TED BUTLER COMMENTARY

October 7, 2008

AN EXCEPTIONAL OPPORTUNITY

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.)

When fear and emotion run high, as they presently do, it often creates exceptional profit opportunities. In other words, when everyone is running scared and is concerned about risk, it is precisely the time to look for rewards as well. We are currently positioned the best I have ever witnessed for risk and reward in silver. The downside looks extremely limited and the upside looks explosive. Yes, volatility is great, but everything is lined up perfectly.

I would like to revisit a familiar theme - the suggestion that gold-heavy investors take advantage of the extreme undervaluation of silver compared to gold. This is not intended as a knock on gold, or a suggestion that gold can’t or won’t go higher. It would not surprise me if gold moved much higher. I hope that it does. Then why would I suggest that gold owners convert some of their gold into silver? For the simple reason that silver should climb much higher in value than gold. Maybe two or three times, and perhaps much more.

In fact, if silver eventually reverts to its historical ratio of 16 to 1 to gold, that means silver would have outperformed gold by more than four-fold. At that rate, every dollar invested in silver would return four times more than a dollar invested in gold. What are the chances that old ratio could return? Quite good, I think.

It has been a long time (except for a brief moment in 1980) since the world has witnessed a 16 to 1 gold/silver ratio. This is the ratio that prevailed for hundreds of years. This ratio was set arbitrarily, by government edict back when gold and silver were money. Regular readers know I don’t envision silver as being used as money again. So why would I think the ratio would move to 16 to 1, when conditions are much different today?

When the ratio was 16 to 1 there was much more silver in the world than there was gold. In fact, much more than 16 times more. That was before the industrial revolution at the turn of the last century, when it was discovered that silver was a marvelous and versatile industrial material. After the industrial consumption of the past 100+ years, there is no longer more than 16 times more silver in the world. There is now much less silver than gold. I am talking about bullion material available to the market at anywhere near current prices.

Maybe one in a million of the world’s citizens realizes that there is much more gold in existence than there is silver. If sufficient numbers of people knew this fact, gold would not be 75 times the price of silver. In fact, gold might be a lot less than 16 times the price of silver. This isn’t complicated. When enough people come to learn that there is less silver than gold in the world, they will buy silver (and maybe sell gold) until the relative price of each reflects silver’s greater rarity.

While silver’s rarity to gold is the main factor assuring that silver will climb in value compared to gold, there are other reasons. For one, the price of silver is below the cost of its primary production for many miners, while the gold price is currently above the cost of production. This suggests a contraction in silver production compared to gold. And while silver is produced as a byproduct for the majority of its production, many of the base metals, like zinc, are below the cost of production, suggesting a curtailment of supply.

Additionally, a large amount of the world’s gold inventory resides in government hands. While there does appear to be a lull in central bank gold sales, higher prices and budget pinches may induce more official gold selling in the future. This is a threat largely absent in silver, because so little is in government hands.

Further, a larger percentage of the remaining world silver inventory is in the control of publicly-owned investment entities, like ETFs, closed end funds and exchange-licensed warehouses. Such holdings are less likely to be sold than government metal. More often with these the metal goes in but rarely comes out. I estimate total world silver bullion inventories to be one billion ounces. More than 460 million ounces, or almost 50% are in publicly-held funds and exchange warehouses. In gold, two billion ounces exist in world bullion inventories, and less than 50 million ounces, or less than 2.5%, are held in publicly-owned entities. What this means is that not only is there much less silver than gold in the world, the silver is held in much stronger hands. This silver is much less likely to be sold than gold. Certainly, silver doesn’t face the threat of central bank or IMF dumping.

Silver is basically an industrial commodity, while gold is not. However, any fear of a decline in industrial demand for silver is misplaced because 70% of silver production comes as a byproduct to other types of mining, such as copper, lead and zinc. The real advantage of silver being an industrial commodity is lost in the current financial crisis. That advantage is profoundly powerful. Because silver is an industrial commodity, it is a candidate for an industrial shortage, while gold is not. We already have a widespread retail silver shortage, so a wholesale shortage is likely. What clinches the likelihood is that the world’s vast army of silver industrial consumers hold little in the way of inventories, thanks to just-in-time inventory and production practices.

When they face delays in silver shipments the industrial users will panic and attempt to build inventories all at once. I see them as a vast herd of wildebeests on an African plain, nervous and easily spooked. It won’t be the scent of a lion that sets them off, it will be a phone call from their silver supplier telling them there will be a 10 day delay. This is unique to silver and not gold.

If you are gold heavy and silver light, please fix that. If you are just silver light, fix that as well.

COMING ON STRONG

By James R. Cook

I talk to silver analyst Ted Butler every day and lately I’ve never heard him give a more optimistic view on silver. About eight years ago he affiliated with my company and we’ve literally had thousands of conversations since then. Never was he willing to put his predictions in any kind of time frame. Now, in our private conversations, he’s telling me this is it. A price explosion is imminent. He may not want to go public with that bullish forecast, but with me it’s different. He claims the shortage in silver must now worsen and the price rise high enough to change the dynamics of silver forever.

The one thing he always told me for the past eight years was that before the big upward explosion took place, the price would be crushed. He said the big shorts would be among the first to notice a shortage in silver. They would then do everything in their power to extricate themselves from their short position. They would manipulate a big sell-off so that when those who held silver on margin were forced to sell, they would buy back their silver and thereby reduce their short position. They could never cover all of it, but they would make their short position more manageable. They would still be trapped and suffer losses when silver rose, but they would only lose a toe and not a foot.

More importantly, those who once maintained large short positions would be reluctant to do so again. They would not put their head in the noose again because they had information on silver that indicated the price must rise. This absence of short sellers would be tremendously bullish. It would mean that buyers would not find ready sellers. Nothing could be more bullish than not having anybody willing to go short.

The information that makes the short sellers queasy has to do with the enormous current investment demand that’s now superimposed on already strong industrial demand. Mostly it comes from people who believe they can profit from owning silver. That’s been augmented by nervous individuals who see silver as a safe haven and others who are concerned about inflation and a weak dollar. As Ted Butler has pointed out, this investment demand curtails the amount of silver available for industrial use. The heated demand for silver has made many silver products unavailable. It is truly unprecedented. We’ve never seen anything remotely like it.

From the beginning Ted Butler has told me the silver manipulation (which he has proved without doubt) would be ended by a shortage. That shortage appears to be unfolding. Ted claims that when that happens, the industrial users will dramatically bid up silver. In fact, he says they will panic because they must have silver, no matter what the price. Without silver, they would have to close their doors.

In the past eight years, Ted Butler has been a pioneering thinker on silver. He has shown an incredible breadth of knowledge about silver and the futures markets. For the most part, he has been phenomenally accurate on what he said would happen. He warned about the possibility of every price decline, including the last one. The only time he has been wrong is on two occasions when he thought the price correction was over sooner than it was. His amazing record of predictions and fresh insights on silver argues for everyone to pay close attention to his advice and act on his instructions to buy physical silver. This has never been more true than today when his innermost belief is that we are on the eve of a breathtaking shakeup of the silver market.