In Ted Butler's Archive

April 6, 2004



By Doug Hornig

Ted Butler is a man on a mission, and since that mission concerns an anomaly in a market that is of interest to many of our readers, we decided to investigate.

Butler is an independent commodities analyst with thirty years’ experience. For the past two decades, his particular focus has been the market in silver. He believes there is something very fishy, and perhaps illegal, going on.

We caught up with Ted at his office at Butler Research and asked him to explain the situation as he sees it. “It’s complicated,” he says. “But simply put, a huge anomaly has developed over at least the past fifteen years in the short market in silver.”

Our investment-oriented readers will probably understand short selling as it pertains to the stock market, where it is used to profit from a security’s declining share price. To conduct such a transaction, you arrange for your broker to borrow shares of stock from someone who actually owns them, then you sell them to someone else. You pocket the proceeds. Later, after the stock’s price drops to your satisfaction, you “buy back” the security, and the difference between your original sell price and the current buy price represents your profit.

With commodities, Butler says, the rules are different. Long and short contracts, of which there is always an equal amount, are written whenever someone feels like it. There does not have to be any underlying physical stock to back them up. They represent the mechanism by which actual metal changes hands, but this is in only a tiny percentage of cases. With the vast majority of contracts, only the paper is traded, with the participants making or losing money depending on the rise and fall in commodity price.

What this is supposed to do is help stabilize prices and, with most metals, it’s working as it should. Not so with silver.

“Silver has been operating at a structural deficit for fifteen years,” Butler says, “meaning that every year we consume more than is produced, thereby drawing down existing stocks. When that happens, it’s incredibly bullish, isn’t it? Demand exceeds supply, the price goes up. That’s the way capitalism works. Yet silver hasn’t moved.”

True. After a brief spike in 1987, silver has remained locked in a very tight trading range between $4 and $7. Most years, in fact, it never made it past $5.

Butler contends that the primary reason for this counterintuitive situation is the gigantic short position in silver. “It’s grown to absurd proportions,” he says. “What you have is an open interest in silver that far exceeds the supply of the underlying item. This has never happened with any other commodity. It’s off the charts.”

We asked him how far off the charts, and whether he could back up his allegations. “Sure,” he says. “I get my information from the Commodities Futures Trading Commission (CFTC), a Congressional committee charged with oversight of this market. While the CFTC, due to antiquated commodities laws, is forbidden from identifying particular traders, they do put out a quarterly Commitments of Traders (COT) report. And the January COT report is very revealing. While there may be thousands of investors with long positions, the short sellers are few in number, and they have huge positions. We’re talking about less than 20 major players. In fact, according to the COT, a mere eight traders have a net short position of 325 million ounces of silver. That’s eight times annual US production and more than twice the 125 million ounces of known reserves! In other words, if these people were called upon to deliver the metal their contracts represent, they couldn’t possibly do it. It’s fraud. A derivatives market must, by definition, be derived from something, and this one isn’t.”

Butler doesn’t know who’s doing this short selling, but he’s read the annual reports of all the major U.S. and Canadian producers, and he knows they’re not forward selling production. Instead, he thinks it’s a handful of large bullion banks. He mentions AIG, HSBC and others.

“They’ve been manipulating the market for years,” he says, “taking paper profits from small, downward movements in the silver price. But they’re so caught up in the game, they don’t realize they’ve been manipulating the actual price of silver, too. Commodities law specifies that producers/consumers should set price, but the derivatives market is now so much bigger than the physical market that it is doing the job.”

That’s why Butler has been bombarding the CFTC and NYMEX (New York Mercantile Exchange) with letters demanding an investigation. Recently, he’s been joined by an independent group of 3,000 small investors who petitioned Eliot Spitzer, New York’s attorney general, to look into the matter. So far, official response has been tepid.

“Gobbledygook,” Butler says, “that’s what they send me. ‘We find no evidence of manipulation,’ etc. They just don’t want to admit it’s happening. ‘Not on our watch,’ you know what I mean? But it’s going to catch up to them. Stock has been drawn down too much. Last year, there was an 87-million ounce deficit, which is typical. In the near future, supply to meet the actual physical demand won’t be there.”

And what will happen then? “Well, the longs could demand their silver, and the short sellers would have to default, because they can’t get it. Or, if they didn’t want to go to jail, they could buy back their contracts at an inflated price. These are big companies, and they can stand billion dollar losses. Though they don’t want to, of course. No matter what, the price of silver goes up. Either there is massive short covering, or the market reverts to being driven by real, physical supply and demand.”

We noted that silver has definitely been in an uptrend, from $4.50 an ounce last July to a closing around $7.70 as of this writing, and suggested that perhaps the supply deficit was finally being recognized.

Butler concurs. “No one can predict what will happen,” he says, “or when. There could even be a temporary price decline, if the shorts can pull it off. They’ve been raking in billions by doing just that. But eventually the inventory will be gone, and people will demand delivery from stock that’s no longer there. When that happens, the price is really going to spike.”

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