TED BUTLER COMMENTARY

October 31, 2006

A Red Flag?

(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 good news is that the price of gold and silver has advanced, as expected, due to the washed-out Commitment of Traders (COT) structure. The bad news is that, so far, the advance appears garden-variety in nature, namely, speculative buying and more dealer short selling. While the overall level of dealer short selling in silver is not excessive, the concentrated net short position of the 4 largest traders has grown to levels not seen in six months. Their net short position has grown to 37,421 contracts on the COMEX. Throw in the 5100 contracts held net short on the CBOT by, most likely, the same big 4 traders and the combined net short position is more than 212 million ounces. Talk about concentration.

Clearly, the big shorts are not covering. They don’t cover much when prices decline and they certainly don’t cover at all when silver prices advance. I still think they are trapped, but that makes them more dangerous, not less, and more likely to try and rig sell-offs. Whether they succeed is anyone’s guess. But if they do succeed, no one should be surprised.

I’d much rather write about the long-term situation in silver because that’s what investors should be focused on. But we live in the short term as well and it is the concentrated short position and the ongoing manipulation that determines daily prices. A friend of mine refers to it as "The Curse." The curse is knowing full well where silver is going to end up eventually, but not knowing when or how the big move will start. For now, we must live with the reality of the super-concentrated short position.

But that’s not the only red flag flying in silver. An extraordinary development has occurred at the NYMEX/COMEX. This development is unusual and may be unprecedented. Their Chief Financial Officer/Chief Operating Officer (CFO/COO), Jerome Bailey, has suddenly resigned. Any time a CFO suddenly and unexpectedly resigns, great attention is paid to what caused the resignation, since it may signal a serious problem with the organization. For a CFO to resign just prior to a planned initial public offering is downright shocking. I doubt if anyone reading this has ever witnessed it before. I know I haven’t.

Of course, there are many possible explanations that would not signal a problem within the organization, in spite of the extraordinary timing, and every reasonable effort must be made to discern the truth. Is he ill, was he fired, did he quit, and if he quit, why did he quit? For the answers we rely on public information and facts. When the documented information and facts run out, then we are forced to rely on speculation. First, let’s look at the facts.

Mr. Bailey was recruited and hired by the NYMEX, as CFO/COO. In March 2006. He came with impressive credentials. He was, successively, over the past two decades, a partner at Price Waterhouse, a controller and managing director at Morgan Stanley, the CFO at Salomon Bros, and Salomon, Inc., the CFO at Dow Jones & Co., and the CFO and Director at Marsh, Inc. (Marsh and McLennan). Each of these companies is larger than the NYMEX/COMEX. The terms of his employment contract indicated he was hired in anticipation of the NYMEX’s initial public offering (IPO) of securities. (All this information can be confirmed on www.nymex.com and in the NYMEX’S SEC filings). In my opinion, Mr. Bailey had better credentials that the combined credentials of the entire NYMEX management team.

There can be no question as to the suddenness of Mr. Bailey’s departure. His signature appeared on an SEC S-1 Registration statement on Friday, October 20. Two business days later, on Tuesday October 24, his termination and release agreement were signed and recorded. From a reading of that agreement, it does not appear that Bailey was fired or quit because of illness http://www.nymex.com/media/8KA102706.pdf It appears he pulled the trigger and wanted out in a hurry. The key aspect to the release was a $500,000 extra payment to not speak badly of the NYMEX.

The central question is why did Bailey resign so suddenly? You would think that this is the question regulators and the underwriters would be asking. Whatever explanation you come up with, why couldn’t it wait until after the IPO? The only answer I can come up with is that he left so quickly to eliminate some personal liability that he foresaw. Remember, he was also looking at a very big post-IPO potential payday that could have netted him many millions of dollars. Here’s where the facts end and the speculation must begin.

Please keep in mind that this is my speculation only, and I could be way off base. What follows is purely my personal opinion on a theory that explains this very unusual resignation. I think this is silver related and the timeline seems to fit. I think Bailey was an outsider at the NYMEX and may not have known about the allegations of the silver manipulation. Certainly, I never wrote to him, as I have repeatedly written to other NYMEX officials.

When I wrote the article, "You Make The Call" on September 19, many hundreds of you wrote to the SEC, asking them to insist that the NYMEX respond to my silver manipulation allegations, as befitting a Self Regulatory Organization (SRO). I think the SEC took your concerns seriously (as they indicated in their individual replies) and would have, as a matter of course, asked the NYMEX about your concerns. I believe that as a result Bailey, as CFO/COO, may have learned about these allegations for the first time. Since some seat holders on the NYMEX are extremely likely to be the same traders holding the concentrated short position the possibility for conflict of interest and manipulation would be clear. The NYMEX is a self-regulating organization where the investigators into accusations of manipulation could be the very same traders doing the manipulating. This would be obvious to an honest man. Bailey investigated, may not have liked what he saw, and left to avoid any personal liability.

I think we’ll know soon if my speculation is close to the truth or not. I can only emphasize that anything that promises to expose the silver manipulation can have an explosive effect on price. There is only one thing standing between the current price of silver and a free and much higher price – the concentrated short position. If that concentrated short position did not exist, there would be no manipulation. Period.

A while back, I wrote that the planned IPO of the NYMEX could have a profound impact on the price of silver. I didn’t elaborate then, but I will now. I don’t care if the NYMEX goes public or not. I think it’s a win/win for silver either way. A public company gets much more scrutiny and regulatory oversight than a privately held company. I don’t believe this silver manipulation can survive much more public scrutiny. The NYMEX has chosen to ignore the allegations and hope they go away. I don’t think that’s going to work.

In the lead-up to the IPO, the NYMEX has been forced to reveal facts that I am sure they would have preferred keeping private, like the details of Bailey’s resignation. The revelations will not stop there. As a publicly traded company and an SRO, I believe the allegations of the silver market manipulation will take on a new meaning.