(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.)

This past week, the investment world witnessed an event that has only occurred rarely in the past. Due to an unprecedented scarcity of metal, the LME was forced to revise the delivery terms of its nickel contracts. In return for allowing short sellers to delay delivery of metal, a daily penalty fee of around 1% of the contract value was payable by the shorts to long holders.

Here is a comment from Simon Heale, LME Chief Executive, "Nickel stocks are at historically low levels and we now have a genuine material shortage. Our first priority is to ensure that trading remains orderly and to prevent the risk of settlement defaults."

Although there has been widespread reporting of this event, I have been thunderstruck by how the reports have danced around the key fact that the LME declared that its nickel contract has gone into default. While Mr. Heale states that the action by the exchange is designed to prevent default, the action taken is nothing but a declaration of default, rendering his statement absurd. Any time you unilaterally violate or negate the terms and conditions of any legal contract, that contract is in default. Moreover, a simple analysis of the situation reveals that the LME is aligning itself with the interests of the naked shorts in nickel.

A contract default is the absolute worst event that can befall an exchange. A delivery default renders an exchange suspect as an institution. It makes no difference if that exchange has existed for hundreds of years, a delivery default can immediately destroy the strongest reputation. This is the grave risk that the nickel debacle poses to the LME. That is because legitimate long contract holders, particularly industrial consumers, have been left in a lurch by the deferral of delivery of actual metal. What do the industrial nickel users now do?

The LME has relieved the shorts of having to round up actual metal to deliver against their contractual promise to deliver, and unilaterally transferred the obligation to the longs, the industrial user. These industrial consumer longs entered into their nickel contracts voluntarily and legally, with the option of taking delivery. Now they are told, with no warning, they can’t take delivery and must secure metal elsewhere. The shorts don’t have to scramble for material they promised to deliver, the longs have to scramble for material they were legally promised to receive. Nothing could be more unfair.

Furthermore, as long as the shorts’ obligation to deliver nickel is suspended, there is no good reason for an industrial user to buy an LME contract. This is the greatest threat to the LME. With the delivery mechanism destroyed in nickel, the linkage between the price of real metal and the LME contract is also destroyed. Without the requirement for delivery, the price of an LME contract, and nickel, in the real world loses its connection. In this case, the price of LME nickel is merely a figment of anyone’s imagination. What good does it do an industrial consumer to hedge on the LME, if there is no assurance his contract will converge with the price of actual metal on the delivery due date? Without the delivery mechanism, there is no linkage between a paper contract and actual metal.

It is also the same thing with the short-side manipulation in COMEX silver. It is just a coincidence that this LME nickel disaster has occurred precisely at the same time others, and I, have been alleging a manipulation in COMEX silver. However, nothing could prove our case more clearly. A short-side manipulation, like those in LME nickel and COMEX silver, is evidenced by a concentrated short position and prices lower than they would be without the concentrated short position. The regulators have little or no experience with short side manipulations, and since the concentrated shorts are industry insiders, rather than outside speculators, there is little incentive for the regulators to move against their own.

The real problem with short-side manipulations is that it is very difficult to terminate, without great damage, because they have a long duration. When a short-side manipulation is terminated, as with LME nickel, it threatens great and lasting disruption to the actual market, because the resultant shortage of material causes real hardship with no easy remedy.

I think there may still be time for the US regulators to act in silver and avoid a COMEX silver delivery default. But I also have my doubts. That’s because the CFTC and NYMEX/COMEX officials have been dragging their feet on the issue of the concentrated short position. Instead of promptly responding to allegations of manipulation and a looming delivery default, the regulators are stalling. This stalling didn’t benefit the regulators in LME nickel. It only made matters worse.

The main difference between nickel and silver is that the regulators will never be able to say they were not warned in silver. And if the regulators in silver still do not see how the recent events in LME nickel are directly foretelling what is going to happen in COMEX silver, then they do not deserve to be regulators. It is entirely possible that government regulators and COMEX officials will continue to evade their legal responsibilities and allow the silver manipulation to exist, right up to the inevitable delivery default. That will be tragic, but it will be on their heads.

The strongest message is being sent to the silver users of the world. If the LME can get away with suspending delivery requirements in nickel, how hard will it be for the COMEX to suspend delivery requirements in silver? Any user who is not stockpiling real silver inventories, in light of what just occurred on the LME, is missing the boat.

If there has ever been an exclamation point given to "buy and hold real silver", it has been given to you by the LME actions in nickel. If an exchange that has been in existence for hundreds of years can suddenly terminate delivery obligations in its contracts, how hard do you think it will be for those issuing pool and leveraged accounts in silver to do exactly the same thing? I think anyone holding such accounts needs to have their heads examined.

There are powerful reasons for investors and industrial users to buy real silver. How many wake-up calls are necessary?

"The uses for silver are so numerous that, despite the dwindling role in photography, you can expect demand to remain strong as long as industrial economies remain strong. And they have been so for some time now – with China and India leading the charge.

Consumption has been eating into above-ground stocks of silver at a phenomenal rate for decades, eroding total world bullion inventories from an estimated 2.1 billion ounces in 1990 to around 400 million ounces today – a drop of 1.7 billion ounces. A large chunk of the drop, about 240 million ounces, came from government sales.

Silver is like uranium as an industrial metal, in that, it is hard to replace and used in such small relative quantities the price could double or triple without having a major impact on industrial usage. But the main reason, as mentioned above, silver is being rediscovered as an investment vehicle, most notably in Barclays’ new silver ETF (SLV).

Barclays’ silver ETF will pull a lot of silver off the market. As of this writing, August 7, 2006, the ETF has already sucked up 92.4 million ounces of silver. There goes the supposed surplus.

Will silver hit its previous 1980 high? It was $48.70 then, but that’s $120 in today’s dollars – almost 10 times the current price. Given that, just below the surface, the threats to the U.S. economy are even greater today than in the late 1970s, we can easily envision silver closing in on its previous high and even going way beyond it."

There’s been a lot of recent criticism of the government’s inability to fix New Orleans. Katrina victims are depicted on TV as abandoned by federal, state and local governments. In reality, the government has pumped $122 billion dollars into the disaster area. That’s five times more than any other previous disaster.

The Wall Street Journal reports, "The post-Katrina spend-fest will be remembered as one of the greatest taxpayer wastes in U.S. history. First came the FEMA $2,000 debit-card fiasco intended to pay for necessities that were used for things like flat-panel TVs and tattoos. Then came the purchase of thousands of mobile homes that cost as much as $400,000 per family housed; the $200 million for renting the Carnival Cruise Ship; millions more in payments that went for season football tickets, luxury vacation resorts, even divorce lawyers." The Journal failed to mention the numerous swindlers who got multiple payments or the money that was wasted on everyday vices like gambling, drugs and alcohol.

Despite the outrageous examples of bureaucratic incompetence, American liberals still have boundless faith in government. Leaders of the left are calling for large public works projects in New Orleans. Despite the waste, corruption, negligence and failure, the left wants more government. They never learn.

Nobody’s talking about the real issue that’s making it difficult, and even impossible, to put New Orleans back together again. A large percentage of the population has been dependent on government welfare payments and other subsidies for decades. Consequently, they have lost the ability to do anything for themselves. Over time government subsidies render the recipients helpless. They can no longer accomplish anything. Often this helplessness goes hand in hand with alcoholism and drug addiction. Subsidies also promote a breakdown in character and encourage bad behavior. The government’s greatest failure is the creation of a dead-end culture among the underclass. The offset from the boredom induced by free money is the bizarre. Rich or poor, when you give people money they didn’t earn on a sustained basis, you do them the greatest disservice that can ever befall them. New Orleans is living proof.

"We now have overwhelming evidence that the Fed is done [raising rates] (despite rising inflationary pressures). The dollar has begun to roll over, and the consumer is headed for big trouble in the fall. We all know what the Fed’s response to trouble in the economy is (i.e. – print money like water), and it’s only going to exacerbate the inflationary pressures that are already present.

"We’re already seeing signs of inflation due to all of the excess liquidity that is still in the system as a result of the Fed’s tech bailout. For the Fed to now spur even more credit creation in response to the bursting of another asset bubble (this time its in housing) is only going to generate a lack of faith in the Fed and the dollar instead of another bubble in asset prices. This is the road that Uncle Al set us on when he gave the drug addict more and more drugs in order to prevent withdrawal, and we’re now nearing the natural end to it, meaning the patient is going to die (i.e. – a virtual vaporization of the dollar)."

The Financial Privacy Report had this to say recently about silver and the ETF.

"This is a great buying opportunity to either add to your holdings or begin investing. Silver will, over the next three to five years smash through $15, $20, and even $25 an ounce….

"That brings me to the question of the new silver ETF: Is it a good deal for investors? It is, of course, extremely bullish for the silver market. But the question is: Should you, as an investor, buy shares in the silver ETF?

"My recommendation is an emphatic: NO!…

"The first reason is financial privacy. If you own pure silver, you have a great deal more privacy than you do with the ETF…

"When you hold silver and store it yourself, either hidden safely in your home or in a safe deposit box, you have much greater privacy than you do when you hold it in a fund that’s regulated by the federal government…"

We would add our own caveats about holding paper. No institution is so big that it can’t go broke, thus rendering its paper suspect or worthless. The future could be extremely volatile with the kind of violent fluctuations in financial markets that catch mainstream managers by surprise and cause enormous losses.

Here’s the most important reason to own actual silver. If you own paper silver, you will invariably sell too soon. When you own physical silver you are far more likely to hold onto it and not trade in and out. It’s harder to trade than a futures contract or a stock which you are often tempted to sell for a small profit. Taking physical possession and having patience are the two necessary ingredients to make the kind of huge gains that Ted Butler predicts are coming in silver.

(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.)

It’s not wise to plan on being lucky, especially when it involves money. But sometimes, good luck comes your way. It is up to the individual to fully take advantage of any situation that turns out better than originally anticipated. Yes, I’m thinking about silver again. Eventually those who own it will, in my opinion, be considered very lucky people.

Silver’s price performance over the past few years, while terrific, has not been exactly as I had anticipated. I always thought that if silver were to double or triple in price, it would be because those who were short massive amounts of silver were buying back their short positions in a panic. And such a buying panic would propel the price to much more than double or triple. I thought my efforts to expose and attack the concentrated and manipulative short position in COMEX silver would have those shorts on the run. Instead, those big shorts have not panicked, although the tripling of the price has hurt them.

The fact that the big short concentrated position is still intact surprises me. More importantly, it is a lucky break for all silver investors. It should translate into much higher silver prices. That’s because the short position can’t stay intact indefinitely. Sooner or later, this silver short position will be covered. A short position in a commodity must be resolved at some point, either by delivery, repurchase or default. It is possible for a short position in a security to be resolved by a bankruptcy, but silver is a commodity and, as such, can’t go into bankruptcy.

Any of these three possible ways of closing out the silver short position will be extremely bullish for the price. A buy-back of hundreds of millions of ounces would be extremely bullish, as would a default. This would eliminate any possibility of future short selling. Even a delivery of silver against the short position would be bullish. The quantities involved are so massive that, once delivered, it would likely preclude the seller from ever going short again. The short sellers would lose their silver and any legitimate reason for further short sales. This assumes the actual silver exists, which I seriously doubt.

The resolution of the silver short position still lies ahead of us, not behind us. After a tripling of price, I would have thought I might be singing a different tune and the short position would perhaps be resolved. I would have been disappointed if all we got was a tripling in price, since I expect so much more. But the silver short position has not been resolved yet. That is why we are all lucky. We have had silver prices double and triple from the lows, and we still have no resolution of the short position. With this favorable wind at our back, prices could literally explode upward. To say this is good luck is an understatement. You are fortunate to be given this opportunity. However, you have to own silver to be lucky. Today’s prices are a gift with a major unresolved short position still to be concluded. You don’t need a four-leaf clover or a rabbit’s foot if you buy silver now.

In my discussions with Ted Butler each business day, he analyzes every new piece of available new data on silver. Frankly, I’m amazed at how thoroughly he understands the silver market. I read all the other silver commentary and nobody comes close to the completeness of his analysis. In fact, when other writers on silver fail to mention Ted Butler’s work, I dismiss what they say. You can't write seriously about silver today without including Ted Butler’s pioneering analysis.

I’ve been totally committed to the gold and silver business for 33 years. I’ve seen my share of con-men and charlatans. I can sniff out a fraudulent character in a hurry. Conversely, I know the real thing when I see it. Ted Butler is everything you could hope for in an expert. I believe his advice is as good as you can get.

If you want to follow his advice, here’s what to buy. For storage 1,000-ounce silver bars are a good way to go. These large 68-pound bars are stored at HSBC, one of the world’s largest banking groups. They stand behind the security of the bars. You get a storage agreement in your name and the serial number of your bar. Nobody can match this storage arrangement. (Other storage programs are in the dealer’s name and don’t give you serial numbers.) Call us and buy some 1,000-ounce bars. 1-800-328-1860 They’re a great way to own silver with the safest possible storage program. We also have 100-ounce bars available for storage or for shipping to you.

Among the best available silver items today are 90% silver coin bags. These coin bags have a $1,000 face value. You get 2,000 silver halves, 4,000 silver quarters or 10,000 silver dimes. There are 715 ounces of silver per bag. A bag weighs 55 pounds and is the shape of a bowling ball. We ship them in half bags, registered and insured through the mail in plastic pails and marked "machine parts." The coins are all dated prior to 1965 when silver was eliminated from our coinage.

BU Dimes and Quarters: These uncirculated bags of either Roosevelt Dimes or Washington Quarters have 725 ounces of silver. They are generally dated in the 1960s. The supply is small.

BU Kennedy Half Dollar Bags: These uncirculated silver coins were struck in 1964 only. A bag contains 725 ounces of silver. We don’t get many. It’s probable that a lot of these coins have been melted.

U.S. Silver Eagles: These one-ounce silver coins are newly struck by the U.S. mint. They have a face value of one dollar. They have a Walking Liberty on their shimmering surface and are big beautiful coins.

Complete roll sets of U.S. Silver Eagles are available. This set includes one roll of coins for each year of mintage, from 1986 through 2006. There are 420 coins in 21 rolls of 20. These sets are hard to put together.

Call us now at 1-800-328-1860 and buy silver, both for profit potential and to hedge yourself against uncertainty. Put 10% of your net worth into silver. Get this all-purpose precious metal now at today’s still reasonable prices (according to Ted Butler). Industry wants silver, and so do growing numbers of individuals. Call us today. 1-800-328-1860

Sincerely,

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