In Ted Butler's Archive

The Vise Tightens

By Theodore Butler

(The following essay was written by silver analyst Theodore Butler. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

The Commitments of Traders Report (COT) still suggests further room to the upside in gold and the currencies (dollar down), as the tech funds have not yet come in heavily. Silver’s COT is still neutral, with room for the price to move either way. It goes without saying that even if the manipulative dealers do engineer a sell-off to the 50 day moving average, their obvious target at around $6.30, that is a small move compared to the potential move up. That’s what is meant by a good risk/reward ratio. If we do get a sell-off in which the brain dead tech funds are flushed from the long side, we will set up a monumental buy point, once again. But please remember that here is no guarantee the dealers will succeed in triggering a sell-off. However, at some point, the fundamentals will overwhelm the COT structure.

The Chicago Board of Trade (CBOT) announced that they will be initiating trading in gold and silver on an electronic and 21 hours per day basis. I have seen comments that suggest this might make a difference in terminating the silver manipulation or could be a big deal for the real silver investor. I don’t think so.

This is not a brand new attempt by the CBOT to compete against the COMEX contract, as the mini-silver contract (1000 oz) has been trading there for years. The difference, or gimmick, this time will be the electronic trading feature, where traders can enter orders and review all bids and offers from their computers. The COMEX currently allows trading electronically through their after hours Access system, but the CBOT will be open more hours per day. I suppose the extended hours feature may appeal to a small set of traders, but for the vast majority of silver investors it will matter little.

It is important to recognize why the CBOT is introducing this electronic system. Their principal motive is to increase income to the exchange and their member firms by creating and increasing the number of trades that are transacted on the exchange. They are not trying to promote the ownership of real silver. They are trying to promote the rapid trading of electronic silver. Their proposed contract is not designed to encourage people to take delivery of silver, but to rapidly day trade it electronically. It appears to be neutral and insignificant to the real silver investor.

But there are two things about the CBOT announcement that auger well for silver. One, no one introduces a new contract unless they expect increased interest in the underlying commodity. The people who run the CBOT are market sensitive and savvy, and it is obvious that in their opinion, there will be growing future interest (and higher prices) in silver. Here, I would clearly agree with them.

Also, the trading world is intelligent enough to understand that there must be a valid delivery feature to support a new legitimate paper or electronic silver futures contract, otherwise no one would trade it. That’s why the first thing I looked for in the CBOT announcement was the delivery details of the new silver contract. I wanted to see where was the real silver and exchange-approved warehouses that backed up the contract. Without such real silver and legitimate warehouses, the new contract wouldn’t stand a chance. What I found was important to the real silver investor.

The CBOT will use the very same warehouses and silver that also backs up the COMEX contracts. (They’ve already signed up two of the four COMEX-approved warehouses and are trying to sign up the other two.) This proves there is so little visible and available silver in the world that the CBOT had to piggyback on the COMEX-approved warehouses. More and more paper and electronic claims on a shrinking foundation of real silver. This is unprecedented and very bullish for silver.

Aside from the CBOT announcement, it has been interesting to watch the recent movements in the COMEX silver warehouse stocks. It has been my opinion that these movements are directly as a result of the big category transfers and deliveries in the first days of the July COMEX futures contract. I’m still of the opinion that someone was tricked out of their silver (20 to 25 million oz), and the unusual warehouse movements are related to that. I had expected to see big movements between the various warehouses, so it has been no surprise that those movements have occurred. But I am very much surprised that, in addition to those warehouse-to-warehouse physical transfers, there has been a significant net outflow of silver. It is the movement between warehouses that actually excites me more, at this point, than the net out movement. Of course, continued net outflows become very important at some point.

As of the close of business August 16, the total amount of silver in the COMEX-approved warehouses was just less than 112.2 million ounces, down over 6 million ounces from the beginning of July. Adding in the 12 to 15 million ounces involved in the warehouse-to-warehouse transfers, more than 15% of the total COMEX silver inventories have been physically moved in the past six weeks. That’s an enormous amount; because it strongly suggests that 15% of the COMEX silver inventories have changed hands in a month and a half, and all at current prevailing prices. Since this amount is close to the unusual July transfers and 2nd day delivery totals, I think this confirms my snookering thesis.

I raise this issue because I think it adds to my sense that the wholesale silver market is very tight. In fact, this physical movement in COMEX silver inventories makes the market much tighter. I wrote recently that it would be impossible for anyone in the world to pick up the phone and buy 20 to 25 million ounces of silver ($150+ million) in a simple cash-for-metal transaction, without launching the price sharply, as the metal just wasn’t available. The only way it could be done was for the buyer to utilize the futures market cleverly and clandestinely, as I think was done in the July contract.

Let me add something new here. Now that someone has pulled off this feat of buying 20 to 25 million ounces of silver by buying 4 to 5 thousand COMEX futures contracts in the July switch migration, let me restate the equation. As a result of the July transaction, and the resultant 15%+ change in ownership of the total COMEX silver inventories, I’m convinced that no one could ever do that again without causing an explosion in the price of silver. No matter how cleverly the futures contracts were acquired, it could not be done. The only reason the traders likely associated with HSBC and Mocatta were able to pull it off is because they knew that Calyon had the silver and would have no choice but to deliver without a fuss. That silver has been acquired and there is nothing to suggest similarly large concentrated quantities belong to any other entity, save the ones who just secured it. The next time someone demands delivery on 4 to 5 thousand silver futures contracts, and maybe a lot less, I think all hell could break loose. And that next time could come in any upcoming delivery month. (As an aside, I don’t think Calyon could get back the silver that was taken from them, without a major impact on the price.)

Of course, this is speculation on my part, albeit, hopefully, informed speculation. While not all of my speculations come true, particularly those with a time frame, I have also speculated correctly in the past. In an article 5 years ago, I complimented Warren Buffett for his purchase of over 100 million ounces of silver, equating it to someone hitting 100 homeruns in a season, a feat never to be duplicated nor exceeded. Five years later, it is impossible to imagine any one entity amassing 100 million ounces at any price, let alone at $5 per ounce.

Due to the continuing structural deficit, and the recent July futures maneuver, I don’t think anyone could buy a fifth of what Buffett bought then, and certainly not at less than $5 per ounce. And that’s not because of a shortage of entities financially capable of buying 20 million ounces of silver, as there are many more today financially capable of a $150 million ounce purchase than six years ago. The shortage, clearly, is in available silver itself. It is simply not available at current prices. Sooner or later, someone will test my speculation. More importantly, every day there is less silver in the world and more money and people who might make the connection.

In response to a recent e-mail from a reader who questioned my conclusion concerning the Central Fund of Canada’s delay in receiving their silver as proof of tightness in silver, I passed along some thoughts I’d like to share. I mentioned with recent in and out movements of 1, 2, and 3 million ounces a day at the COMEX warehouses, The Central Fund’s 6.5 million ounces of silver could have been delivered in a week, instead of six months or so.

In addition, I have heard that many of the 1000 oz silver bars being delivered to the Fund (as well as at the recently completed delivery to the other Canadian outfit) are newly refined bars. I have also heard that, on the retail side, many of the smaller bars being purchased are newly refined and poured. This tells me that old silver is no longer coming to market, either because it doesn’t exist or is tightly held.

I wrote that I thought that the silver market was so tight and closely managed by the remaining big dealers that the Central Fund was experiencing delivery delays because they wouldn’t complain and panic, like an industrial user would panic with the delay of a just-in-time silver shipment. The Central Fund wouldn’t have to shut down due to a silver delivery delay, like an industrial user might have to. That’s how tight I think the silver market is – the Silver Managers actually have to decide, by urgency of need, who gets silver first. It’s also why you’ll never see, in my opinion, an ETF (Exchange Traded Fund) that is purely silver. The silver market is just too tight to allow valuable physical silver to be diverted from industrial users. The good news, of course, is that you can set up your own personal ETF, by buying real silver directly.

The fact that silver appears so tight, yet the price remains so low, should scream manipulation to you. It should also scream that this manipulation can’t continue for much longer. That is why it is more important than ever that all the producers of silver, primary and byproduct alike, attempt to put an end to this manipulation. With the silver miners sitting on their duffs, the manipulators can claim that proves there is no manipulation. The producers must wake up to the realities of the market and live up to their responsibility of protecting their shareholders’ interests.

Just this week, another silver mining company (Endeavor), announced they would be, in effect, withholding silver production from the market for higher prices, thus joining Silver Standard’s actions of a few months ago. While this shows that some in the silver mining industry see the real value in silver, it is a sad reflection on those who won’t open their eyes. Specifically, the four companies I have mentioned previously, Pan American Silver, Hecla, Coeur d’ Alene and Apex Silver, still haven’t lifted a finger to benefit their shareholders. This, in spite of earning no real profits yet on their silver operations, even with silver hitting 16-year highs in the first quarter. The CEOs of these companies should reconsider.

These four companies are sitting on a combined cash cushion of more than $800 million. By deploying 10 or 20 percent of that cash into real silver, or by withholding an equivalent production amount, they could break the back of the manipulation. This is the same amount of silver involved in the recent COMEX trickery. When will these four companies (to say nothing of the hundreds of other primary and byproduct miners) see the light? If you’re a shareholder, you should be giving them heat for dumping your resources at garbage prices.

Start typing and press Enter to search