In Ted Butler's Archive

Crunch Time?

(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.)

It is one thing to analyze on a long-term basis, and quite another to make short-term predictions. There is no doubt in my mind that silver is a rock solid long-term investment opportunity, with an absolutely spectacular risk to reward ratio and value. It’s just a matter of time before silver is priced substantially higher. As I try to point out week after week, the rise in the price of silver is inevitable. That’s all that should matter to long-term investors. Silver is the ultimate buy and hold.

Asked when this dramatic silver price rise will take place, I have always answered that the exact timing is impossible to know, even though prices have already climbed substantially over the past few years. The important point is that prices are still depressed, principally due to the manipulation, offering the long-term investor an attractive entry opportunity. Still, silver is a very interesting topic to many of us, and it is hard not to try to consider the short-term factors. That’s why, for instance, I study the COTs.

I have always been convinced that the price of silver, when it moves to true value, will make that move with a violence that will shock most observers. It will not be a “normal” market move. It will be as unprecedented as much as the true meaning of that word allows. You had better be positioned before the move commences, because it will be extremely difficult to jump on board at attractive prices once the move has begun. Those who have talked with me personally about this, will confirm that I always say that when the real move comes, they will not have to ask me if this is the real move. They will know it simply by observing the price action. It will be unmistakable. Therefore, it is natural to attempt to anticipate when such a move may begin.

The real move in silver will come when a wholesale physical shortage is at hand. When that shortage comes, no one can stop the silver price explosion. Not the silver users, not JP Morgan, not the US Government. Further, I have always thought that any signs that the wholesale shortage were at hand would likely to be subtle, as opposed to being clear for all to see. When the signs of the real move are clear to all, when the wholesale silver shortage is truly upon us, it will clearly be too late for all to capitalize on those signs. This will develop very quickly, with little time to react. All we’re likely to get are subtle signs, not personal invitations to buy. The trade-off is that subtle signs can turn out to be false readings. So we are forced to be hypersensitive to the signs of a developing wholesale shortage in silver. We can play it safe and wait for the inevitable shortage to hit and say I told you so afterward, or we can stick our necks out and point to the signs while they are still subtle and maybe false.

With that caveat, let me tell you some of the signs I see of an impending silver wholesale shortage. Some of these signs are micro, meaning very specific and detailed. Others are macro, much broader. The main micro sign that we may be entering into a wholesale silver shortage is the appearance of an inversion or backwardation on the COMEX. For the past week, the nearby current delivery month of March has closed at a premium to the next major delivery month, May. What this means is that buyers are willing to pay more to get immediate delivery of wholesale quantities of silver. It means wholesale silver is “tight.”

While not completely unprecedented, this inversion in the March contract is rare enough to command attention. It’s not just the premium of the March futures contract to the May contract that is unusual, it’s also the pattern of deliveries that suggests genuine tightness. The buyers are having to wait for deliveries, where they didn’t have to wait so long in the past. Conversely, the sellers seem reluctant, or unable to make physical deliveries with the ease they demonstrated in the past.

What’s somewhat ironic is that there was a tremendous amount of discussion over the past few months about backwardation and potential delivery troubles in the past December contract. None of those threats came to fruition. Now, with very little public discussion or warning, delivery tightness and backwardation seem to have arrived.

Other micro signs include the very recent announcements of production disruptions at two of the world’s largest silver refineries, the MetMex complex of Penoles in Mexico and the La Oroya facility owned by Doe Run Peru. MetMex declared a force majeure on silver contracts due to a strike, while La Oroya ceased production due to non-payment to concentrate suppliers and a subsequent credit line cancellation. These circumstances may prove short-term in nature, but if anyone could imagine a more bullish announcement for silver than these two facilities suddenly being shut down, I’d like to hear it. That prices plummeted today on this news is so bizarre that it can only be explained by manipulation.

On the macro side, there are also very strong signs that the wholesale physical silver shortage is here. Over the past few months I have been writing about the impending decline in silver mine production as a consequence of declines in base metal production.

More than 60% of all silver mine production comes as a result of byproduct mining of three base metals, copper, zinc and lead. With the collapse of the world economy and the subsequent decline in industrial consumption of all commodities, the inventories of base metals grew dramatically. After all, it is a lot easier for an industrial consumer to quickly cut consumption than it is to shut down a mine. Therefore, in the time lag before mine production declines sufficiently to match the new lower level of industrial consumption excess metal is produced and flows into inventories. That is exactly what we’ve seen over the past six months. Inventories of copper, zinc and other base metals exploded in size. (Silver inventories grew as well, but all the excess silver was gobbled up by investors, as discussed previously).

Now there are signs that base metal mine production has fallen enough to match the lower level of demand. Those signs can be found in the recent flattening out and decline in copper, zinc and lead inventories at the London Metal Exchange. After growing non-stop for months, inventories at the LME have stopped growing in the past few weeks. This suggests a current balance between supply and demand for copper, zinc and lead. Of course, if inventories start to grow rapidly again, this flattening out in inventory growth will have been a false signal. But assuming that mine production of copper, zinc and lead has now been reduced enough to prevent inventories from growing, then the conclusion for silver is clear. Silver mine production has also been dramatically reduced. This can only add to the wholesale silver shortage, as investment demand is still surging.

Allow me to summarize what all these micro and macro signs of wholesale shortage mean to silver investors. Quite simply, it means that the price of silver should explode soon. Either that, or all these signs must reverse direction. You must remember that the manipulation is a manipulation of price. The price is the only thing wrong, or out of kilter with everything else that exists in silver. The price is the aberration. If the silver price today was $50 or $100, everyone would see the tightness in wholesale silver. But because the price is $13, very few see it.

The good news is that of all the factors that matter to silver, it is the price itself that can change quicker and more radically than any other factor. More good news is that nobody can prevent a wholesale shortage. No matter how powerful they may appear to be. This is about physical supplies, not how many paper contracts can be sold short. Additionally, if we are entering into a wholesale silver shortage, then nothing could prove that the silver market has been manipulated more than this. Let’s face it, the regulators maintain that all is well in silver and that the price is at a free and fair level. Nothing will expose that lie like a wholesale shortage.

If the short-term signs I see, both micro and macro, are true representations of what is occurring with supply and demand, then it may be crunch time in silver. If that’s the case, buckle up and get ready for the ride of your life.

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