TED BUTLER COMMENTARY

July 8, 2008

The Sole Silver Price Depressant

(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.)

In a recent article, I likened the silver market to a multi-ringed circus, with various activities occurring on different levels. I’d like to draw on that analogy again, and describe the conflicting forces at work that are both pushing prices higher and pulling them lower.

Many factors combine to push prices higher, including investment flows, supply/demand fundamentals, and a long-term depletion of world silver inventories. Current fears concerning financial system stability increase demand for silver as a flight to quality asset. Undoubtedly, there will come a time in the future, at a much higher price, when these same factors will work to depress the new high price. This is the essence of the law of supply and demand.

In stark contrast to the myriad bullish factors in silver, stands a single force depressing the price - a small group of short sellers. Without these few short sellers, the price of silver would be multiples of the current price. To be sure, the dedicated small group of short sellers, operating primarily on the COMEX (and now also in the big silver ETF, SLV) are aided and abetted by others, such as the issuers of unbacked silver certificates and pool accounts. But without the COMEX and SLV short sellers, the low price of silver could not exist.

The primary cause of the current low price of silver is, ironically, the most important factor that will boost prices in the future. Therefore, the short position in silver is not to be feared. It is just a reality that must be objectively dealt with. The evidence is clear and compelling that a small number of short sellers are primarily responsible for the current low price. I am truly amazed how anyone studying or writing about silver (or gold) could deny its importance. That’s not a complaint, as many have come to appreciate the significance of the concentrated silver short position on the price. The evidence speaks for itself and is not dependent on how many recognize the influence of the short position.

The documented evidence can be seen, once again, in the most recently released Commitment of Traders Report (COT). For positions held as of July 1^st, the commercials, as a group, increased their net short position by 35 million ounces on the recent $2 rally. The eight largest traders accounted for most of that amount, increasing their net short silver futures position to a two-month high of 70,728 contracts, or more than 353 million ounces. That’s the equivalent of more than 196 days of world mine production. No other commodity comes close to that.

The eight largest COMEX silver traders now hold more than 79% of the net

short position of the entire COMEX silver futures market (all spreads removed). This is a level of concentration that, in and of itself, is unquestionably manipulative. This is a level of concentration that would not be tolerated by the regulators on the long side of silver or gold or any other market. This is a level of concentration only exceeded by the COMEX gold market, at more than 81%. In gold, the commercial net short position increased by more than 40,000 contracts for the week, the largest weekly increase in almost a year. If silver and gold sell-off sharply, there will be no explanation other than engineering by the commercials.

At 353 million ounces, the documented net short position of the eight largest COMEX traders is almost equal to all the known silver in the world. The only problem is that the concentrated shorts don’t own all, or even a significant chunk, of the known silver in the world. If they did, the CFTC and COMEX would have responded to my complaints of manipulation by proclaiming real silver backs up the short positions and not beat around the bush.

That such a documented concentrated short position exists in COMEX silver is beyond question. The only question then becomes, "why are they short?" I have asked myself that question everyday for more than 25 years, since first discovering the anomaly of the outsized COMEX silver short position. The most consistently plausible explanation is that the short position grew so large, so many years ago, that it took on a life of its own. It had become so large that it could not be resolved without scandal and disorderly market conditions.

Yes, the short players have changed over the years. Yes, the shorts have been incredibly nimble in managing their positions profitably (thanks to their counterparties, the tech funds). Yes, the regulators have looked the other way. Yes, the price has climbed sharply over the past few years. In spite of all these things, the short position has endured. If the silver short position had been reduced to levels comparable to other commodities, this issue would have become moot. Certainly, I would have dropped the matter. But the short position has only grown larger and more concentrated over the years.

Much like a parasitic tapeworm or tumor that has grown larger in mass than its host victim, the removal or resolution of the silver short position threatens the very existence of the silver market. Or more precisely, the resolution of the short position threatens the continued existence of the silver manipulation and guarantees sharply higher prices.

In addition to the documented concentrated short position on the COMEX, strong circumstantial evidence has surfaced of a new unreported silver short position in the big silver ETF, SLV. In an article three weeks ago, "A Hidden Silver Default?," I speculated that unreported naked short selling of SLV shares amounted to as much as the equivalent of 50 million ounces of silver, or more. In the past three weeks I would estimate as much as the equivalent of ten million additional ounces have been shorted. I base my figures on several facts.

First, the canned response and denial that everyone received from Barclays was tepid and weak. They should have been outraged by my allegations, and issued a strong and unequivocal denial. Instead, they merely acknowledged that short selling existed and it was normal. I think Barclays inadvertently confirmed my allegations.

Second, the numbers I am attributing to SLV shorting is minor (if you can call it that), compared to the documented concentrated short position on the COMEX. If my guess of 60 million equivalent ounces (6 million shares) in unreported naked short sales in SLV is accurate, that would represent less than 17% of the 353 million ounces held net short by just 8 traders on the COMEX. I would understand doubts about my numbers if the documented short position was 60 million ounces and I was speculating that an unreported additional short position of 350 million ounces existed. Clearly, that is not the case.

The same methodology, SLV share volume and price action, that led me to conclude that up to 50 million equivalent ounces had been sold short from April 15 to early June, tells me up to 10 million additional ounces have been sold short in the past three weeks. In addition, the strong growth in the deposit of gold into the big gold ETF, GLD, over that time of 2 million ounces (almost $2 billion) make the lack of any addition of silver to the SLV more suspect. After all, silver’s price had advanced as much as gold’s price and we had previously witnessed growth in silver deposits while GLD’s holdings had actually declined. All other public and objective evidence (such as US Mint statistics and reports from retail dealers) confirm stronger silver demand than gold. The most plausible explanation for the lack of growth in SLV holdings is unreported naked short selling.

While I believe the large concentrated short sellers on the COMEX and in SLV shares are largely one and the same, there is a critical and important distinction in the motives behind the short selling on the two venues. Sure, the short selling in both markets share a price capping or manipulation motive, but the selling in SLV shares goes beyond price control.

I am convinced the prime motive in the unreported short selling in SLV is incredibly simple and straight-forward - the physical silver needed to be purchased to back up new share issuance is just not available. It’s not there without immediately forcing the price of silver sharply higher. Since the real silver isn’t available for purchase at near current prices, the Authorized Participants (AP’s), who are the market makers in the SLV have no choice but to sell short the new shares being purchased by investors without depositing the required new silver.

What I have just described is a default and a massive fraud. It is illegal by any possible definition. It is a desperate, last-ditch attempt by the manipulative short sellers to buy time before silver explodes in price. Will that desperation translate into a final sell-off? Maybe, or even probably. Should this concern the long-term silver investor? Not in the least. That’s because the desperate and illegal short selling in SLV proves one thing beyond doubt - that we are in the midst of a bona fide wholesale silver shortage.

I believe the naked and unreported short selling in SLV shares is occurring because if the real silver was being purchased, as it should be, industrial users around the world would be denied the silver they depend on for their operations. If industrial users were denied silver, that would send them into a panic and set off a silver inventory buying binge the world has never seen.

So the AP’s in SLV, who are also the wholesale silver suppliers to the industrial users, have made the choice to supply the users at the expense of SLV investors. In reality, there is little real choice. Meeting the fiduciary requirements to SLV investors to have 10 ounces of silver behind every share issued would cause the silver manipulation jig to be up. After all, it is possible to short sell to SLV investors, while there is no way to short sell a silver delivery to a user. Either you deliver to a user or you don’t. If and when you don’t, all hell will break loose.