WEEKLY COMMENTARY

December 13, 2005

The Test Of Time

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.)

Five years can be either a short or a long time, depending upon one’s perspective. To the very young, anxious to speed things up, five years is an eternity. To the old, anxious to slow things down, five years goes by in a flash. In investment terms, five years sort of sits in the middle, certainly not short term, but not very long term either. But in investment terms, five years is ample time for reflection and re-analysis of strongly held opinions and expectations.

It has been five years since I started writing about silver for Investment Rarities. In that time, I think I’ve written close to 200 essays. Those essays are available on the Internet and a good number have been bound in print form by IRI. While I try hard to be original and interesting and have never appropriated anyone’s ideas without acknowledgement, let’s face it - I write about a very specific topic and it would be impossible not to be repetitive. But repetition isn’t necessarily bad, especially when you are trying to deliver a message.

The message I have attempted to deliver is that silver has been artificially depressed in price due to a blatant and easy to prove manipulation and that this manipulation has so distorted the supply and demand fundamentals as to create a lifetime investment opportunity for those who take the time to investigate my claims.

I freely admit to holding the very selfish prime motive of seeking personal satisfaction for documenting in advance and of trying to terminate a market manipulation that has spanned more than 20 years. That termination has not yet occurred, and that is mostly good news for us all. While I don’t expect anyone to share my prime motive, I can further assure you that what stimulates me is intellectual satisfaction and not some type of retribution against the manipulators

What I would expect from potential investors is investigation and challenge of my consistent claim that real silver is the best investment possible. I know what my reaction would be if someone claimed something was the best investment possible. I would want to know the reasons for such a claim. Did it make sense and sound plausible? I would want to know the facts backing those reasons. Were they verifiable? And I would certainly want to know how the reasons, facts and claims fared against the test of time.

Let’s look at the record. While I don’t think it is the most important consideration, at any particular point in time, it is natural to consider price history. From my very first article for IRI in November 2000, for the next three years, silver was readily available at $5/oz or less, and averaged close to $4.50. The recent move to 18-year highs is about double the lows. As a result of acting on anything I’ve written, no real silver investor should be holding at a loss, with the vast majority showing significant profit. That is very important to me. Causing anyone to lose money would bother me very much.

This is not to suggest that silver’s price performance to date proves it has been the best investment possible. That has yet to be proven. Many commodities have had similar or better performance, from copper to oil to natural gas to zinc and to gold. But none have left silver in the dust. And when you get down to those commodities that allow for practical real ownership, namely, the precious metals, silver has been the easiest to accumulate at the most advantageous prices, over the past five years. My point is that price-wise, silver has not disappointed.

What really should matter to the serious investor, of course, is not past price performance, but the price going forward. You can’t profit on what already has occurred, but only on what will occur. Relying on past price performance alone is like driving by only looking in the rear view mirror, it will tell you where you’ve been, not necessarily where you’re going. For that you need to be aware of and judge all current and future developments.

After almost doubling in price over the past five years, do the supply and demand facts in silver still warrant continued investment? Let me review what was true five years ago and what I think is the case today and let you decide. Remember, I’m not talking about the next dollar move up or down in silver, because that is unknowable. But I do think I know that the next four-dollar move will be up and that the next eight-dollar move must be up.

Central to the facts surrounding silver is that the market is still operating in a structural deficit today, as it was five years ago and for the 50 years before that. We are still consuming more silver than we are producing. The world is still drawing down silver inventories, not building them. As I have written repeatedly, a deficit is the most bullish condition possible in any commodity.

What has changed over the past 5 years is that silver is no longer alone, among the industrial metals, in its deficit consumption pattern. Declining inventories and sky rocketing prices in copper, zinc, lead and other minerals confirm that deficits have become a fact of life in many items. The common denominator in the widespread consumption deficits is growing demand, principally from the East, particularly China and India. There have been no shocking supply disruptions and production has continued at a very high level in most metals and minerals. It’s just that demand has been relentless and has overcome production.

This widespread struggle of mine production straining to meet industrial demand is something the world has never witnessed, to my knowledge, except perhaps in times of global war. Given the long lead times needed to ramp up mine production, especially considering that the easy ore bodies have been exploited already and the demographics in Asia driving the industrial demand, this does not appear to be a short term phenomenon. While deficits can only continue until inventories are effectively depleted, I am struck with the thought that we face near-permanent strains on metal production and mineral extraction as hundreds of millions, if not billions of world citizens strive to improve their standards of living over the coming decades.

The past five years demonstrate to me that we are entering into a long-term era of natural resource revaluation. After all, only price can ultimately regulate and balance supply and demand. In other words, there seems to be no let up to upside price pressures for natural resources in the long run. We have too many people joining the demand side of the equation and too few giant and low-cost metal and mineral discoveries adding to the production side. Even economic recessions, when and if they occur, should not alter this long-term trend.

If you accept this thesis, how can you profit from it? The easy answer is to buy silver. The more involved answer is to buy any depleting industrial metal or mineral that you can, at the cheapest price possible. But how does the regular investor make a direct investment in real oil, natural gas, copper, lead or zinc? He can’t – strike one. And the soaring profits of the companies producing these commodities tell you they are not cheap in production terms. That’s strike two in a two-strike investment count. You can’t effectively buy them and they’re not cheap anyway, even if they may go higher.

Now compare that to silver. It can be bought by anyone and in any denomination and can be held personally or in bona fide storage. And the profits being reported by the silver producers, where they exist at all, certainly do not suggest a high price. Real silver is do-able and not expensive.

I’m leaving gold out of this comparison because it is not industrially consumed and therefore does not have depleting inventories. Platinum is a precious metal that is consumed industrially, but at $1000 an ounce and, considering the profits of the platinum producers, could hardly be called inexpensive. Palladium doesn’t look expensive, but I understand it can be difficult for the average investor to deal in, unlike silver.

But the most important fact that separates silver from any other metal, mineral or any other investment item, is as true today as it was five years ago. In fact, it is the essence of what attracted me to silver more than 20 years ago, aside from the structural deficit. It is at the heart of every letter, petition and complaint to the CFTC, COMEX and every regulatory official by me for two decades. It is the clincher that sets silver apart from anything else. I’m referring to the short position in COMEX silver.

I know it is hard for the average investor to fully grasp this short selling concept, but it is important to try. Short selling is selling something you don’t own or haven’t bought yet. Mathematically, it doesn’t really matter if you buy first and then sell (like is true in almost all transactions) or sell first and buy later (short selling). You profit if your buy is at a lower price than your sale and lose if the opposite is true, regardless of whether you buy or sell first. A short sale is an open transaction and must eventually be closed out by buying back or by delivering what was sold.

Short selling is not inherently evil or manipulative, although all sales are a natural price depressant; just as all buys are a price enhancer. Short selling moreover, is an integral part of futures and derivatives trading, as there must be a short for every long in every contract. I am not anti-short selling in principle. But I am anti-short selling when it is used as a manipulative device, as it is in COMEX silver.

My contention, for two decades, is that the short selling in COMEX silver has been so enormous as to have artificially depressed the price and created a dangerous (and potentially very profitable) condition. Simply stated, the short COMEX silver position is larger than that of any commodity in history when compared to real world inventories and production. This was true 20 years ago, five years ago and today. The COMEX silver short position is so large as to constitute a massive and ongoing fraud.

That the management of the COMEX and officials from the CFTC look the other way and sanction this fraud is one of the great scandals of our day. It is an allegation easy to prove. Only COMEX silver has a total futures short position (open interest) greater than world mine production. No other commodity has, nor has ever had, such a ridiculously large short position. It is absurd to have a short position greater than what exists or could be produced.

This has been the great constant in silver, a short position that is so large that it cannot be resolved in a normal fashion. Even the price rally to 18-year highs has had no effect on the massive silver short position. In fact, the short position has actually grown, as the big commercial dealers/manipulators have dug in their heels and have continued to sell short. This does increase the odds of a sell-off, as the dealers will be forced to engineer lower prices and get the tech funds to sell out, which would allow the dealers to buy back their short positions. But it is also possible that the dealers could be overrun for the very first time.

This short position should be put in proper perspective by real silver investors. It is not something to be feared long term, although it can be responsible for short-term volatility. The price performance over the past five years proves that. Like the manipulation itself, it is the real silver investors’ best friend. It will be the resolution of this outsized short position that will tell us when the silver price is no longer manipulated.

Let me speak in some absolutes. This obscene COMEX silver short position will cease to exist one day in some way; it is not something that can be maintained indefinitely. When the COMEX silver short position is no longer out of proportion to the short positions of all other commodities, the price of silver will be dramatically higher than current levels. Either the obscene COMEX silver short position ceases to exist through market forces (which may be quite violent), or the COMEX silver market itself will cease to exist.

It is important for real silver investors to recognize that the past five years were merely a warm-up for the next five years. There is obvious tightness and prospective tightness in just about all industrial metals and minerals. The long-term fundamentals and demographics greatly favor natural resources. Of all the candidates for investment, silver stands out as the best due to its ease and practicality of ownership and its relative low price, which creates a compelling risk/reward equation. The unique short position in silver gives the real silver investor an advantage of unprecedented dimensions. It does not matter how the short position is resolved, it will be resolved and that will be good for the real silver investor.

In the spirit of the season, it is appropriate to be mindful of those around us who need assistance. Particularly if you have been materially blessed with silver profits, please share your bounty and good fortune. To whom much is given, much is expected. If you are looking for suggestions, local food banks, homeless shelters and other community organizations, including animal rescue groups, tend to stretch the charity dollar. You can’t take it with you, even if it’s silver.