In Ted Butler's Archive

Testing Your Brain

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 price of silver has surged to multi-year highs, to levels last seen 16 years ago. That means that anyone who purchased silver any time since 1988 should be holding silver at a profit. More specifically, at $7.50 per ounce, silver is more than 50% higher than its $4.80 average price for the past 15 years. It also means that anyone holding a short position in silver sold since 1988, now has a losing position.

A 50% or greater price change in any commodity is ordinarily big news, particularly when a commodity’s price has been comatose for years, or decades, as silver’s has been. Such large percentage price changes, especially when they occur suddenly (silver’s price gain has taken only a few months), usually impact both the supply and demand sides of the fundamental equation. Silver is different, of course, than most commodities in that both its demand and supply are said to be price-inelastic. That means that price rises in silver have little short term impact on increasing supply or production, and little impact on reducing demand or consumption. So far, the price-inelastic label on silver has proven to be true, as there has been little evidence that the price surge has reduced demand or increased supply.

While the evidence suggests no falloff in actual industrial silver consumption, there has been a decided increase in the rhetoric of the industrial silver users. The sharp increase in the price of silver does impact bottoms lines, even if it doesn’t alter near term production and consumption. The silver industrial users must pay more, and that’s painful for them. Since there is not much that these users can do, except to pass the silver cost increase along to their customers, we might expect to hear them moan about the silver price rise.

So it was no surprise to read the following passages from a Bloomberg story aboutr industrial silver users.

March 17 (Bloomberg) — Ames Goldsmith Corp. co-founder Ronald Davies, who sells metal powders used by Dow Chemical Co. and Fuji Photo Film Co., said a rally in silver prices to a six- year high may force some customers to seek cheaper alternatives.

Glens Falls, New York-based Ames Goldsmith, a closely held company that processes about 50 million ounces of silver a year, will offer a copper-based coating that can be used in place of an all-silver product used to shield phones and computers from electromagnetic inference. The copper version sells for 75 percent less at $50 a kilo, Davies said.

“We are concerned substitution will accelerate and reduce our market, particularly in the electronics world,” Davies, 71, said in a telephone interview.

Silver’s rally “is going to make traditional photography more expensive and less competitive with digital,” said Davies, who sells silver nitrate crystals to film makers Fuji, Konica Minolta Holdings Inc. and Polaroid Corp. Ames Goldsmith passes on the higher silver prices to customers, he said.

Ames Goldsmith, which employs 125 in four processing plants, sells silver oxide salts to Dow Chemical, the largest U.S. chemical maker, for catalysts used in making ethylene oxide found in engine antifreeze, polyester fibers and adhesives. Ames supplies DuPont Co., the second-largest chemical maker, with silver nitrate crystals used on capacitors found in cell phones and other electronic appliances such as television sets.

Davies, who came to Malvern, Pennsylvania, in 1966 as a chemist for Johnson Matthey Plc before helping to found Ames Goldsmith in 1979, says he doesn’t own any bullion after watching the market for more than three decades.

“There are people touting silver as a good investment, but if you look at silver over the course of ages, it’s been one of the worst investments you can possibly pick,” Davies said. “It’s all right for Warren Buffett to invest in the silver market because he’s got tons of money. But for the average person to invest in the silver market today, they need to get their brains tested.”

I’d like to dissect what Mr. Davies really said and to strongly urge you to follow his advice and test your thinking about silver. First, copper is a commodity that has excellent electrical conductivity properties. In fact, it is second in conductivity only compared to silver. Whenever copper, which is priced and quoted by the pound or ton, can be substituted for silver, which is priced by the ounce or gram, I would expect a user to do so and not merely issue a threat about doing it in an article about the recent increase in the silver price. Second, while digital photography is growing, there is no credible evidence to suggest it’s because silver-halide photography is about to get too expensive. As I have written previously, the silver-halide process has become the lowest cost version of photography, and it would take truly monumental increases in the price of silver to warrant a significant impact on the price of film.

Finally, Mr. Davies pulls out all stops in stating that silver is a bad investment for regular people, but is somehow OK for the world’s most successful investor, Warren Buffett, because of his “tons of money.” That’s silly, as the size of one’s bankroll has no bearing on the objective merits of any investment. Silver has been a poor investment if one bought it at the very high prices of the past. The same could be said about any asset purchased when overvalued. Certainly, anyone buying silver at the average prices of the recent past few years had very low risk, the hallmark of a good investment.

As a card-carrying member of the Silver Users Association (SUA), Mr. Davies will always to discourage anyone from investing in silver. The SUA will never represent silver as a good investment because this would provide competition for the scarce remaining silver supply. To me, this is clearly public misrepresentation, which should be of concern to Bloomberg, the CFTC, the COMEX, and any regulator or organization concerned with upholding the truth and fair dissemination of market information. I don’t think the Silver Users Association, or its members, should be allowed to misrepresent the investment merits of silver publicly, without full disclosure that members are in direct competition with silver investors.

Mr. Davies labels as touts those who promote silver as a good investment. I suppose he would include me in that characterization. But I will tell you this – whereas Mr. Davies or any other public spokesman for the SUA will always represent and misrepresent silver as being a poor investment regardless of price and supply/demand fundamentals, if I felt silver were overpriced or if the fundamentals were not favorable, I would say so. That is not to say I will not or could not be wrong, just that I don’t have to be bullish on silver, or anything else, like the SUA has to be bearish on silver, for their own ulterior purposes.

The fact that there is such a users organization for silver, alone among all commodities, should reassure silver investors as to just how valuable and coveted silver is. After all, there is no gold nor platinum nor diamond nor any other commodity users association, constantly urging the public not to invest. Test your brains, and ask yourself, why just silver?

Two things left out of the Bloomberg article were the epic short position in COMEX silver and the billion plus silver ounces loaned out in the leasing scam over the past two decades. That’s curious because it is widely believed that some members of the Silver Users Association have been big lessors of silver. I know that it’s crazy for a user to borrow material and consume it and then to pretend he might be able to pay it back one day, but that’s how the crazy (and manipulative) world of silver leasing works. Of course, a rising silver price is the absolutely worst thing that could happen to someone who leased silver and can’t pay it back. It can easily crush an enterprise to the point of extinction.

Where do we go from here in silver and what’s an investor to do? Could we have a sharp sell-off? Of course, we could. Could we explode in price at any moment? Yes, we could.

We do know that silver is still in a deficit and we consume more than we produce. We know that silver is still in the most bullish condition a commodity can be in. There is no credible evidence that the price move to $7.50 has impacted the deficit in any way. Talk of substitution doesn’t lessen demand, only real substitution does. That means that the price must go higher to eliminate the deficit. Not because I say so, but because it is mandated by the law of supply and demand.

Only higher prices will eliminate the deficit, according to economics 101. While short-term sell-offs are possible, eventual higher prices are mandatory. The urge to capture a 50% short term move is tempting, but is it prudent? Trying to focus on the possible (a short term sell-off), at the expense of the mandatory (certain long term higher prices) seems a prescription for missing a once-in-a-lifetime opportunity. If you’ve been fortunate enough to have acquired silver at cheap average prices, sit back and be patient.

What about those who are new to the silver story and are just now learning of this exceptional opportunity? It is highly unlikely you will be able to acquire silver at the low prices that prevailed, up until recently. But all is not lost. Silver in the single digits should still prove to be an investment bargain. In addition, now that silver appears to be “in play”, the tradeoff for having to pay higher prices is that newcomers won’t have to wait as long as long as others have. We have entered an exciting price period in silver. As a precaution from entering the market before a sharp sell-off, new buyers may not wish to commit to a fully invested position. Hold some reserves to exploit any correction. I am referring to fully-paid-for, unleveraged positions. Also, get used to increasing volatility, which is here to stay and will intensify.

The near term fate of the silver price rests upon the resolution of the mammoth COMEX naked short position. Tell me what the commercial naked shorts will do with their position, and I will tell you what silver will do. If they try to cover their shorts in earnest, the price will rocket up. If they add to their short positions, they will contain the price rise and it remains possible for them to maneuver the price lower to induce technical fund and speculator selling. If they succeed in causing a sell-off and they cover large amounts of their short contracts, that will be a perfect time to buy more silver.

Of course, a shortage in the physical market can override the paper transactions on the COMEX at any time. There is no way to accurately predict when that may happen. It must happen at some point, due to the deficit, and that forces you to keep the COMEX paper games into perspective. It’s possible for the physical shortage to overwhelm the paper market at precisely the same time a maximum commercial naked short is in place, like now. If that occurs, it will cause a price explosion and damage to the shorts similar to the damage caused by the strongest hurricane on record hitting the most densely populated coastline at precisely the time of the highest tides recorded.

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