Weekly Commentary

WEEKLY COMMENTARY

October 22, 2002

Here We Go Again
By Theodore Butler

(The following essay was written by silver analyst Theodore Butler. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

Prices of silver have come down again, to the lower end of the roughly low $4 to low $5 range that it seems like we have been locked in forever. There is no doubt that patience has been a requisite for silver investors. Low prices are an irritant to existing holders, but a blessing to those accumulating. The price is known to all, and how we deal with it and feel about it is a personal matter. One thing that invariably develops in just about every silver investor's mind, at times like these, is to reevaluate the facts behind the metal. Don't worry, this will be a quick review.

First and foremost, silver is still operating in a deficit. That is, every single day, we consume more of the metal than we produce. That means that every single day, we have less above ground silver inventory in existence in the world than the day before. This has been occurring for 60 years, and doesn't appear to be about to change any time soon, at current prices. This means that we have, at a bare bones minimum, less above ground silver in the world, than we had 60 years ago. In reality, we have less above ground silver in the world than we had hundreds of years ago, thanks to the fact that we have eaten up those inventories of 60 years ago in satisfying the structural deficit, and those inventories took the world hundreds, if not thousands, of years to accumulate. Based upon the wide variety of uses of silver to modern life, growing daily, and the practical constraints to taking it from the ground (mainly the low price), this condition promises to continue. Like all industrial minerals, the fundamentals of silver are as easy to change as making a U-turn in a supertanker.

I offer this brief review to hopefully balance what is an ingrained human condition, namely, when the price of any investment item declines, any bearish stories sound more plausible. Just like, when prices rise, bullish stories are granted more credence. While that human condition will never vanish, recognizing its existence, and dealing with it as logically as possible, should be the goal of any thinking investor. In silver, of the many recent bearish sounding stories that seem to suggest that the recent price decline is here to stay, two popular ones come to mind - what if there is no deficit and what about the flood of silver from Red China?

What if the statistics are wrong, since they are so hard to keep anyway, and we don't have a deficit after all? To this, I answer that the vast majority of input of the statistics comes from public companies and official government statistics (like export/import figures), cross-checked by any number of independent public and private organizations over many years. And even if that is not good enough for you, let me offer knockout proof that the long term silver structural deficit is real. In a commodity deficit, by definition, inventories must be reduced by the amount of the deficit. In silver, I can point to a couple of simple inventory statistics that confirm the long-term structural deficit. For one, there is the US Government. Uncle Sam had 6 billion ounces at the start of World War II, 60 years ago, the largest known stockpile of silver in the history of the world. The US is now officially tap-city in silver and a buyer for the first time in many, many years. The 6 billion is gone. Oh, we may have a couple of hundred million ounces kicking around in old coins, but the vast bulk is gone. By the way, 6 billion over 60 years, is 100 million ounces per year, which not coincidentally, mirrors the size of the annual amount of the long-term structural deficit. In addition, the current largest known stockpile of silver in the world, the warehouses licensed by the COMEX, had 350 million ounces in 1993 (adjusted for additions from the Delaware warehouses). Those COMEX stockpiles have dropped 70% to around 110 million currently. Think about that for a moment. The two best known inventories in the world are down 100% for the biggest and 70% for the next biggest. Combined, the two most widely known and trusted inventories of silver have been depleted by more than 98%. Don't you think that confirms that we have had a deficit in silver? Of course, as I have asked repeatedly over the past couple of years, if anyone can document a lot of silver out there, please let me hear from you.

Now to China. There is a lot of talk about silver coming from China. Too much talk, if you ask me. I'm a commodity guy, and have been for over 30 years. I must tell you, I have never seen the volume and detail that is given to this China silver export talk, on any other commodity that China produces or consumes, which means all commodities. Try to get detailed import and export statistics on any commodity from Red China. It is extremely difficult. But not with silver, where it seems we get daily bulletins. It smells fishy to me. My common sense tells me something's wrong. These reports have China exporting more than their entire silver mine production. We know China is a very, very large consumer of silver (just like they are a very large consumer of oil, copper and other base metals, food, electricity, etc.), because they have almost 25% of the world's people. So, it is fair to assume that any exports of silver coming from China are coming from existing stockpiles, not as a result of a net surplus of current production. A few observations - one, selling (probably leasing) from stockpiles can't be a continuous process, as stockpile sales are finite in nature. Two, why is Red China dumping silver now, for the first time in modern history, at the lowest inflation adjusted prices in all of history? They certainly don't need the export earnings, as they generate the largest trade surplus in the world, and silver proceeds are minuscule. Are they all of a sudden stupid? Or perhaps they are sending out intentional false signals, so they can accumulate a commodity that they see is in a critical shortage. Verified information is hard to come by, stories are plentiful. My point in all this is simple - even if silver is coming from China to satisfy the deficit, think of how bizarre and bullish that is. It has come down to the world depending on Red China, of all countries, to perhaps balance the silver deficit, even though China does not produce more silver than it consumes. Who do we go to next for silver - Iraq?

But if silver is not down in price because of China or because we don't have a deficit, then why is it down? Silver is down because of the continued manipulative trading practices on the COMEX, the worlds largest, and I would claim, only silver exchange. Please allow me to try and prove my allegation, one more time, and at the same time, bring you some very good news. I will base my proof on the weekly Commitments of Traders Report (COT), issued by the Commodity Futures Trading Commission (CFTC).

As you probably are aware, I had conducted a campaign this year, starting in February, to try and convince the CFTC that the price of silver was being manipulated by unfair and illegal trade practices on the COMEX. Because so many of you participated in that campaign, the CFTC and the COMEX were forced to respond. While they denied a manipulation existed (I say because the alternative, admission, was unthinkable), I wrote that there may have been some action taken behind the scenes. A few months ago, I also wrote that we would know if my speculation was correct, depending upon the behavior of the ever-controlling dealers on the next real rally. If, on the next rally, the dealers sold in the price-capping uneconomic quantities that they had in the past (when 4 or less traders sold net short 260 million ounces, and 8 or less sold 350 million) the rally would be contained and the manipulation would live on. If the dealers didn't sell, the price would explode beyond belief. Since we have not had that rally yet, the jury is still out on the verdict. But the day of decision draws near.

In the most recent COT, issued Oct 18, 2002, the price-controlling dealers appear to be very close to having bought back the entire price-capping net short sale that they maintained most of the year. This was exactly their plan and what I had warned about (to no avail) in a dozen letters to the CFTC. Even though I don't shy from calling them crooks, the dealers' manipulation of the silver market must be viewed with awe. The latest COT shows that the dealers have covered almost 80% of the total net short position they held at the market top in the summer, or almost 60,000 contracts out of a peak net short position of over 75,000 contracts. In ounces, the dealers have covered almost 300 million ounces of their total net short of 375 million ounces net short. For sure, the ring-leading 4 and 8 largest traders have also covered like amounts.

Stop and think about those numbers for a minute. I say that proves that paper games by the big speculators and dealer-speculators on the COMEX are controlling and manipulating the price. Here's why - a lot of people point to China, for instance, for being responsible for the current low prices because China is dumping silver on the world market. The amount that China is said to be dumping? 30 to 60 million ounces a year, or 2.5 to 5 million ounces a month. Yet, a US agency, the CFTC, has reported that in just three months, paper contracts, in the amount of 300 million ounces, or 100 million per month, were dumped on the COMEX. This is not just volume, mind you, this is actual ownership of contracts being transferred. Hell, world mine production only runs 50 million ounces a month, yet the CFTC blindly reports 100 million COMEX ounces transferred between concentrated hands. I can assure you that this sick and bizarre circumstance does not exist in any other traded commodity - just sick COMEX silver. You tell me - which amount do you think has the greatest price impact - the maybe 5 million monthly from China, the 50 million oz monthly spread out among all the mining companies in the world, or the 100 million monthly concentrated in a few crooks' hands? That is not a trick question.

It is this glaring mismatch of amounts of silver that changes hands in the real world, and that which transpires on the COMEX, that proves conclusively that the COMEX is rigging the price of silver. How could it not? It is also the obscene, concentrated and coordinated amount of silver that is contracted on the COMEX that renders any talk of legitimate hedging as silly. It is also why the CFTC, nor the COMEX, can't verify that real silver exists to back up the concentrated paper dealings on the COMEX. Of course, the reason lies in the lack of legitimate speculative position limits in COMEX silver, contrary to commodity law. If you are a shareholder in CDE, HL, PAAS, or any other silver producer, and you have not demanded yet that their CEO's make inquiries into this sordid affair, you are missing something that may benefit you greatly.

Some people have asked me, how can the dealers, crooked or not, pull off such a feat? Or more precisely, how can the dealers buy back such amounts on a decline in price, as short covering connotes rising prices? The answer is the brain-dead technical funds. They buy on the way up, and they sell on the way down. They don't care about values. They care only if the price is moving up or down - nothing else. It is the tech funds mindless and indiscriminate selling that has allowed the dealers to buy back their own shorts on lower prices. The dealers have picked the funds pockets clean, once again. This article is getting longer than I intended, so I ask you to read a piece I did a year ago, that describes the COT - http://www.investmentrarities.com/08-14-01.html Remarkably, this previous article describes just where we are also at now in the current condition of the COT.

This is the good news that I referred to. For the first time in almost a year, we have finally entered a "good zone" on the COT. Let me be clear on this. For all of this year, the dealers were net short big in silver. That is why I complained to the CFTC repeatedly. They are not short big now. The tech funds are. That means the path of least resistance is up. It means sell-offs from here are likely to be shallow and brief. It means that the "bad guys" are configured for the market to go up. It means we have explosive price potential. I can't tell you when the all clear signal will be flashed. Perhaps it will be when the big Dec silver/gold option expiration comes, four weeks from now. Perhaps it will come tomorrow. I can't tell you when the last new technical fund short (and resultant lower low) will be put on. But I can tell you when we get in the extremely favorable structure we are now in, good things happen on the upside. Perversely, I can tell you that this very favorable current COT structure has come about precisely because of the very bad recent price action, which was caused by the tech fund selling.

Now, we are once again at the critical juncture. The market structure is saying that the dealers may be in the best position they can possibly be in, for silver to rocket higher and them to sustain minimal damage. It is at times like this when our expectations should be the highest they can be. It is true, that every single time we have been at this juncture before, the dealers have turned aggressive sellers on the resultant rally and have dashed the bulls' hopes. This is the essence of the silver manipulation. It is also true, however, that a market in a deficit will inevitably have to explode in price at some point, especially if there have been artificial price constraints. So this may be it. It comes down to - will the dealers cap it with uneconomic short sales, especially after all the attention they have garnered this year. I don't know. I have tried my best to shine the light on the COMEX. But considering the low risk/high reward created by the current COT, you got to play it like it's the real move - for one simple reason. If it turns out to be the real move, you won't get a second chance. Not at these prices. Good luck.