WEEKLY COMMENTARY

August 9, 2005

More To The Picture

By Theodore Butler

(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.)

There was quite a bit of price volatility and changes in the market structure for the metals recently, particularly in silver. According to the most recent Commitment of Traders Report (COT), there was deterioration, as expected, in both gold and silver, as prices rallied during the reporting period. The big news, however, was what transpired since the Tuesday cut-off date. There was a marked divergence between the gold and silver price action and the market structure since the cut-off.

In gold, the tech funds added to their net long position and the dealers added to their net short position by some 30,000 contracts since the cut-off, in my opinion. This is why prices rallied during the COT reporting period. That would put the dealer net short position around 130,000 contracts, not at screaming negative readings but up almost 50,000 net contracts from recent lows, on the $20 rally. As such, more two-way price movement should be expected. My sense is still that we have not seen the top in gold (or bottom in the dollar) yet.

In silver, we had the opposite experience than in gold, from the cut-off date. Whereas the tech funds plowed onto the long side of gold, they were the big sellers in silver over the past week, causing prices to plunge. Yes, the brain dead tech funds were tricked once again by the dealers. The bad news is that silver ran up from under $7 to over $7.30 to back under $7 again. The good news is that the tech funds are now just about maximum short again in silver, creating another ultra-low risk buy point. I know it is contrary to human nature to celebrate sell-offs, but this new buying opportunity being presented in silver is good news.

The fact that gold’s price has been much stronger than silver recently provides a special opportunity for those thinking of switching gold into silver. Since there is much more gold in the world than silver, the recent price action provides an especially attractive short-term pricing opportunity To my knowledge, no one has been able to refute my assertion that there is more above ground gold in the world than silver.

Recently, I have received a large volume of e-mail concerning the increase in COMEX silver warehouse stocks by some 10 million ounces to a bit over 111 million ounces. Although I have written about the COMEX warehouse stocks in the past, based upon the common theme of the messages to me, I think it appropriate to revisit the issue here. Basically, people want to know where this silver is coming from and whether it disproves the deficit story in silver. Also, many are upset with recurring clerical errors in the Internet reporting of the COMEX inventories. (These appear to me to be just that – clerical errors, and not anything conspiratorial.)

It is easy to understand why observers would reach the conclusion that increases in COMEX silver warehouse inventories would undermine the deficit or shortage story in silver, because deficits and shortages are all about decreasing inventories, not increasing inventories. In the case of increasing COMEX silver inventories, the easy and obvious conclusion, namely there is now a surplus, is wrong, in my opinion.

First, I think people pay way too much attention to the daily changes in the COMEX inventories. This is clearly a case of "do as I say, not as I do", since I’ve followed the changes in COMEX silver inventories on a daily basis for more than 20 years. Having paid such close attention to them myself, why would I tell others not to? Because most people approach the warehouse stocks with the wrong perspective. They are looking for a quick and simple deficit confirmation signal to invest in silver. They think COMEX stocks are the same as world inventories. They think that when the COMEX stocks decline in earnest, that will be the all clear signal for a price move in silver.

Perhaps that will be how things work out, but I don’t think so. It won’t break my heart if the COMEX silver stocks decline consistently from here, and everyone gets plenty of advance notification to load the boat with silver, but I wouldn’t count on it. I think it much more likely that the silver price explodes long before we get the big decline in COMEX stocks. I think it’s possible that the COMEX silver stocks will never decline materially from current levels, and that those waiting for this signal may be left high and dry.

I can make that statement because I think I know what the COMEX silver stocks really are and are not. They are not the only silver inventories in the world; they are the only inventories that are transparent. There are no other silver inventories left in the world we can see (save the inventories of the Central Fund of Canada, which are clearly unavailable and are not subject to daily physical movement). But there are other, non-transparent inventories. Because of their transparency, the COMEX inventories attract attention from all interested in silver.

In my opinion, COMEX silver inventories represent the only legitimate public place in the world to buy and store investment quantities of silver in 1000 oz bars, the industrial standard form. I’m aware that others will be quick to argue that London and Zurich are other places where similar silver could be bought and stored, but I would never advise anyone to buy and store 1000 oz bars other than at COMEX-approved warehouses. There are no transparent and audited accounting of silver held anywhere in the world other than the COMEX. Even Warren Buffett had to originally get his silver from the COMEX to ship to London. If there was, or is, so much audited and legitimate silver in London, as many insist, why not just buy it there, instead of shipping it there?

Whether you take delivery or buy from a bank or dealer (like IRI), you are buying and storing real 1000 oz bars, that will be held in a COMEX warehouse. If you are buying Swiss Bank silver certificates on an unallocated basis or into a leveraged scheme, your bars will not be stored in the COMEX warehouses because your silver does not exist. Only real silver is held in the COMEX warehouses, not make-believe silver.

Because all the privately held legitimate and real silver in 1000 oz bars in the world that are professionally stored are, basically, held in COMEX licensed warehouses, you must consider this fact when observing daily changes in the inventory levels. If there is investment demand for silver that is professionally stored and safeguarded, that investment demand must find its way to the COMEX warehouses. There is no other place for this investment demand to go. Therefore, increased investment demand for professionally stored silver must result in increases in COMEX warehouse levels. Period.

This is the mistake, in my opinion, made by those observers who fret over increases in COMEX inventories. The COMEX stocks are not increasing because there has been a sudden end to the 60 year-old structural deficit and there is magically a surplus, as many conclude every time we witness an increase. There is not one iota of substantiating evidence of that. The COMEX inventories are increasing because more people become aware everyday just what an investment bargain silver is and put their money there.

The real question is not the level of COMEX stocks and whether they are rising or falling. The real question is how much of the total COMEX stocks are available at current prices. Of course, there is no daily public report for this statistic. This is one you have to figure out for yourself. You have to ask yourself if people are more likely to buy and hold silver at current prices because those prices are low, or are they more likely to sell silver because prices are too high. Here, I’d like to pass along a personal observation. I’ve yet to run across the real silver investor (and I’ve run across quite a few) who has voluntarily decreased his total silver investment position. Every single person I know who invests in silver holds or has increased his/her total position.

The point here is two-fold. One, it provides a compellingly logical explanation for why COMEX silver inventories would increase and, two, it should illustrate how the silver held at the COMEX is increasingly falling into stronger and stronger hands and is therefore less available at current prices. The more you see (at the COMEX), the less is available.

What’s kind of funny is that even though there may be more silver in total, there is less available for sale. Even funnier is that this silver is even considered "inventory", in that that term is used to generally describe a commodity waiting to be consumed. From the people that I know who own big chunks of this COMEX silver inventory, it’s going to be a long time before they decide to part with their silver.