BEST OF JIM COOK

July 25, 2006

BUILDING WEALTH

Could silver turn out to be one of the best performing assets over the next decade? Silver analyst Theodore Butler certainly seems to think so. If his projections prove to be correct, silver could be the best vehicle available today for an individual to accumulate wealth. However, there’s a right way and a wrong way to try and capitalize on the silver story. We’ll tell you exactly how to do it, but before that, let’s examine Ted Butler’s powerful case for silver.

First, there’s industrial demand. Silver is used in a myriad of electrical, chemical and photographic processes. Every TV, cell phone, washing machine and automobile uses silver. A car may have up to 18 specific applications. With Asian economies exploding, the demand for the products that use silver continues to rise dramatically and this trend can be projected into the future for a lifetime. The demand for silver appears to be open ended and nearly infinite.

Since only a tiny amount of silver goes into each industrial application, if the price of silver goes up, it will not significantly reduce demand. Furthermore, these small increments of silver can’t generally be recovered. Once it’s used it’s gone forever. That means that most of the silver ever mined (that was once piled up in bars and coins, as is gold today) has been used up by industry and is gone. The U.S. government once had three to four billion ounces of silver in their possession. Over the past 50 years industry gobbled it all up. Today the U.S. mint must buy silver on the open market to make their silver coins.

At the same time, silver mining has stagnated. Each year for several decades more silver has been consumed than has been produced. For one thing, silver most often comes as a byproduct to copper, lead and gold mining. No matter how high the price of silver, it’s unlikely that a gold mine or a copper mine would ramp up production to get more silver. Furthermore, geological analysis indicates that less silver remains underground in comparison to other metals. Because it was epithermal (deposited close to the earth’s surface) most of the major silver deposits have been discovered and mined out.

Higher prices for silver and other metals have stimulated mining exploration the world over. Nevertheless, discoveries are few and far between. Should a major silver deposit be discovered, it takes a decade before it gets into production. We can think of one in South America that faces years of permitting, infrastructure requirements, nationalization threats, environmental concerns, and years of mine construction before it can ever come on stream.

When you have a shortfall between silver production and the amount used by industry, it would normally cause the price to rise. That process probably should have started decades ago, and, by all rights, silver should be much higher today. The kind of drawdown we’ve had in the above ground supply of silver should have set off a price rise. Other commodities in similar straits have frequently soared upward. Yet, for many years, silver has been essentially dormant. No one thought much about this boring price predicament that kept silver flat. It had soared to $50 in 1980 in a blaze of glory and then collapsed. For the next 20 years it put its followers to sleep.

Along came a trailblazing thinker who asked a question no one could answer. Why wasn’t the price of silver rising when the demand for it was so great? Everyone assumed there was a glut of silver above ground, and it would take forever to chew through it. Theodore Butler looked at that premise closely and decided that too much of the silver supply had already been depleted. Therefore, this so called "abundant supply" was not the reason silver wasn’t responding to the law of supply and demand. He claimed there were other forces at work.

First, he uncovered silver leasing. This was a procedure cooked up by Wall Street. A silver mine, or a big silver holder, could lease the silver to a financial organization who then sold the silver to get cash and paid a small leasing fee to the people they got the silver from. Mr. Butler claimed that this resulted in "dumping", where silver was sold with little or no regard to price. Shortly after he raised his voice against it, leasing began to unravel. The leasing process, which he called both stupid and economic, terminated with some mining companies losing hundreds of millions.

Next, Mr. Butler began to attack the outsized short position in silver which existed on the commodities exchange. He claimed that a few dealers were artificially suppressing the price of silver by selling large quantities of it on paper. He used the word "manipulation" and showed how a few big dealers had a disproportionate impact on the price of silver and were thereby reaping large profits. He claimed that this concentrated short position had an outsized influence on price to the benefit of these same shorts. He complained to the CFTC and others in hopes of changing this abuse.

To make his bullish case, he pointed out that the silver that was sold short on paper would have to be bought back and repurchased some day, thus giving silver a powerful reason to rise. He also suggested that much of the silver that was in storage for people did not exist. He claimed that banks and brokerage firms have given people storage certificates backed only by derivatives. He argued that most pool accounts had no real silver behind them and someday many of these entities would have to buy real silver. He also suggested that, when silver becomes difficult to get, the industrial users would go on a buying rampage to get it. Since they must have silver to survive, they will bid it up relentlessly and, at some point begin to stockpile. The competition between investors and users for silver will be ferocious. He concluded that all these factors would cause the price of silver to explode some day. He projected prices that were many multiples of today’s levels.

Lately, Mr. Butler has claimed that silver supplies are perilously low. Between institutional investment demand that requires 130 million ounces for the new silver fund and industrial demand around 900 million ounces, silver looks to be on the verge of another big price runup. Mr. Butler has said he’s more bullish on silver at $10 to $11 an ounce than he was when it was $5.