TED BUTLER COMMENTARY

November 4, 2008

MORE SIGNS OF A SILVER SHORTAGE

(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.)

The evidence of a wholesale silver shortage continues to build. This is in addition to the current retail shortage. The continuing tightening in the price differentials between the trading months in COMEX futures has continued and become more dramatic.

One of the clearest indicators of a shortage in a physical commodity occurs when the nearby futures months trade at a premium to more deferred trading months. That means buyers are willing to pay more for a commodity because it is not immediately available. Remember, the definition of a commodity shortage revolves around delays and premiums. While the nearby months in COMEX silver futures haven’t yet grown to a premium over the more deferred months (called backwardation or an inverted market), they have moved noticeably in that direction.

A second sign was the unusual and persistent buying of the recently concluded October COMEX silver futures contract, which recorded almost 1300 contracts delivered (6.5 million ounces) for the month. The bulk of these contracts resulted in a removal of silver from COMEX silver warehouses.

Finally, the big silver ETF, SLV, reported a decline of around 4.5 million ounces over a two day period recently. It is impossible to tell whether declines in the metal holdings in the ETFs are due to investor share liquidation or if shareholders are removing metal for other purposes, such as industrial consumption. Looking at the share trading volume and price action for the period corresponding to this drop, I’m inclined to think it was due to removal, rather than liquidation. Recent reports of big inflows by air transport of silver from London to India seem to explain the declines in SLV more than investor liquidation. If I am correct, wholesale silver is a lot tighter than most assume.

The draw down in visible silver inventories coincides with a new theory that my mentor and friend, Izzy Friedman, conveyed to me a month ago. Izzy remarked to me then that if visible inventories stopped growing and began to decline, that might signal the silver crunch was at hand. At first, I tended to dismiss his new theory. But, after further contemplating his theory, I concluded he may be on to something.

Don’t Be Fooled

By Israel Friedman

(Israel Friedman is a friend and mentor to Theodore Butler. He has followed silver for many decades. He has written articles for us in the past. Investment Rarities does not necessarily endorse these views.)

Sooner or later the COMEX will close their doors for one reason only - they will be considered as only a paper exchange. I write this for those people who intend to take delivery on their futures contracts. Don’t bank on receiving actual silver for your contracts.

We have signs that the supply of physical silver is drying up. Investors are buying 1000 oz bars in quantity and the miners and smelters are cutting production. The two US banks were successful to bring low prices on the COMEX by destroying the mining industry, but you the physical investor will benefit from their actions.

I was reading a study that said that twenty years from now, due to growing global demand, we will need the equivalent of a new planet to supply us with the resources we will need. Today silver is closer to a shortage situation than ever, only the price doesn’t show it. If you have decided to invest in silver, think big. 1000 oz of silver in the long run will buy you a two bedroom apartment in Trump Towers.

My crystal ball tells me that when the users panic, don’t be surprised that the price of silver could double in a week, and we could reach $40 in less than two months, and move quickly to $100, only because there is no silver available.

Be careful, those who have certificates from COMEX, don’t deliver your contracts for paper futures contracts no matter how attractive the spreads become. Don’t give real silver for paper obligations. It is not sure if your paper contract will be worth more than the paper it is printed on. Learn that one bird in the hand is worth more than ten birds on the tree. It is better to have 1000 oz in your hand than 10,000 oz in paper futures contracts.

It’s time to be very careful. These moderns gangsters are looking for ways to trick you by discouraging you from buying silver or to swindle you out from the silver you already own, by offering you many goodies like backwardation, leasing your silver with high interest rates and many other tricks. The organizations will offer you all the guarantees in the world for your silver, but remember, they can’t do that legitimately because there is less and less silver in the world.

Hold your silver close to your heart and remember that the real gold is silver. When the price of silver is equal to the price of gold, then think of profit taking. If you don’t have silver, you won’t be able to take profits.

WHY THE SILVER USERS WILL PANIC

By Theodore Butler

(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.)

An integral component of my analysis has been that, as the inevitable shortage of wholesale silver became apparent, the industrial users would panic and attempt to build inventories of physical metal. Faced with prolonged delays of a material that threatened to shut down their production lines, the users would rush to buy enough physical silver to prevent those shut downs. This would provide a bullish price thrust that few comprehend.

Recently, I had an experience that may drive home why the silver users will panic and why that will cause the price of silver to explode. About a month ago, I drove home to Florida from Maine. Normally, I take a slightly longer, but more scenic route, than the straight run down I-95. This year, because I was sensitive to reports of gasoline shortages along the route I normally take, I swung over to I-95 further north than I usually do, to avoid any problems getting fuel. It seemed that Hurricane Ike and pipeline problems were causing gas shortages throughout the Southeast U.S.

Having navigated successfully over to I-95 (over much pouting and resistance from my wife, a strong proponent for the scenic route), I thought I was headed home gas-worry free. However, at a rest stop in South Carolina, a traveler approached me with the warning that gas was now a problem on I-95. He related to me that he just came from a gas station that was sold out and had heard that there "was no gasoline at all in Georgia." Georgia was still 100 miles ahead, and there is no other way to get to Florida.

Since I had less than half a tank of gas, I decided to fill up at the next gas station. Sure enough, that station had long lines and the dreaded plastic bags over many of the fuel nozzles, indicating empty tanks for premium and mid-grade gas. Fortunately, my car only requires regular gas, so I was able to fill up with no great difficulty.

I must tell you that such an experience wakes you up and focuses your attention on something you normally take for granted. I confess that 75 miles down the road, in stopping at a hotel for the evening, I pulled into an empty gas station and topped off my tank with 2 gallons. I wanted to get home.

It occurred to me that it didn’t matter if your vehicle was worth $1000 or a hundred times that amount; without fuel, it was of no use. You need fuel to run your car. Same thing with silver for an industrial consumer - your $100 million factory could grind to a halt without silver.

I related to my wife that the price of a gallon of gas was no longer a concern, only its availability. If there was a way to insure a guaranteed supply of gas for the next year or so, I would sign up. But that’s impossible, as the problem was that there was no practical way of storing such a supply, as we are all limited by the capacity of our vehicles’ fuel tanks. Where would you put 1000 gallons of gasoline?

It occurred to me that there was no practical way for anyone to hedge against a shortage of fuel, save build your own tanks to store the fuel. Even those that had successfully hedged the price of fuel in the past, like Southwest Airlines and others, were hedging against just the price and couldn’t guarantee themselves actual supply in a shortage. For fuel and many other commodities, there was no practical protection against a shortage of the commodity.

That’s when it dawned on me to write this article. Silver is a lot different than fuel in that not only is it a lot easier and less dangerous to store, it is more likely to go into a shortage, given silver’s investment demand. Not only could the silver industrial consumers hedge themselves against the giant silver price increases ahead (buying futures), they could easily guarantee actual supplies before the coming inevitable shortage. All the users have to do is buy actual silver, not paper contracts, but real silver. Just like you do. The users buying actual silver to protect against both price increases and availability is as easy as falling off a log. Plus, it is a very rational act.

The silver industrial users have yet to initiate any type of buying protection program, either with paper contracts or with the actual metal. But, the users are run by people who are human. When they can’t get timely delivery of actual silver, like what has occurred to investors for the past months, they will do what I did in North Carolina; they will top off, and keep topping off. Only they won’t be limited by a 15-gallon gas tank. Because of the physical nature of silver and its ease of storage, the users will be able to buy as much silver as they care to, price permitting. They will buy more silver than they need because they will fear not being able to get it, once the delays in shipments start. This will set off a chain reaction, exacerbating the shortage and causing more silver users to do the same thing. This chain reaction will set off a price spiral that will shock the world.

COT Update

The most recent Commitment of Traders Report (COT) indicated a market structure that supports a strong move to the upside in silver and gold. While there was no improvement in the latest COT for silver despite strong downside price pressure during the reporting week, I believe that is due to the washed out condition of the market. How much blood (long liquidation) can you get out of a stone?

In gold, however, there was a dramatic cleansing of speculative longs and even notable speculative new short selling. This enabled the commercials to buy many gold contracts. I believe gold is now as washed out as silver. In more measurements than not, both the gold and silver market structure is as good as it has been in years. That means low downside and large potential upside.

I read an article today in the Idaho Statesman concerning layoffs at a local silver mine, due to the low price of silver. I took the occasion to write the following e-mail to various officials at the CFTC -