GAME CHANGER?

By Theodore Butler

Late-July 2009

(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.)

Every once in a great while, something big comes along to upset the status quo. Sometimes the change is long overdue and welcome. I think we may soon witness such a game-changer in silver. The new chairman of the CFTC, Gary Gensler, issued a statement on July 7 that I felt was very important. Subsequent additional statements from Commissioner Bart Chilton, convinced me that great change may be on the way.

The chairman is deeply concerned about speculative position limits. These limits are designed to prevent large futures traders from unduly influencing the price of a commodity, either on the long or short side. If legitimate speculative position limits were in place in COMEX silver, manipulation would not be possible. This is the clear intent of commodity law. Knowing this, I have pressed the CFTC on this issue relentlessly. Unfortunately, the CFTC and the COMEX dismissed my arguments for more than 20 years. Now the CFTC has done an about face and this holds profound implications for the price of silver.

There are two aspects to speculative position limits. First, what is the maximum number of contracts a single trading entity is allowed to hold, long or short? Setting hedging limits too low would restrict market liquidity and should be avoided. Setting hedging limits too high could allow futures traders too much price influence, which goes against the purpose for having limits in the first place. A regulator must look at as many factors of an objective nature as possible in coming up with the proper level of limits.

Secondly, what exemptions from the maximum number of contracts should be granted to trading entities with bona fide hedging requirements larger than the stated position limit? Under commodity law for granting of these hedging exemptions there has to be a legitimate economic reason.

The economic purpose of futures trading is for legitimate hedging. So the first place a regulator would look is to the level of actual production and consumption in the real world. Since futures trading is not supposed to set the price of a commodity, but follow the supply/demand developments of the actual commodity, speculative position limits must be set low enough to not disturb real world commerce. Therefore, the most important factor regulators consider is the world production and consumption of each commodity. They would then apply a logical and consistent formula that treats each commodity objectively. The regulator wouldn’t arbitrarily assign radically inconsistent position limits relative to actual production and consumption.

For the most part, the regulators have set the level of speculative position limits in a consistent method on almost all traded commodities. I don’t see a problem with the level of position limits in most commodities. In fact, there is only one commodity where the level of the position limit is radically out of line with all other commodities - COMEX silver.

Most commodities generally have a position limit, which runs less than one percent of world annual production. But not silver. As the following graphs indicate (courtesy of Carl Loeb), silver is way out of line with all other commodities, when it comes to the level of position limits relative to world production. Silver has an accountability limit of 4.5% of annual world production (30 million oz vs. 672 million oz). Gold has a limit of 0.8% (600,000 oz vs. 75 million oz), while crude oil has a limit of 0.07% of annual world production (20 million barrels vs. 30 billion barrels). Therefore, silver’s accountability limit ranges from being 5.6 times larger than gold to being 64 times larger than crude oil, as a percent of world production.

Here’s a very simple question - why is silver’s limit so out of line with every other commodity? There is no good reason and it should be reduced to a level consistent with all other commodities, including gold.

Some might say that you can’t compare silver to commodities like grains, or even crude oil or copper, because as a precious metal, there are large stocks of existing above ground inventories. This observation would obviously apply to gold as well, which also has large above ground inventories. But when you make an apples to apples comparison of the accountability limits in silver and gold relative to their respective above ground bullion inventories, a shocking picture emerges.

Using one billion ounces as silver bullion inventories and two billion ounces as gold’s bullion inventories (silver conservatively high, gold conservatively low) relative to the 30 million oz silver position limit and gold’s 600,000 oz limit, silver has a position limit equal to 3.0% of world inventories. Gold’s limit comes in at 0.03%. In other words, silver has a position limit, relative to above ground bullion inventories, 100 times greater than gold’s limit. Once again, I ask why does silver have such a large position limit? Once again, there is no legitimate answer. Silver’s limit must be lowered.

Only silver needs to be radically reduced relative to all other commodities. If silver had an equivalent limit relative to world production as gold’s limit (0.8%), the proper limit in silver would be 1000 contracts (5 million ounces), not the current 6000 limit (30 million oz). If silver had an equivalent limit relative to above ground inventories as gold, the new silver limit would be only 60 contracts (300,000 oz). That’s too low, but 6000 is too high. What should the proper limit be in silver? (In my opinion, somewhere between 1000 and 1500 contracts (5 to 7.5 million ounces).

Whatever the proper limit the regulators decide in silver, it should be consistent with all other commodities. The current sentiment is that position limits are generally too high and should be lowered. I don’t necessarily agree with that. But, if the regulators do decide to lower speculative position limits across the board, then silver should be lowered below the 1000 to 1500 level I recommend here. It’s all about consistency and fairness.

Exemptions to Speculative Position Limits

Another integral part of commodity law grants exceptions or exemptions to those limits for bona fide hedging. Remember, the economic purpose behind futures trading is to allow real world producers and consumers a market to transfer unwanted price risk to those speculators willing to assume that risk. Speculators are vital in enabling producers and consumers to have the ability to hedge price risks, but the economic legitimacy behind futures trading is not to provide a venue for gambling or for traders to dominate the pricing of world commodities. Therefore, it is appropriate for there to be limits on the amount of contracts that speculators may hold.

But that doesn’t mean that hedgers have a green light to trade in any amount they desire. Even though commodity law allows hedgers to hold contracts in excess of applicable position limits, the amount they can hold is limited by demonstrated commercial needs. Here, commodity law is quite specific, generally allowing a producer or consumer to hold contracts in an equivalent amount no greater than 12 months production or consumption, or the amount of the inventory at price risk. So even bona fide hedgers have some type of limit, which may be greater than regular speculative position limits. The framers of commodity law intended for neither speculators nor commercial hedgers to unduly influence prices through excessively large long or short positions.

If commodity law is so clear and specific when it comes to position limits and exemptions to those limits, then why all the recent attention on position limits? The answer is because all sorts of exemptions, never intended under the original Commodity Exchange Act, have come into being. A consensus emerged over the past decade or so that allowed all sorts of traders, who were not real producers and consumers, to be granted exemptions to speculative position limits. All this was done under the belief that less regulation was better and that the exemptions would increase liquidity. Among the traders granted exemptions were index fund traders on the long side, and commercial and investment banks on the short side. Now serious questions are being raised as to the wisdom of granting those exemptions to non-producers.

Evidence has emerged that indicates that the index traders hold too large and dominant a long position in many markets and that their exemptions to position limits should be rescinded. Just because they represent large investment funds looking to invest in commodities, they are not true hedgers in the meaning of commodity law. So says the Senate Permanent Subcommittee on Investigations in wheat and other markets. This issue is what Chairman Gensler and the Commission are wrestling with.

On the short side, large commercial banks have amassed shockingly large positions under the guise of them being a hedge to other derivatives positions. But just as the index funds are not consumers of the commodities they are long, the banks are not producers of what they are short, nor do they hold actual inventories. These banks sold a bill of goods to the regulators pretending they were hedging, when in fact they were speculating across a variety of markets.

Nowhere has this bank shorting become more egregious than in silver (and gold). In the most recent Bank Participation Report, for positions held as of July 7, one or two US banks held a short position equal to almost 24% of the total world annual silver mine production. (160 million oz vs. 672 million oz). If a couple of banks held 24% of the world’s crude oil annual production, that would be equal to more than 7 million crude oil futures contracts, truly a preposterous amount.

This position held by one or two US banks is more than 32% of all COMEX silver contracts. The Senate report on wheat was concerned that a position held by 25 to 30 index traders of more than 35% of the market was a controlling position. If that’s the case, then what is a position held by one or two US banks of more than 32% of the silver market? It is not only a controlling position, but a manipulative one as well.

I am convinced that the CFTC now fully appreciates the manipulation problem in silver. Fix the position limit in silver and the manipulation is over. If the CFTC sets position limits in COMEX silver at 1000 to 1500 contracts for both longs and shorts and discontinues the phony hedging exemptions currently granted to the big US banks and other shorts, the silver manipulation is history. I think this is in the cards. I think this is what Chairman Gensler intends. But it won’t happen if the big shorts get their way. If they are allowed to continue to hold their manipulative short positions, then we must wait for the physical shortage to inevitably break the manipulation.

For more than 20 years, the CFTC has turned a blind eye and a deaf ear to the problem of legitimate position limits in silver. Apparently, that has changed. The new Chairman appears to be interested in the public’s opinion on this issue. It’s time for everyone to be heard. The new commissioner deserves respect. Ask him and the other commissioners to reduce the position limits in silver to between 1000 to 1500 contracts, or explain why that limit is not appropriate. Ask them to do away with the phony exemptions granted to a few big shorts. Make it specific - lower the silver limits to equal all other commodities and disallow phony exemptions.

Ggensler@cftc.gov
Mdunn@cftc.gov
Bchilton@cftc.gov
Jsommers@cftc.gov
If you wish to write, the address is:
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21St Street, NW
Washington, DC 20581
Fax: (202) 418-5521

Editors Note:

The first thing that came to my mind after hearing this news was how can I get more silver? Position limits on silver mean the big short position would have to be dramatically reduced. That much short covering means a lot of silver has to be purchased or physically delivered.

It seems unlikely the big short sellers won’t find a way to hedge against a big price rise that this short covering implies. They could buy silver stocks, mining production, exchange- traded funds, OTC traded silver, futures or options. Perhaps they have already done some of this. If not, they must act soon because as more people become aware of the bullish nature of a mandated reduction in short selling it could lead to a short squeeze and a price blow-off.

Most importantly, position limits would mean that no big short seller could impact the price going forward. Years of price suppression would also be rectified. The big short position has been a de facto price control. Whenever price controls are lifted there tends to be an overreaction to the upside. Eventually the free market price resumes at a much higher level than the current price. The fact that no large player will ever again be able to gain an outsized short position has the most profound implication for the future price of silver.

The silver market has yet to react to this astonishing news. In a way, the knowledge that position limits are probably coming in silver is like having inside information. It’s not really inside information, it’s just that this fact has not yet been widely disseminated or understood. When you buy a stock you have reasons why you believe it will go up. If you get powerful new reasons you know it improves your odds of picking a winner. You buy silver because you believe it will go up. There are numerous reasons why it should. Then you hear a super-bullish piece of news. The big short seller will likely be cut back. It dramatically increases the odds in your favor. However, there are no guarantees. The government could protect the short seller in some way. Nevertheless, this is pretty strong medicine. I’m personally buying more silver and plotting ways to get more.

BUTLER’S ARCHIVES

In his August 2002 commentary, which we published, Ted Butler wrote: “Anyone who can buy and sell in unlimited quantities of futures contracts controls the price. Period! That’s why commodity law dictates speculative position limits. Setting speculative position limits so high, as to not limit anyone, is a cheap end run-around the law. The CFTC and COMEX must stop dancing around this issue and institute and enforce legitimate speculative position limits in silver.”

In a February 2002 letter to then CFTC chairman, James Newsome, Ted Butler wrote: “The concentrated short position is at the heart of a long term silver price manipulation, that I ask you to review for the purpose of fixing this serious threat to the workings of our free markets, please allow me to offer a very simple solution to the problem. Direct the COMEX to institute reasonable speculative position limits in their silver contract, as is clearly intended by the Commodity Exchange Act. ”

DOOM OF THE DOLLAR
By James Cook

If you’re not a millionaire, don’t worry, you will be soon. If wages and assets keep up with the coming rate of inflation, everybody will eventually be in the highest tax bracket. All those envious characters who want to soak the rich will be getting soaked themselves.

As for the 40% to 60% who pay no taxes, they will be screaming to index the 85 different federal welfare programs to the inflation rate. Meanwhile, the government money printers will be chopping down whole forests to get the paper that’s not worth what it’s printed on.

With Federal tax revenues still plunging, and government spending going into orbit, dollar debasement threatens to obliterate the newfound savings of worried Americans. There’s only one way out for the wastrels in Washington whose runaway social sympathy outweighs economic and financial good sense. Create money out of thin air in whatever quantity necessary to pay for their bankrupt social schemes. Make no mistake, they have ruined our money and we are facing ruin because of it.

Here’s an excerpt from an article by Stewart Dougherty that describes the frightful predicament we are in. “Compared to current fiscal, monetary, economic and financial reality in the United States markets, Bernard Madoff’s losses were modest, even quaint. “

“The United States’ fiscal year 2009 federal loss (euphemized for the masses by the term ”deficit,” which sounds technical, econometric, and not nearly as bad as what it really is, a loss) will exceed $2,000,000,000,000.00, more than 30 times Madoff’s $65,000,000,000.00 loss. Keep in mind that it took Madoff a professional lifetime to lose that money; the United States will lose $2,000,000,000,000.00 in just one year, and according to official budget projections will continue losing hundreds of billions more, annually, for decades to come.”

“The cost of the government’s financial-crisis-related bailouts and guarantees currently exceeds $13,500,000,000,000.00, which is 200 times larger than the Madoff scandal. And the nations’ unfunded contingent liabilities, for programs such as Social Security, Medicare, Medicaid, government pensions and the like stand at $75,000,000,000,000.00, 1,150 times larger than Madoff’s fraud. They should let Madoff out of jail and put him in charge of the Treasury. Maybe American could get some relief.”

Big government and statism can’t survive without inflation. Inflating money and credit is socialism’s method of financing itself. Inflationists and socialists are blood brothers. Prudence and sound money doesn’t work for those who want to expand government. They debase the currency to pay for their extravagant and costly social schemes.

That’s why spending and money creation are out of control. But as the economist Ludwig von Mises pointed out, “Inflation cannot go on endlessly. If one does not stop in time the pernicious policy of increasing the amount of money and fiduciary media the nation’s currency system collapses entirely. The monetary unit’s purchasing power sinks to a point which for practical purposes is no better than zero.” When you think about the gargantuan size of our deficits and the current spending requirement’s you can be certain this is no idle warning.

WE COULDN’T HAVE SAID IT BETTER

“Starting in the next 6 months and culminating in 2011-12 the world will experience a series of tumultuous events which will be life changing for most people in the world. But 2011-12 will not be the beginning of an upturn in the world of economy but instead the start of a long period of economic, political and social upheaval that could last for a couple of de-cades . . .

Every single sector of the real economy is deteriorating whether it is production, unemployment, corporate profits, real estate, credit defaults, construction, federal deficits etc.

“And what is the government doing about it? They are doing the only thing they know which is to print more money. This is total lunacy! How can any intelligent person believe that printed pieces of paper can solve an economic catastrophe? If that were the case we could all go home and write out pieces of paper or use Monopoly money to spend in the shops or repay our debts. . . .

“What governments are doing with people’s money is to totally destroy its value. Purchasing power in the US and many other countries has declined more than 95% in the last 100 years. While it might buy votes short term it will only generate massive misery long term. And this is what many countries are starting to experience now. But sadly it will get a lot worse. We are still only in the first phase of this tragic saga.” Egon von Greyerz, Matterhorn Asset Management

“The health care bill unveiled this week by the House of Representatives (with the full support of the Obama administration) is one of the worst pieces of legislation ever drafted. If passed, it will reduce the quality and increase the cost of health care in America. But more
importantly, it will severely undermine our already weak economy. To burden a country currently in the throes of a violent recession with such a bureaucratic albatross clearly illustrates the scarcity of economic intelligence in Washington.” Peter Schiff, Author and Asset Manager

“Today, pundits defend Obamanomics by noting the lack of inflation. Wrong. Along the way, inflation is soon to return. We do not have price inflation, we have monetary inflation. Inflation in goods and services will come later. We believe inflation is now inevitable, stoked by the Fed-led expansions of the money supply. Eventually this inflation will spiral to hyperinflation.” John R. Ing, Maison Placements Canada

“The financial assets individuals and institutions were depending on, will significantly depreciate, as taxes and living expenses rise to extremes that will bankrupt the private sector, and local and state governments. This will leave the Federal Government, with its dollar printing press, the last man standing, and Washington can play the role of Superman coming to the rescue. This is what is going to happen. Mark J. Lundeen, Newsletter Editor

“Approximately 50% of the eligible voters in the United States pay no income tax whatsoever. These voters overwhelmingly vote for public officials and programs that they perceive will improve their well being. The have no concern for private property rights, the U.S. Constitution, or the fiscal condition of the country. Because these eligible voters are essentially exempt from income taxes, it is in their economic interest to vote for all social programs. At least they believe it to be so.” Kenneth N. Matson

“Recent Fed moves to accelerate monetization of Treasury debt, and calls among major central banks to replace the U.S. dollar as the global reserve currency, significantly increase the risk of triggering a near-term U.S. hyperinflation as soon as late-2009 or earl 2010. A hyperinflation already was inevitable in the next five years – before the current systemic solvency crisis – based on extreme pre-crisis U.S. fiscal abuses. My best estimate on U. S. hyperinflation timing remains in the period from late-2009 to 2014, with particularly high risk in the year ahead.

“Over the long haul, the general outlook is unchanged: a hyperinflationary great depression, much lower stock prices (at least in inflation-adjusted terms), much higher interest rates, severe dollar selling against most major currencies, and much higher prices for precious metals, particularly gold and silver. With unstable economic and systemic solvency issues, the current financial markets remain in extreme flux, unstable and dangerous, with high volatility, tremendous gimmicking and likely at least sporadic, government-coordinated market manipulations. Accordingly, over the short-term, almost anything remains possible in the markets.” John Williams, ShadowStats Newsletter

MISES

“Capitalism has improved the standard of living of the wage earners to an unprecedented extent. The average American family enjoys today amenities of which, only a hundred years ago, not even the richest nabobs dreamed.

“The improvement of well-being brought about by capitalism made it possible for the common man to save and thus to become in a modest way himself a capitalist. A considerable part of the capital working in American business is the counterpart of the savings of the masses.

“Millions of wage earners own saving deposits, bonds and insurance policies. All these claims are payable in dollars and their worth depends on the soundness of the nation’s money. To preserve the dollar’s purchasing power is also from this point of view a vital interest of the masses. In order to attain this end, it is not enough to print upon the bank notes the noble maxim In God We Trust. One must adopt an appropriate policy.”

SILVER GOES BOOM

We may be on the verge of something big in silver. Because position limits could cause a price explosion; it’s time for caution. You absolutely want to have physical silver and not paper. If you have silver in pool accounts or stored in someone else’s name or with the big brokerage firms it’s likely not there. If we get a short squeeze there could be casualties as everyone scrambles to cover.

In hectic market period’s dealers can do foolish things. Be careful about sending money to brand new internet dealers with giveaway prices. The failure rate in the gold and silver business is 90% every decade. Future failures are inevitable. Don’t rely on a newsletter to steer you to a dealer. Some of them are taking kickbacks and not disclosing this fact.

It’s time to have a minimum of 10% of your net worth in silver. In my private conversations with Ted Butler we both agree that position

limits on silver could be the catalyst to drive up prices. If you’ve read this newsletter you now have this information. We urge you to act on it.

We recommend you buy the following products aggressively. One-hundred ounce bars are a great way to own silver. We have beautiful new bars. Each bar weighs around 7 lbs. We ship them to you in a box, five bars to a box.

U.S. Silver Eagles: These one-ounce silver coins are newly struck by the U.S. mint. They have a face value of one dollar. They have a Walking Liberty on their shimmering surface and are big beautiful coins.

Among the best available silver items today are 90% silver coin bags. These coin bags have a $1,000 face value. You get 2,000 silver halves, 4,000 silver quarters or 10,000 silver dimes. These are 715 ounces of silver per bag. A bag weighs 55 pounds and is the shape of a bowling ball. We ship them in half bags, registered and insured through the mail in boxes marked “machine parts.” The coins are all dated prior to 1965 when silver was eliminated from our coinage.

Call us now at 1-800-328-1860 and order silver.

Sincerely,

James R. Cook

President