will not be denied profit when the price of silver explodes. It is the only way you will not be cheated by arbitrary rule changes and temporary and artificial price drops. Things can also go wrong in silver mining shares, even in a silver price rise. Also, as I’ve mentioned many times, certain forms of storage may not be foolproof.

Cook: A lot of people see silver as an inflation hedge. Do you agree?

Butler: Yes, I agree. All tangible items are an inflation hedge, but that’s a peripheral issue with me, not a central reason to buy silver. However, the upward inflation pressure of the cost of producing an ounce of silver is important to me.

Cook: An analyst recently wrote that gold was money, but silver wasn’t. I know you don’t see either one of them as money nowadays, but assuming paper money failed at some point, wouldn’t silver be just as acceptable as gold?

Butler: Money is whatever people accept as such. I don’t think we will ever see gold or silver used as universal currency again by the masses. But I suppose they could be used and accepted by smaller numbers of people. In that case, I don’t know how anyone could say gold but not silver would be used as money.

Cook: Why do you like silver so much more than gold?

Butler: Silver is rarer than gold in terms of above-ground supplies and getting rarer every day. Silver is a vital industrial commodity, gold isn’t. Silver has a much larger short position. Governments still own a massive amount of gold, but little, if any, silver. This is not a knock on gold, just that silver is more undervalued. It there was no such thing as silver, I probably would focus on gold. But, silver does exist and it has so many unique factors going for it that it is hands-down superior to gold at current prices.

Cook: So, how does this translate into advice?

Butler: People with an all-gold portfolio should switch a big chunk to silver. People with all silver should sit tight.

Cook: We have a lot of new readers who never have thought about silver or considered it for purchase. What can we say to them that will convince them?

Butler: I’m not interested in convincing anyone to buy silver simply because I say so. I’m very interested in convincing people to study and investigate whether they should buy silver. I want to see people buy silver because they’ve done their homework and concluded it makes sense to do so. I believe that if anyone takes the time to truly investigate the silver story with an open mind, that person will end up buying silver. It is impossible to have a different outcome, in my opinion.

Cook: Didn’t you write something about that a few years ago?

Butler: Yes, four years ago I wrote "The Silver Challenge." Although we are more than 60% higher than the $4.50 price at that time, the fundamentals in silver are actually more compelling today. So the challenge still holds – do your homework and see if you don’t buy silver.

Cook: You’ve been beating the drum for silver for quite a few years now. Why are you doing this?

Butler: One of my purposes is to end the manipulation. While I never imagined still being at it, 20 years after I first started, I have to make a confession. While there have been disappointments and frustrations too numerous to count along the way, it has been an enormously satisfying intellectual challenge and experience. You have no idea how much enjoyment I am getting out of it. Naturally, I appreciate the compensation I’ve received over the past few years. But I am also rewarded by the fact that people I don’t know have read my analysis and have made money on silver.

Cook: Do you ever see silver prices surpassing the $50 high in 1980?

Butler: Sure. In fact, I don’t see how it can’t happen. After all, the silver price has been artificially depressed, for the most part, for 60 years. When that artificial price depression fails, as it must, there has to be an over-reaction to the upside. The only question is how far the over-reaction carries. $50 may be very conservative in the coming spike.