BEST OF JIM COOK

December 27, 2005

WHAT THEODORE BUTLER

TAUGHT ME

I’ve been in the gold and silver business for thirty-three years. That’s why it’s surprising that I’ve learned so much from silver analyst Ted Butler. I started Investment Rarities in 1972. I became friends with Jerome Smith, the silver guru whose book on silver prompted the Hunt brothers to start acquiring the metal. I was very close with Howard Ruff who had a huge following because of his gold and silver advice. I was friends with Harry Browne, who pioneered concerns about the dollar and first advocated precious metals. All three were major best selling authors and experts in the field.

I have to say that Ted Butler’s intimate knowledge of what makes the silver and gold markets tick dwarfs the understanding of these earlier experts, as well as any contemporaries. He’s extremely knowledgeable, always current and incredibly experienced after focusing intently on silver every day for twenty years. He doesn’t seem to miss anything.

He taught me to ignore all the reasons the newsletters and media give for rising gold and silver prices. I always believed it was because of inflation, a falling dollar, Chinese buying, Indian offtake, Arab hoarding, Central Bank purchases or some similar reason. Ted says none of that matters much.

Ted claims the long-term rise in gold stems from the termination a few years ago of gold leasing, hedging and forward selling by the gold miners. That provides the backdrop for rising gold, but daily, weekly, monthly and yearly price movements are determined on the futures market, principally in New York. Here you have two major players with more money than you can add up on your calculator. The hedge funds that buy commodity futures operate primarily on computer programs that give them buy or sell signals when the moving averages are penetrated. Let’s say it’s a twenty day or fifty day moving average. When the price penetrates the twenty day average to the upside (an average of the price over the past twenty days), it triggers buying. You can see the price spurt ahead, or hasten to decline, as the price penetrates these various moving averages. The computer programs also trigger buy or sell orders based on new highs or lows and other technical indicators. No person decides anything, only the computers do the buying or selling solely based on price movement. Ted calls these hedge funds "brain dead," because they pay no attention to fundamentals.

On the opposite side of the trade are the big dealers. When the hedge funds buy, the dealers sell. Futures are paper transactions. No actual metal changes hands. At some point you can take delivery of a futures contract, but that’s infinitesimally small compared to the large volume of futures trades. Whoever sells a contract is short the metal. Whoever buys is long. So the big dealers are, on balance, heavily short the metals. To identify the dealers, think of the biggest New York brokerage firms and banks.

As the dealers go more and more short to accommodate the new buying, they lose hundreds of millions of dollars on paper. A surprising level of Japanese futures buying was probably responsible for the big gold spike in early December. The same big dealers were going short to accommodate this buying. Maybe they are down a billion dollars in gold, but all on paper. Generally, the big dealers manage to knock the price down when the buying cools and recapture their losses. They can rack up big profits if the price really washes out. They know that if they lower their bids or push the price down, it will trigger additional selling from stop loss orders. They also know if the price penetrates the moving averages on the downside, it will trigger computer driven selling. They are living proof that man is smarter than a computer.

Silver prices have been rising slowly in sympathy with gold, the end of silver leasing and a pending silver shortage. However, the same dealers and hedge funds dominate price movements in the silver futures market. Nevertheless, monumental differences exist between silver and gold. Silver is indispensable to those industries necessary to a modern civilization. The demand for silver rises while the supply falls. Billions of ounces are used up and gone, and billions more are mandatory for future use. According to Mr. Butler, enough silver will not be available to meet the demand.

The two futures market giants battle back and forth, and the dealers invariably win. Their sheer financial muscle gives them the clout to take huge short positions, knowing full well they can eventually push the price down and get off the hook. This is the manipulation that Ted Butler constantly harps about. It explains why price drops are so much more violent than the gains. It explains why the price of silver has stayed low for so long. It’s the reason why Ted Butler thinks that silver provides the opportunity of a lifetime.