WEEKLY COMMENTARY

October 11, 2005

A Surprise Silver Endorsement

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.)

The most recent Commitment of Traders Report (COT) indicated continued tech fund buying/dealer short selling in gold and silver. In gold, especially when factoring in the trading from the Tuesday cut-off, the tech funds now hold a record long position, on both a net and gross basis. The dealers, likewise, hold a record net and gross short position in gold. While these respective positions could grow larger with higher prices, in poker terms, the pot is full. Soon we will get the resolution.

In silver, based upon the current COT report and subsequent trading from the cut-off date, the dealers appear to have sold short an additional 40,000 net contracts (200 million ounces) on the price rally over the past month or so. By my calculations, the dealer net short futures position has increased to roughly 375 million ounces, including the extrapolation from the cut-off date. While not at a record like gold, the silver COTs are very full, although they could get fuller at higher prices. The bottom line is that we are close to a "do or die" extreme juncture in the market, where volatility and risk are high. One side or the other, tech funds or dealers, will win or lose. This is not a contest in which other market participants, including small traders, play much of a role in the determination of the outcome.

Can silver move sharply higher from here, in spite of negative COT readings? Of course it can. Can we sell down through the moving averages easily? Yes. Is that doubletalk? Maybe, but I would be leery of anyone who claimed to know how the short term will play out. I do think I know that on a short-term basis, while profit potential may be high in silver (as it always is), risk is also high.

While past extremes in gold and silver have always eventually resulted in the tech funds running, it is always possible for the dealers to be overrun. No one knows how it will play out, although many have already declared the dealers the losers. This is premature, as the game is very much in play, with both sides increasing their bets. Open unrealized profits and losses are very much different than closed out and realized profits and losses.

We know the tech funds have held enormous open profits in the past, only to lose those profits on sell-offs below the moving averages. It would be instructive to determine beforehand just what would constitute a dealer loss. The simplest definition would include the tech funds closing out their long gold and silver positions at big profits to them and big losses to the dealers. While that has never happened in gold and silver, it could happen. But until it does happen, we won’t know. Let’s declare who wins and count the money when the dealing’s done and the positions are closed out.

Of course, this COT analysis is short term in nature. As such it is necessarily of speculative concern, as opposed to long-term investment, which is the way the vast majority of investors should handle their money. Let me keep it simple. Long term, silver goes much higher based upon the law of supply and demand. Short term, who knows? But if we do experience a significant short-term sell-off, I’d like to make two points in advance. One, it should provide a low-risk buy point in silver. Two, we will have come down for one reason only – tech fund selling.

This week, silver received an unexpected endorsement from an unlikely quarter – the Silver Users Association (SUA). For those of you who may be unfamiliar with this organization, here’s their website http://www.silverusersassociation.org/index.shtml I have previously written about the SUA, in non-flattering terms, in an article 4 years ago, "Silver Users, Silver Abusers" http://www.investmentrarities.com/03-26-01.html

I don’t want to go off on a tangent, but I could never understand how the SUA was allowed to exist, since their main purpose seemed to be to keep its members supplied with cheap silver and that they were the only commodity consumer group in existence. If a group of commodity producers banded together for the purpose of artificially increasing the price of their commodity, that would be clearly illegal under US law. How a group of commodity consumers could get away with the reverse goal is a mystery to me.

Additionally, the SUA was the main driver behind the US Government disposing of its massive silver stockpile over the past 60 years. This was the main reason the SUA was formed. In the interest of full disclosure, I did complain to the Justice Department’s Anti-Trust Division about the SUA, some 15 years ago. Suffice it to say, I’m no friend of the SUA.

That’s why I was surprised when a received a number of e-mails from friends and readers this week about the SUA. First, I learned that the SUA had actually published one of my articles in their April 2005 newsletter. No, it wasn’t the Silver Abusers article, but one on digital cameras. I’m used to seeing my articles published by others, but I never expected the SUA to do so. I’d be lying if I said I was flattered.

More importantly, it turned out that the SUA had written articles in their two most recent newsletters, dated July and September 2005, on the pending Silver ETF from Barclays. One reader wrote to me that the position of the SUA on the Silver ETF fully endorsed my take on the ETF, which I wrote about in June - http://www.investmentrarities.com/06-28-05.html

While I would concur that the SUA agreed with my assessment, of much greater significance is that the SUA has fully endorsed silver as an investment. As much as I loathe what the SUA stands for and has done to the silver market, I will acknowledge that they know as much about silver as could be known. For them to tell you that real silver is a great investment is powerful beyond any words I could ever write. They’re even telling you to buy allocated silver, the only kind of stored silver that I preach about.

No, the SUA is not suddenly in the investment advisory business and is not intentionally promoting silver. That would be preposterous. But if you take the time to read why they are opposed to Barclays Silver ETF, and apply your common sense, you will be able to reach no other reasonable conclusion. Here are some excerpts from their position on the ETF (full statement - http://www.silverusersassociation.org/news/wash_rpt_0509.shtml)

The excerpts -

"Background on ETF

An ETF is an Exchange Traded Fund, created under the Investment Company Act of 1940. They are index-based products, which hold a portfolio of securities that is intended to provide investment results that, before fees and expenses, generally correspond to the price and yield performance of the underlying benchmark index. In the case of a Silver ETF, the index would track the silver price and be backed by physically vaulted silver. Gold ETF's gained popularity in the recent commodity bull markets as investors were attracted to an alternate form of gold investment other than mining shares, options, futures and physical. Many are interested in gold from a 'buy and hold' perspective. Each unit that is bought on the gold ETF has resulted in physical gold metal being purchased on the open market and stored in a vault. In total, these gold ETF's have contributed to 250 tons of gold being purchased in the open market, approximately $3.4 billion dollars.

Impact of Silver ETF

Fortunately we do not have to look back very far to see the impact a significant amount of allocated silver would have on the market. It was 1998 when Warren Buffet purchased over 100 million ounces of physical silver and the spot price rallied over $3 dollars and one month lease rates soared over 30%.

………As it is, silver can be an illiquid market because there are few central banks which own silver. Silver is inexpensive in terms of commodities, and its volatility is typically 2-3 times that of gold.

These are both reasons investors are drawn to the market. A silver ETF would only exaggerate silver's illiquidity given the sheer volume of physical silver needed to be shipped and stored. While a silver ETF might initially provide price benefits for producers, we believe it would disrupt the market in the short term and may harm the market in the long term.

SUA Position

The Silver Users Association opposes the creation of a silver ETF because of the concerns that doing so will require the holding of physical silver in allocated accounts, thus removing large amounts of silver from the market. By doing so, the ETF most likely would cause a shortage of silver in the marketplace……"

I urge you to read the entire article. The SUA writes in very clear and blunt language, just like I tried to do in my ETF article. You decide if the SUA agrees with me. They are telling you there is not enough real silver in the world to fund a silver ETF, just like I did. They are telling you that the silver ETF will create a shortage and send the price soaring, just like I did. They are comparing the impact of the silver ETF to Warren Buffett’s silver purchase in 1998, just like I did. They are telling you that there is plenty of gold for any number of gold ETF’s, but not enough for even one measly silver ETF, just like I did and further confirming my contention that silver is more rare than gold. They are confirming that there is little silver left in the central banks of the world. They are confirming that allocated (with serial numbers and specific bar weights) silver is the type of silver that counts, just like I’ve always done. They are telling you that silver is cheap and will move much more than gold. Is there an echo in here?

Please understand me – it’s not just that they wrote exactly what I wrote. It has to do with who I am and who they are. I’m an analyst who is bullish on silver and who is interested in ending the silver manipulation and seeing as many regular people take advantage of a great investment as possible. You would expect me to say bullish things about silver. But what about the Silver Users Association? What would you expect to hear from them?

I’ll tell you what I have come to expect from following them for 20+ years. Up until this ETF article, I have never heard them say anything bullish about silver. It was always "there’s plenty of silver, the price should go down, it will always be a poor investment, yada, yada, yada." Never have they issued a bullish word about silver. That’s what is so significant about their ETF article; it is nothing but bullish. Not enough silver for an ETF, silver’s inexpensive, the ETF will cause a shortage, it moves faster than gold, the ETF will benefit producers, the ETF will have the same impact that Warren Buffett did. All I can say is "huh?"

This SUA article is serious stuff. It is unprecedented. There was only one reason they came out against this ETF as forcefully as they have – they knew this silver ETF could blow the silver market sky high. The SUA had to do whatever it took to kill it, and as I wrote previously, there’s no other way to spin it. If the silver ETF is killed, it will be for the irrefutable fact that there is not enough real silver in the world to fund it anywhere near current prices. It should be simple for you to recognize that the SUA was in such a bind that it forced this open and blunt approach.

And you can rest assured that writing articles in their newsletter is only the tip of the iceberg as far as their real, behind the scenes effort to derail the silver ETF. The SUA and their members are the masters of backroom lobbying and influence peddling. How else do you think they succeeded in causing the disposal of billions of ounces of government silver over half a century, right in front of our eyes? The army of well-paid lawyers and lobbyists from Eastman Kodak, Dupont, Dow Chemical, Engelhard and Tiffany have been petitioning and influencing the SEC to kill the ETF. Against this concerted and well-organized effort against the silver ETF, I’m not aware of any forceful attempt to get it approved.

While I can be wrong, and I do hope I am, the effort to kill the ETF should prevail. It won’t be a surprise, because there never was enough real silver to back it. The surprise is to see the SUA come out so publicly against it, and in doing so, prove to the world just how little silver is left the world. It would be hard to ask for clearer proof. In fact, we don’t even have to wait for the final SEC decision to deny the ETF in order to confirm my contention that there is not enough silver, at near current prices, to back it. The SUA just did that.