In Ted Butler's Archive


The prime component for my investment case in silver has always been the likelihood of a physical shortage. The potential for a physical silver shortage exists now more than ever. First off, I am referring to a coming shortage in the form of silver that matters most – 1,000 ounce bars. The wholesale price of silver is determined by 1,000 ounce bars, because they are the industry and institutional investment standard.

The entire world supply of verifiable 1,000 ounce bars in existence (including ETF and COMEX inventories) is just under 900 million ounces, to which I would add 500 or 600 million ounces in unrecorded 1,000 ounce bars (of which I believe JPMorgan holds the majority). Let’s call it 1.5 billion ounces, worth around $30 billion. Compare that known gold in all forms of 5.5 billion ounces, worth $7.5 trillion. In dollar terms, there is 250 times more gold than silver in the world. Common sense would suggest if there is going to be a shortage, it would likely occur in a commodity where inventories are small.

Like most investment assets very little of what exists is available for sale. That’s because relatively few sellers exist at any time in any asset, usually amounting to 5% or 10% of the total. Only 100 million ounces of 1,000 ounce bars, worth $2 billion, are available. We live in an era when billions of dollars can flow into an asset at any time. Should a small amount of money get directed towards silver, say 10% of what flowed into gold ETFs over the past six months, it would likely exceed the amount of metal available. In addition to sending prices higher, sudden investment demand would disrupt the entire silver supply chain and lead to the “doomsday” effect in silver – an industrial user inventory buying panic.

Because 90% of silver demand is earmarked for industrial fabrication an investment buying surge would result in growing delays in delivery to industrial users. When faced with this shortage they will not only buy, but buy more than usual, adding to the physical shortage. The first stage of investment buying may have already begun. If investment buying depletes the available supply of 1,000 ounce bars, industrial users will pour into the silver market. World silver inventories are down more than 90% from 75 years ago and only 10% is available from current production for investment in 1,000 ounce bars. It will take much higher prices to balance supply once a combination of investment and user demand kicks in. This is the case for $100 and higher silver.

At precisely the same time as developing investment demand, 8 commercials (major banks) have never been short so much silver on the COMEX (nearly 500 million ounces). Higher prices have put those traders more deeply underwater (in combination with gold) than ever, while those same rising prices threaten to ignite an investment stampede. Their bottom-line loss since year end is $2.5 billion, the most ever. Even more stunning is the quickness in which the commercial losses developed. Only five weeks ago, the commercials were ahead for the year by around $1.5 billion, meaning there has been a turnaround in the collective commercial position in COMEX gold and silver of $4 billion.

The commercials have never been this deep in the hole before in combined gold and silver losses. These unprecedented losses to the commercials make them more vulnerable to further losses and more desperate to turn prices down. Make no mistake – whether the commercials succeed or not is what will determine which way gold and silver prices move in the immediate future. Even if the commercials prevail again, and that is far from certain, the tide seems to be turning on the whole COMEX game that has existed for decades. It’s hard to characterize the current extreme set-up in COMEX market structure as being deliberately constructed by the commercials in its current form. Who would knowingly dig themselves into the deep hole the commercials find themselves in? Never in the past have gold and silver prices rallied strongly after historic commercial short positions had been established. Yet, for the very first time, prices have rallied.

It’s not possible the commercials intended to be billions of dollars in the hole. The most plausible explanation for why they are so deep in the red is simple miscalculation. And if the commercials have miscalculated to this point, that would seem to increase the odds of continued miscalculation, leading to a total failure which I would define as aggressive short-covering on escalating prices. If these big banks manage to extricate themselves from the trap they are in, I wouldn’t expect them to go so heavily short ever again. That’s the key to the future. It’s definitely a good time to own silver.

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