BEST OF JIM COOK

June 26, 2007

MORE VALUABLE THAN GOLD?

(Rewritten and Revised)

When I started Investment Rarities thirty-four years ago, the author and silver analyst Jerome Smith was a legend. In those years, he made a series of price predictions for gold, silver and platinum that were phenomenally accurate. In 1967 he recommended his readers buy silver at $1.29 an ounce. In 1974, it rose to $6.40 an ounce, and six years later $50. In 1971, he recommended gold at $42.00 an ounce. Nine years later it had gone up twenty times to $840. In 1977, he recommended platinum at $147 an ounce immediately before it shot up to $1,000. In his 1982 book Jerome predicted that within our lifetimes silver could very well be worth more than gold. I recently revisited that prediction to determine the exact basis for which Smith had made this amazing claim.

In the 1970s Smith and silver were synonymous. He had a huge following. Here’s how he described his uncanny track record. "In 1972, when I wrote the results of a five-year study of silver in a book that has since been regarded as ‘the bible’ on silver, I said that in the coming decade, ‘silver would double in price and then double again.’ Only a few of the many who read that in the early 1970s believed me. And I was wrong. Instead of doubling twice, it doubled three times over on an annual average price basis."

In 1980 silver climbed to $50 and fell back to under $8 the ensuing year. Then in 1982, Smith claimed, "I expect the price of silver to be in the $100-plus per ounce range by 1985." Smith based this bullish conclusion on five primary causes.

1. Industrial demand for silver was exploding.
2. Mining production of silver was less than the amount consumed by industry.
3. Silver production couldn’t be greatly ramped up because 75% of new silver came as a byproduct to base metal mining.
4. Since silver was used in such small amounts in its many applications, a price rise in silver would not reduce the demand.
5. The government had sold off most of its two billion ounce hoard in a way that kept the price down. Now that it was gone, free market forces would re-establish the true price at much higher levels.

Smith went on to predict, "Fundamentally, the outlook for silver is more bullish from 1982 on than for any other commodity I know of – including the much-ballyhooed strategic metals. Silver in 1982 is a cheap precious metal on the way to becoming a scarce and expensive strategic precious metal within this decade."

How could this premier silver analyst, who had so accurately predicted the price rise for silver, gold and platinum in prior years, miss the mark so widely in the 1980s? The greatest reason has been outlined many times by today’s premier silver analyst, Theodore Butler. In the 1980s, the world’s supply of above-ground silver was rapidly being depleted and the price should have been moving higher, rather than stagnating. Ted Butler became the first analyst to pinpoint why. The world’s remaining stockpiles of silver, mostly in foreign government hands, were being leased out and then sold off at low prices. This selling kept the price depressed. In this process, the silver market was oversupplied. No thought was given to getting the best price. Free market mechanisms that would have lifted the price of silver were overwhelmed by a glut of silver sold off by the banks and brokers, who leased the silver from foreign governments and others. They sold it off differently than would the true owners. They were more interested in the silver lease rate than the price. Some might even have wanted the price to stay low.

Ted Butler also pointed out a second crucial fact. A few large trading houses and banks had been able to get a stranglehold on the silver futures market. Their finances dwarfed the size of the silver market, and it was highly profitable to take the short side of futures transactions and cash in when the price dropped. (They could sometimes engineer the drop by lowering their bid prices.) This could also be highly profitable for them in writing options. This outsized short position remains intact today, concentrated all the more into a few dealers hands.

These two artificial market tactics acted somewhat the same as price controls. Ted Butler has pointed out that, by holding the price down, these manipulations have made silver more attractive to silver buyers because of the resulting low price. He predicted a dramatic price rise. In that sense, he echoes Jerome Smith’s claim that the market always has its way. Said Smith, "The longer and greater the interference, the more sudden and precipitous the market reaction will be. All the more quickly prices will move all the lower or all the higher – opposite the direction of the control – to bring the demand made and the supply offered into balance." This is what Ted Butler means when he says the price of silver must explode.

In the spring of 1972, I first read Jerome Smith’s influential book, Silver Profits in the Seventies. Probably no paragraph I ever read influenced me more than these words, "Truly outstanding investment opportunities occur only occasionally. In general, the better they are, the rarer they are. Such opportunities are normally long term in their maturation and by careful study can be foreseen long before they come to the attention of most investors….. The very highest profit potentials occur whenever there is a convergence of two or more primary causes. Such as is with silver today."

Fast forward to 2007 and, more than ever, silver has a number of primary causes for extreme bullishness. Not the least is a much lower world supply of silver than at any time in the past 100 years. We are likely on the eve of a shortage, and the price doesn’t reflect that fact. This falling supply has been camouflaged by an artificially low price brought about by the big dealers’ chokehold on silver in the futures market. Paper transactions control the price. This is why Ted Butler says that silver offers the greatest opportunity for gain that most people will ever have. Usually a shortage is made visible by the price. Not this time. Today’s silver price signals nothing. According to Mr. Butler, we will run out of the world’s most crucial metal without any warning and the price will have to soar. The actual physical demand for the metal will trump paper transactions. The silver shorts and the silver users will be blindsided.

One thing Jerome Smith never contemplated is the huge increase in demand from India and Asia for consumer products that use silver (electronics, appliances, autos, etc.) This skyrocketing demand means that the deficit between silver produced and silver used will remain a problem into the future, and aggravate the coming price rise. Furthermore, the booming growth in world populations means that, by definition, this metal, so critical to modern civilization, will be utilized all the more. As it stands now, the mining production of silver is not growing as fast as the industrial and investment demand.

Nor did Jerome Smith anticipate that the U.S. government would sell off every last ounce of the billions of ounces of silver they once owned, including the 100 million ounce stockpile for military and strategic purposes. He would have enjoyed the fact that the government (which he disdained) now finds it necessary to buy the silver it needs for its coinage programs in the open market.

One thing that Jerome Smith forecast seems to be happening now. He assumed that, because of money and credit expansion, a rise in the inflation rate would cause investors to pour into silver. We’ve been inflating for decades and, for one reason or another, it is just beginning to catch up with consumer prices. People are definitely buying more silver than they were a few years ago. The silver story is getting out, and the surge in buying will impact the price. In the future, these private buyers who hoard silver could very well be the source of silver for desperate industrial users. However, the price would have to be much higher to cause them to do more selling than buying.

Jerome Smith also made this observation about the price ratio of silver to gold. "Both gold and silver emerged in markets as money and served as money, by weight, long before any government put an imprint on either metal. A 16-1 ratio, or close to that, held from the 4^th century B. C. until the last quarter of the 19^th century – over 2,000 years. The markets quickly adjusted to the 16-1 ratio when gold was set free in 1968, and again in 1980." Now the ratio of silver to gold is 50-1. A return to the historic ratio would put silver at $40 per ounce.

One can easily speculate that the equilibrium price (what the price would be without market intervention) would be around that $40 price. Normally you would expect it to go up from there each year as demand increased. Ted Butler has argued that it can easily go to $100 an ounce, or higher, as abnormal price factors come into play. Industrial users can quickly panic as a silver shortage deprives them of this metal so indispensable to production. They will have to buy silver no matter what the price.

The shorts will eventually have to cover, and that means the price could go anywhere. Not only are there the big dealer shorts, but Mr. Butler has theorized that most of the silver held by big brokers, dealers and foreign banks for customers does not exist as stipulated. A recent settlement by a large brokerage firm lends tremendous credence to Mr. Butler’s contentions. Rising prices also bring on more buyers leading to a crescendo of overheated, speculative demand. You want to own your silver before any of these events unfold. As Mr. Butler has often remarked, "I couldn’t make it up if I tried."

Silver naysayers are still around, but their numbers are diminishing. From the early 70s to this day, there have been numerous claims that silver usage in photography would be replaced by new technology. In today’s era of digital photography, the cheaper throw-away cameras still hold a huge market share. Jerome Smith seemed to be looking ahead to this day when he wrote about "new consumer products co-existing with earlier similar ones while total market demand for old and new increases." Nobody could have anticipated the great increase in photo prints from digital cameras. These quick prints use silver.

Jerome Smith was a best selling author. On the book jacket of his Silver Profits in the 80’s, there is the following paragraph written by me. "Since I have prospered as a consequence of Mr. Smith’s predictions, it is natural to continue to give significant weight to his current sentiments… If Mr. Smith’s predictions are correct (and his forecasting record demands that we pay heed) silver may be the best single investment opportunity any of us may ever be faced with."

It didn’t work out that way. By 1985 I had given up on silver. I switched my company’s emphasis to gold, and kept it there for fifteen years. Then in the summer of 2000 I came across the writings of Ted Butler. He explained why silver hadn’t lived up to its promise. He showed why Jerry Smith was more right than wrong. He exposed the price manipulation of silver and presented a powerful argument as to why the price of silver was bound to rise dramatically. Theodore Butler replaced the late Jerome Smith as the dominant thinker in the silver market.

Ted Butler has added fuel to the fire. He has shown that leasing is bogus. He exposed the numerous phony storage programs. He warned that mining company forward selling would head to a financial disaster. He claimed that Barrick would lose billions, and they did. He predicted the recent price rise in silver from $4.00 to $15.00. He has argued that the short sellers will be squeezed and the manipulation must eventually be broken. He has pointed out the necessity of holding actual, physical silver to get the greatest gain with the least risk.