TED BUTLER COMMENTARY

December 19, 2006

INTERVIEW WITH THEODORE BUTLER

Theodore (Ted) Butler must certainly be the foremost silver analyst of our time. Not only is he a pioneering thinker on the subject of silver, he is also way ahead of the curve with what’s happening in the silver market. Many of his ideas are original and new. It’s no exaggeration to say that almost everything you see other people write about silver today comes from Ted Butler.

Cook: The recent mid-December sell off is something you’ve been telling us would be coming soon, right?

Butler: Yes. It’s a clear-cut example of price manipulation by the handful of large short sellers. The most recent COT showed the big four held more silver net short than ever in N.Y. and Chicago. More than 250 million ounces. This sell-off was not accidental.

Cook: You also see it as more than a painful correction?

Butler: There’s no question we’re going to go up again. I see these sharp price drops as opportunities. One of these days the shorts will be overrun.

Cook: There always seems to be new things happening in the silver market that could cause the price to take off. You mentioned to me that electronic trading was just introduced on the COMEX in December. Will that change anything?

Butler: It already has. We are seeing much more daily volatility.

Cook: People are familiar with the "open outcry" method of floor trading on the COMEX. Everybody’s hollering and waving their arms. Will this phase out?

Butler: I think so. At least the early indications point to that. In the first days of side by side electronic and pit trading, there is more volume on the electronic side.

Cook: Will electronic trading put any kind of pressure on the big short sellers you rail against?

Butler: Yes, I think so, but perhaps not immediately. Because electronic trading enhances volatility, the big shorts know how to use that volatility to their advantage. When we get sell-offs, the shorts can use the electronic platform to better engineer that sell-off.

Cook: Then where’s the pressure on them?

Butler: I think electronic trading works against them because they lose all the floor trading tricks they’ve developed over the years. The bottom line is that when the real silver physical crunch finally hits, the price explosion will be accentuated by electronic trading.

Cook: You were also telling me about a new type of contract the NYMEX/COMEX had introduced.

Butler: Yes, and for the life of me, I can’t understand why there has been no public debate on this.

Cook: Why?

Butler: The NYMEX/COMEX and the London Metals Exchange have introduced a number of new mini-contracts on precious and base metals. The distinguishing feature of these electronic traded contracts is that they are financially, or cash settled, instead of by physical delivery. Whoever thought this up should be horsewhipped.

Cook: Why do you take issue with these contracts?

Butler: The thought that a physical commodity could be traded without having the possibility of taking physical delivery is preposterous. A naked short seller would love these contracts because there is no obligation to deliver the physical commodity. But buyers would be crazy to deal in such a monstrosity.

Cook: Why is that?

Butler: Any physical commodity contract that doesn’t allow for physical delivery is not a legitimate contract. It is the physical delivery option that gives the contract its legitimacy. The originators of these cash settled contracts are either foolish or have intentionally devised a contract that favors naked short sellers.

Cook: Do you think they’ll gain popularity?

Butler: They certainly shouldn’t.

Cook: You got into trouble once for trying to take delivery on orange juice futures. Maybe they should have had those no delivery contracts back then.

Butler: Very funny.

Cook: How about explaining your orange juice travails?

Butler: First of all, it happened a long time ago, over 20 years ago. And it was a very trying and painful time in my life. Not only did it have a very adverse impact on my wife and children, it still impacts me to this day.

Cook: If you don't want to go there, I'll understand.

Butler: I won't get into the personal aspects of it, but there are some things that can benefit others. I was a commodity broker and had all my clients, including myself, long September orange juice, either outright or protected with spread positions in more deferred contract months. I had been in the position for a long time and although the price was substantially higher than originally purchased, it still didn't reflect true value in my opinion. I did all my own research and felt strongly that there was not enough orange juice to back up the shorts' contracts.

Cook: So what happened?

Butler: When first delivery day arrived, one large customer of mine stood for delivery on over 1000 contracts. I had arranged, months before, for him to borrow the 20 million dollars in case delivery became necessary or desirable.

Cook: And?

Butler: And all hell broke loose. The CFTC and the Exchange started calling and wanted to know what was going on. I explained to them that I had notified the Exchange, months before, of the likelihood of my customer taking delivery, and why were they asking now? To make a long story short, they pretended to deliver on time, but they really didn't. They later charged the customer with attempted manipulation and I and the firm with various related record-keeping charges.

Cook: Did the charges stick?

Butler: The big attempted manipulation charges were thrown out by their own administrative law judge, but the record-keeping charges stuck and it caused me to leave the brokerage business, even though I knew I did nothing wrong.

Cook: Well, if they considered what you did a manipulation, how can they ignore these outsized short positions in silver?

Butler: Good question. There certainly appears to be a double standard for longs vs. shorts.

Cook: Between your orange juice episode and everyone ignoring the big silver shorts, it almost appears as if the deck is stacked. Are they protecting their own at the COMEX?

Butler: The deck is definitely stacked and they are protecting their own. The only real way to even things up is to own your silver outright.

Cook: Any conclusions from your troubles?

Butler: It’s a lesson learned the hard way and it has guided me in everything I write. You didn't think I picked it all up from reading a textbook, did you?

Cook: What’s the lesson for silver investors?

Butler: There can be a big difference between paper contracts and getting the actual material. When the shorts in silver are really pressed for delivery, you can't be sure of what the outcome will be. That’s why it's so much better to have the real thing. Maybe the NYMEX/COMEX and the LME are worried about future defaults, and that's why they are trying to promote these no delivery contracts. It should make you want real silver all the more.

Cook: How long after the orange juice problem did you pick up on silver?

Butler: Immediately.

Cook: What attracted you to it?

Butler: A challenge from my friend Izzy, who was a client at the time.

Cook: A challenge?

Butler: Yeah. He knew I did my own research and really dug into things. He also knew I had finished the orange juice campaign and was looking for my next position. He challenged me to look at silver from a supply/demand perspective, just like I did with orange juice and other commodities. He never told me, but I think he wanted me to double check if he was way off base to be bullish on silver again, after it had come down from $50 to single digits.

Cook: What did you find?

Butler: I confirmed that he wasn’t off base and I further discovered one big reason for the low price – the obscene COMEX short position which originated in early 1983. I didn’t discover the other big manipulative tool, leasing, until years later.

Cook: I see the Chinese came out recently showing them as the world’s biggest user of copper, lead, zinc and nickel. However, they weren’t on top in silver usage. If they were number one in the base metals, they would almost have to be the biggest user of silver. Why this discrepancy?

Butler: The Chinese are also the biggest consumer of tin, cement, iron ore and steel, as well as the second largest consumer of petroleum. If you compare their percent of world consumption of all industrial metals, they claim to consume a very small percentage of silver. That’s absurd. Silver consumption, like the consumption of all industrial metals, is dependent on demographics and economic activity. It is impossible for them not to consume proportionately the same percentage of silver as all the other industrial metals. They are lying about their silver consumption.

Cook: Why?

Butler: The most reasonable explanation that I have been able to come up with is because they are the big short in silver. Then it makes sense as to why they would lie.

Cook: I know you said that before, but what’s in it for them to be short?

Butler: Everyone always asks what's in it for the big shorts, whether it's China or not, implying that the shorts must know something that the rest of us don't know.

Cook: It must have been profitable at one time?

Butler: It was immensely profitable. But it has evolved from being a virtual cash machine for the dealers to a break-even operation. The tech funds build up enormous open paper profits in silver and then the dealers take it away from them in sudden and sharp sell-offs.

Cook: That’s changed now?

Butler: Yes. I think whoever the big shorts are that they are trapped. Sure, they are financially powerful and can lead the tech funds around by the nose, and can rig sell-offs, but they are on the wrong side of the silver market. Even when they rig sell-offs, as they just did, and get the tech funds to sell, there is no way they can cover all their shorts on a sell-off. The big shorts will still be substantially short. They would give anything to be completely out from the short side.

Cook: How do we break that stranglehold?

Butler: It's being broken as we speak. Silver is no longer stuck in the $4 range. People are wising up to the manipulation and taking appropriate long positions. When the shortage really hits, it will overwhelm the manipulators. They can sell paper contract short, but the physical metal is different.

Cook: What evidence do you have of a shortage?

Butler: The same old stuff - delays in various deliveries and the public statistics. The silver ETF now has over 110 million ounces. That's 110 million fewer ounces that can be used to potentially stretch out the manipulation. While the manipulators are not dead yet, the clock is definitely ticking against them. And for the last few years, thanks to the rising price, the wait has not been painful for silver investors.

Cook: More people are acquiring silver than ever before. Won’t that help?

Butler: Of course. That’s the key to unlocking the manipulation. Investment in real silver will accelerate the day of reckoning.

Cook: Do you still believe the price will explode some day, or do you think the rise could be gradual?

Butler: I know the move has been gradual to date, but the price must explode at some point. The underlying premise for the explosion – the termination of the manipulation – is still intact. As long as the short position in silver is large and concentrated, the manipulation lives. But it must end at some point. The really great news for silver owners is that this gradual rise has basically just insured that the lift-off, whenever it comes, will start from a much higher base than I ever thought possible.

Cook: What would cause the price to go down?

Butler: In the near term, dealer manipulation of the tech funds on the COMEX. That’s the only negative we’ve ever had in silver. Unfortunately, the big shorts have dug themselves in very deep on the short side currently and that raises the chance of a sharp sell-off at some point.

Cook: What’s the likely scenario for a price rise? What could we see in a runnup?

Butler: A price rise could come in two ways. One, we have the recurring sharp sell-off, the tech funds get washed out and we rally once the dealers cover as many shorts as they can. Or we get some kind of accident where the dealers are overwhelmed by physical market forces while they are holding a full short position.

Cook: Care to put any numbers on it?

Butler: It all depends on what the big shorts do. When they are forced to stand aside and stop shorting, there will be fireworks. Crazy prices.

Cook: I was looking for a number, so let me put it to you this way. Would you be surprised to see silver go over $100 an ounce?

Butler: No.

Cook: How about $200?

Butler: Look; if we get into a true short covering, a dealer inventory panic and worldwide investment community recognition of the value and rarity of silver, there are not many numbers I would rule out. You have to remember that silver and gold are the only commodities that everyone in the world can hold as a direct investment, in a practical sense. And of those two, silver is rarer and more vital for modern life. All it’s going to take is the spark of collective recognition.

Cook: Do you really think industrial users will panic? Right now they are totally indifferent. How can the biggest silver users on earth be ignorant of your warnings about a coming shortage?

Butler: Yes, I am certain they will panic at some point. People are creatures of habit. They do things a certain way until they are forced to change. I think it would be harder for a purchasing manager to convince his superiors to stockpile silver, considering the career risk if he were wrong. It’s much easier for an investor to decide for himself to buy silver. That’s the great advantage to investors in silver – so few people in the world know the silver story.

Cook: This idea that a huge short position exists outside of the COMEX is something nobody else has ever mentioned. That has to be speculation on your part doesn’t it? There’s no hard evidence.

Butler: Well it’s not data I can reference in a daily public statistical table, but it’s not speculation either. It’s based upon observation and common sense. There’s widespread agreement that silver leasing and forward selling runs, at a minimum, in the hundreds of millions of ounces. I say a billion. And banks, mainly European and particularly Swiss banks, have issued countless ounces of unbacked silver certificates. These are de facto short positions, whether anyone else writes about them or not.

Cook: There’s a new study out on gold leasing. Have you read it?

Butler: Yes.

Cook: I know you were the first to write about leasing ten years ago. What’s your take on this new study?

Butler: The mining companies have basically abandoned the practice. So, why write about it now? Leasing is basically done forever. The report misses the fact that leasing was stupid and manipulative.

Cook: If silver gets too expensive won’t there be substitutes?

Butler: In some applications, yes. In others, no. The key is at what price, and how long, will it take to re-tool for the substitutes. In the vast majority of silver industrial applications, the amount of silver used is very small compared to the total cost of the product. It’s the best conductor of electricity and reflector of light so you give up performance when you substitute. This gives silver a price-inelasticity on the demand side. In applications like jewelry, you’re not going to substitute gold or platinum in a silver price rise any time soon.

Cook: You’re convinced industrial demand will remain strong?

Butler: Sure, There has been no fall-off in industrial demand to speak of in copper, zinc, nickel or oil in response to high prices. Why would silver be different?

Cook: What about in a recession?

Butler: It depends. If it’s just a recession in the US, and not in China, it should be no big deal to silver. The funny thing is that silver historically had its biggest gains in past recessions. A lot of people buy silver for bad times and for monetary purposes. Not me, mind you, but bad economic news might impact silver positively. In any event, I’m not worried about a collapse in demand or big supplies being dumped on the market in a recession, because demand is super-diversified and there are no big supplies to be dumped.

Cook: I see silver as real wealth. It’s wealth you don’t get with paper assets. Do you agree?

Butler: Yes and no. I agree that silver is an undervalued asset that will appreciate in the long term, and that makes it logical to hold. And it certainly offers diversification from other paper assets. But, at some point, and that point may be very far off in time, it will likely no longer be undervalued. If, and when, that time comes, it will probably be prudent to switch into what may be undervalued at that time. I hope this doesn’t shock you, but I’m not a silver worshipper. I’m an analyst, looking for the best value.

Cook: We haven’t had a real financial panic in the U.S. since 1929. The main reason is that we deal with any potential economic crisis by inflating. Money is abundant and it’s impacting the price of assets. Do you see silver benefiting from inflation?

Butler: Sure, but by definition no more or less than everything else. Inflation or currency depreciation is not silver specific. I don’t talk about it because so many do speak about it and I kind of thought it was self-evident.

Cook: What about the monetary value of gold and silver?

Butler: If monetary value means a valuable asset worthy of investment consideration, then I agree. If you mean silver being used as money, it’s a pipe dream. In the modern world money is not the highest and best use. This issue was settled 40 years ago when the U.S. stopped using silver in coinage because there wasn’t enough around to hold the price below the melt value.

Cook: The U.S. recently put a ban on exporting and melting U.S. copper and nickel coins because the base metal content is now worth more than the face value of the coins. Any thoughts on this?

Butler: I think it highlights the overall demand and scarcity of natural resources, and how we must continue to put these resources to their best and highest possible use. That doesn’t include them being used as money.

Cook: What do you mean? They are used as money.

Butler: Yes, but that is obviously changing. The price of base metals has skyrocketed, due to strong industrial demand. It now costs too much to continue using them in coinage. We need the properties of copper and silver for electrical conduction, and nickel for stainless steel and zinc for rust proofing more than we need them in coinage. It’s no big conspiracy that the materials previously used for coinage will change. In the meantime, the government is trying to discourage these coins from being melted for their metal content value while they gear up for making new coins out of different materials. It’s a simple and logical reaction on their part for a world running tight on natural resources. The world must better utilize all its resources.

Cook: Is this along the lines of your recent prediction that the Mint would stop producing Silver Eagles at very high silver prices?

Butler: Absolutely.

Cook: You’ve called silver a miracle metal. Why?

Butler: Think of the word miracle. It connotes a magnificent and unexpected transformation. What better word to describe silver? A substance treasured through the ages for its beauty and store of value transformed by technology into a vital material used in more applications than any other metal. Who could have dreamt thousands or hundreds of years ago that this metal was destined to be used in so many important ways, very different from the reasons it was desired at the time. If that’s not a miracle, I don’t know what is.

Cook: Do you think today’s price is still reasonable for a miracle metal?

Butler: The recent sell-off makes it more attractive than ever. With the price down it’s going to be time to load the boat. Silver is under priced on just about every relative comparison one can make. It’s under priced compared to other industrial metals, precious metals, oil, real estate, stocks and bonds, even itself when looked at on a historical inflation-adjusted basis. Certainly, the price rise to date has not resulted in an increase in mining production yet, or any notable increase in scrap supply, and no demand destruction. This strongly suggests that the price of silver is grossly undervalued. Any time you can buy a miracle on the cheap is a good time to buy.