In Ted Butler's Archive

The Silver Countdown Begins

By Theodore Butler

The question that I am asked most often is, “when will silver explode in price?” Whether in public or private response, invariably I answer, “I don’t know.” It’s not because I’m being cute or evasive, the reason I don’t know is because the answer is unknowable. Of course, to the question of when, I answer, “when silver leasing ends, or when the manipulation ends, silver will go.” But I know folks are looking for a specific timing sequence. It doesn’t matter that I explain that I am not a psychic or fortune teller, but a commodity analyst, and that even the most painstaking research can’t pinpoint the exact time a market will move decisively.

Another reason I shy away from the timing issue, is because if you start thinking in terms of when, and not why (or how), your sense of perspective becomes distorted. If you start concentrating on the timing, invariably you develop an “itchy trigger finger”. Timing becomes your main focus, not value. While there will always be a best time to buy and a time to sell for any investment, that best time is usually discovered by looking to buy extreme undervaluation and looking to sell extreme overvaluation. It is precisely because the average person stands a much better chance for investment success by concentrating on value, and not timing, that I choose to concentrate on the current gross undervaluation of real silver.

With that disclaimer on timing in mind, allow me to convey why I think now is the right time to buy real silver. Don’t worry, I’m not doing an about-face, and I don’t intend to concentrate on the when. It’s just that I see some new developments that hold the promise of impacting the silver market shortly.

Before I get into these new developments that I feel will cause silver to surge soon, I’d like to make a point about what has already transpired. Many people who have already purchased real silver (some on my research) are undoubtedly disappointed that the price hasn’t moved higher. This is normal. I sense there is disappointment (and I share that disappointment). But for those who have really looked hard at the supply/demand situation in silver, the disappointment is merely the wish that they had waited until today to buy, not that silver will prove to be a poor investment going forward. I know that’s how I feel. The point I wish to make is that, while it is normal to wish for a better buy point with the benefit of hindsight, this prolonged, and seemingly endless, price depression of silver has an incredibly positive aspect on the price going forward. Simply stated, I’m saying the longer the price stays at these artificially low levels, the more power the coming bull move will have.

The reason I say this long, long period of silver price depression will translate into a more powerful advance in the future price, than would have otherwise occurred, is because of the silver deficit. Most folks are aware of the old market saw, that the cure for low prices is low prices. That means that ultimately, low prices for a commodity will discourage production and encourage consumption enough to create a shortage of that commodity, and therefore cause higher prices. This is how the law of supply and demand works. But because the silver market has been operating in a deficit for so many years, it appears that the law of supply and demand doesn’t work in silver. Let’s face it – silver’s long term low price has succeeded in discouraging production and encouraging consumption to the point where we have a documented long term deficit in silver, an unheard-of situation in any commodity, but the low price to date has not been of sufficient duration to cure the low price. Nevertheless, it would be a monumental error to conclude that just because silver’s low price has not yet cured the low price, that it will never cure it.

Quite the contrary, the long-term low price of silver guarantees long-term high price for silver. That’s because a deficit in a commodity necessitates the draw down of existing inventory to satisfy the deficit. Remember, if the current production of a commodity, like silver, is less than current consumption, supplies must be taken from inventories of previously produced material to balance the equation. That removal of material from inventories can’t be avoided in a commodity deficit under any condition. Period. It is a law of the natural world. A commodity deficit will always, with no possible exception, result in existing inventories being reduced by the exact amount of the current deficit.

It is at this point when inventories are being reduced to balance the deficit, that prices move higher. That’s because there is growing demand for existing inventories, and the owners of those existing and shrinking inventories realize the growing value of their shrinking stockpiles, and demand higher prices for those stockpiles. A current deficit in a commodity will always result in shrinking of inventories and subsequent higher prices. This is as true with silver, as it is with any commodity.

The difference with silver (and gold) is metal leasing. Because of this backward and uneconomic metals leasing, where inventories are allowed to be reduced without having to be bid away from the owners, the inventories are reduced with no price increase. This is why I rant and rave about metal leasing – it distorts the free market. The price doesn’t matter in the release of inventories, only the phony lease rate matters. But, it would be a grave mistake to assume that just because leasing has allowed over a billion ounces of silver, in the last decade alone, to come to market without the normal price increase, that it can go on forever. In fact, it’s just the opposite. Here’s why: even though there has been no price increase as the leasing inventories have been reduced, the important point is that the leasing inventories are nonetheless reduced. That’s what matters most – inventories of silver have been depleted to a shocking level. How shocking? Well, look at the US Government, alone. What was formerly the world’s largest stockpile of silver, some 6 billion ounces, 60 years ago, has dropped to roughly zero. How much more shocking could a stockpile decline be?

Just because metal leasing has allowed a massive depletion of silver inventories to occur without a free market price increase, doesn’t minimize, in any way, shape or form, the fact that silver inventories have been depleted. The silver is still gone. The silver will stay gone. That’s all you need to focus on. And because these silver inventories are long gone, and so few observers are aware of what I just described, the price impact, when it comes, will be historic in nature. That’s because the price of silver has been depressed for so long by this leasing nonsense that it has created a structural deficit so large it’s hard to fully comprehend. Metal leasing shenanigans have created the most bullish configuration possible. We have had current production running much less than current consumption for many years. We have had silver inventories drawn down on an ounce-for-ounce basis with the amount of the deficit. We have had producers and industrial consumers alike, become accustomed to a long term, artificially depressed price. We have producers and users alike, short the market via leasing and other derivatives, setting up the spectacle of mass financial suicide.

In addition, the silver using industry has become the poster child for extreme just-in-time supply chain management. The last thing the silver using industry is conditioned for is a sudden inability to secure silver instantly. That’s what is so bullish about the long-term depletion in inventories and the structural deficit in silver. Not only will the silver consumers be instantly denied silver, they will be denied silver on a long-term basis as well, because all the inventory, that took 5000 years to accumulate, is gone. Next time you contemplate the low price, try to think of the long term effect the low price has had on the market itself.

There are some recent developments, however, that suggest that we are hitting critical mass in the silver market. These events suggest an early resolution to the question, “when will silver explode in price?” We now see evidence that the structural deficit is accelerating, and thereby self-destructing. Silver production may be starting to fall so quickly, that leasing may not be able to keep up with the loss of that production. If that turns out to be the case, I guarantee silver prices will move immediately and sharply higher.

Several days ago, Hecla Mining Co. announced that, because of the low price, it would sharply curtail silver production at its flagship mine, the Lucky Friday, from 4.5 million ounces annually, to 1.2 million. The resultant 3.3 million ounce production loss, coupled with the annual 5 million plus ounce loss due to the earlier complete shutdown of the Sunshine Mine in Idaho’s Silver Valley, means that US silver mine production will fall some 15%, minimum. And the US is in the top five silver producers in the world.

Naturally I am saddened that miners and their families will be deprived a living, courtesy of the silver price manipulation. But, as an analyst I can’t believe it has taken so long for these shutdowns. I thought they would have taken place 10 to 15 years ago. Since neither Hecla, nor Sunshine earned a profit in the last 10 years, they should have shutdown and kept their decade-long nearly 100 million ounce production in the ground, for the shareholders benefit. But, make no mistake, this is big news. It guarantees a tight silver supply going forward. It should also encourage other mines to follow suit. There are basically no silver primary or byproduct silver producers operating at a profit.

In my last article, I predicted mine shutdowns. If silver prices don’t rapidly escalate, the mine shutdowns will have just begun.

And it isn’t just primary silver mine production that will continue to shutdown. The base metal producers are also getting hammered. Copper prices have declined sharply, and zinc prices are a disaster. Indeed, the smell of death surrounds the largest integrated zinc-lead producer in the world, the Australian outfit, Pasminco. The stock has declined 90 % in the past year, and its chance of survival sinks with every down-tick in the zinc price, which is at multi-year lows. Since stockpiles of zinc (and copper) have been rising sharply recently, (proof of a market surplus) an upturn in the price of those metals seem unlikely. At current zinc prices, it is just a matter of time before Pasminco shuts production down. Pasminco is one of the world’s largest silver producers, the silver coming from byproduct zinc and lead production. Not just one of the world’s largest silver producers, Pasminco is perhaps the largest silver forward seller in the world, holding as much as 35 million ounces of silver sold short, according to the most recent annual report. It’s hard to believe – a company on the verge of bankruptcy, holding such a massive silver short position. If they do shut down, what happens to their silver short position?

In addition, the high-profile mega silver mines due to come on stream in a few years, like those of Barrick Gold and Apex Silver, have been put on hold, or delayed, until silver and base metal prices improve. With those delays, as well as current mine shutdowns and normal reserve exhaustion, it’s starting to look like silver mine production will be slashed dramatically very soon. And speaking of Barrick Gold, their just-released Q2 earnings indicate that they increased their total silver short position to just over 30 million ounces (forwards and short call options), by selling 6.5 million ounces of silver call options due this year. This, for a company that produces roughly 4 million ounces of silver a year. That proves two things – one, Barrick is speculating, not hedging. Two, a number of miners are not expecting higher silver prices. If a miner makes speculative bets on silver not increasing in price, do you imagine he is preparing to increase production?

Just so you don’t think I’m highlighting the coming production shortfall, and ignoring happenings on the consumption side, silver industrial consumption looks strong. Yes, I know there is a severe economic slowdown occurring. I study the economic scene closely. The world’s largest silver consumer, Eastman Kodak, just happened to report their quarterly earnings since my last article was published. While I prefer to analyze their 10K or 10Q, it looks as though the tough economic times have resulted in a 1 to 2% decline in silver consumption. And the decline has nothing to do with digital photography, just economic conditions. I think film consumption (and therefore silver consumption) has held up remarkably well.

The story is similar in other silver consuming industries. While high tech companies have reported sharply lower revenues and earnings due to aggressive discounting, unit volume sales have remained largely intact. For instance, worldwide unit volume shipments of personal computers slipped less than 2% in the last quarter. That means silver consumption dropped less than 2%, in that sector. Automobile manufacturers are slashing prices and increasing incentives, hurting the bottom line, but units produced has not declined. This means silver consumption has not declined. Cell phone sales are disappointing, but they are still up in unit volume shipments. Ditto, silver consumption in that sector. And what about the US Government, through the Mint, or the Department of Defense, coming into the market for the first time as a consumer in over a half century? That will make up for the marginal silver consumption that may be lost.

To be clear, I’m not suggesting that silver consumption can’t possibly fall. I am stating that there is no credible evidence that it is falling now. If your big fear is that silver consumption will fall in a steep recession, or a depression, just imagine what such economic conditions would do to base metal consumption, like copper or zinc. A more severe downturn would create a bigger base metal surplus and production cutbacks, shutting down silver production automatically. I contend a sharper economic slowdown will increase, not decrease, the silver deficit. As it stands, this current slowdown and the artificially depressed silver price threatens to decimate silver production. Further economic weakness would be profoundly bullish for the price of silver. How many other commodities, or investment opportunities, can you say that about?

Trying to time a market is tricky business. I think it is much sounder to rely on known facts. You must first be confident of the investment vehicle you choose. What good does it do you, for instance, to call the timing and direction of the bond market correctly, if you choose to invest in a bond that under performs or defaults? You can eliminate that problem in the silver market by buying the real thing. Real silver can’t possibly default or go bankrupt, or become worthless. That is a big, big plus in a financial world experiencing so many upheavals. Now, with the public record indicating that the silver deficit looks set to explode, the question of timing appears close to resolution. The only real timing risk at this juncture, in my opinion, is waiting too long to buy. Where is the advantage in waiting for upside price confirmation, if it means silver will cost much more? It doesn’t seem logical for someone to wait to buy, in light of these new public developments impacting the silver deficit. From a timing standpoint the best thing about owning real silver, right now, is that time is on your side.

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