In Ted Butler's Archive

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 accurate.)

Yesterday, I had the rare treat of taking my son shopping. I’m not much of a shopper, but this was a way to spend some time with my son, who’s 23 years old, a full-time student, employee, and a great kid. He’s going on a trip and I offered to treat him to some needed clothing  – a jacket, some dress shirts and ties and a pair of shoes. When it came to the shoes, he made it easy on his dad. He wanted a pair of Timberlands to replace a pair he bought years before. All the stores were having sales, and the shoes he wanted were listed at a great price. Unfortunately, not one of five major stores in the mall had his size. A lot of other normal sizes were out of stock. We left, shoeless, so to speak.

I used the opportunity to explain to him how this spotty inventory was getting to be a problem. The previous day I had read how the stock of Circuit City was trashed because of weak sales due to a lack of inventory. My son asked me how this could be, why didn’t they just stock what was needed? I responded that, for bigger companies with extensive product lines, the level of inventories becomes critical to the bottom line. Too little inventory can be just as bad as too much. Everyone tries for a balanced level of inventory. I went on to explain that, with computerization, the business world adopted the Japanese method of just-in-time inventory and production.

Believe it or not, this revolution in supply-chain management is profoundly bullish for the silver investor. Because of new and sophisticated software, today’s factories are radically different from what they were a few years ago. Goods are produced and transported with breathtaking efficiency and precision. Key parts and components get delivered to assembly plants literally hours before inclusion into finished products. Capital tied up in inventory that’s not needed immediately is considered dead money. For more than twenty years manufacturers have concentrated on producing while carrying less inventory. This is the essence of the productivity miracle that has raised our standard of living. However, even the most beneficial of modern developments can suffer from the law of unintended consequences. For example, with just-in-time deliveries and inventories, a break in the supply chain can really mess up the production process. That’s because there are no alternative inventories to fall back on.

No one gains from a break in the process. Most of the time the bad news is minor, such as my son failing to buy the shoes he wanted. More serious disruptions impact profits and jobs. Rarely,  a disruption in the supply chain can present an unintended windfall to those alert enough to capitalize on it. Here’s where silver investors should play close attention.

As I explained to my son, it was really no big deal that his Timberlands weren’t in stock. However, mistakes or disruptions in inventory management could have a severe impact on a large company. I told him about the Ford Motor Company’s recent experience with palladium. Ford panicked at the prospect of shutting down its assembly lines due to a lack of palladium. Then they went overboard in bidding up the price of the metal. They built up a huge inventory. Then the price collapsed and they had to write off $1 billion.

I explained to my son that it wasn’t unusual for a manufacturer to panic. It’s one thing for him to have to return to the mall to buy shoes, but a different matter for a manufacturer to shut down an assembly line due to a missing component. A manufacturer in that predicament will do anything to prevent sending employees home and disrupting its revenue flow. Before I explained further, my son blurted out, “they would pay any price to get that missing item.”  Then he asked, “How could a big company like Ford be caught so off-guard, and be so unaware of the real palladium situation? Don’t they have people that study these things?” My answer was, “Yes, the same people who study silver.”
This should be reason enough for you to drop everything, and run out and buy real silver. If you don’t own silver, and don’t have cash, but have other assets that can be converted into some silver, do it now. Here is a rock-solid certainty, the industrial users of silver will panic at some point and scramble to buy real silver. There is no other possible outcome.

Just-in-time inventories mean as close to zero inventory as possible. It means, don’t tie up money in inventories, put it to more productive use. Let your suppliers hold and maintain your inventories.  I am not claiming that the push for minimal inventories is unique to silver. But, neither is silver exempt from this modern business phenomenon. What sets silver apart from any other inventory items, is the same thing that sets silver apart from any other investment, the critical difference. Do you remember what I recently wrote about that? “The quantity of common stock outstanding, the quantity of bonds and debt issues, the quantity of developed real estate and the quantity of gold or diamonds or works of art generally increases over the course of time….. Silver alone, of all the investment items in our world, has less total quantity in existence every single day.”

Because of the documented, structural deficit in silver, we can state, factually and without fear of contradiction, that there is less total above ground silver in existence every day. So, in addition to the low or nonexistent inventory of silver held at the individual manufacturers (common to all inventory items), silver is the only item racing towards zero in the world inventory. Simply put, the relentless decline in total world silver inventories, coupled with the individual voluntary reduction of the just-in-time manufacturers, absolutely guarantees a monumental buying panic by the users. This is a certainty. It must happen. Basic economics and human nature guarantee this coming inventory buying panic. Once the first inevitable supply-chain delays and disruptions become noticeable, and production line shutdowns loom, it will be every manufacturing man for himself. As my son observed in an instant, they will pay any price to keep their businesses running. I can assure you that my imagination is not fertile enough to create, in a million years, such a fantastic situation. I am merely describing, as a commodity analyst, what I see in front of us, plain as day. But I’m not done yet.

I don’t want to belabor this point too much, but I don’t think 1% of silver investors, or potential silver investors, are aware of this just-in-time inventory smack-up that lies ahead. I want to spell out just why this crunch is so dead solid certain. I want to make the case for not waiting to buy real silver, right now. It has to do with basic human behavior. The same human behavior that consistently recurs when a hurricane, or big snowstorm, or a heating oil or gasoline shortage becomes obvious. The fear of being caught without adequate supplies drives normal people to behave in a panic mode. Perhaps not everyone panics, but enough of them do, which cleans out store shelves and fuel tanks. I’m not making a value judgment on why folks behave this way, I’m just noting it’s something I have observed my whole life.

Normal supply lines are not configured for sudden surges in demand. There are thousands, upon tens of thousands, upon hundreds of thousands, upon millions of businesses around the world, that depend upon silver and silver-containing items and products which are vital to their operation. These businesses are run by people with the same human-behavior characteristics as everyone else. At the first sign of a real silver shortage, these businesses will panic and rush to build silver and silver-containing product inventory, just as folks do before a hurricane. Actually, these businesses will panic much worse than people acting individually.

Why do I say these businessmen will panic worse than individuals in their attempt to build silver and silver-related inventory? For the same reason the Ford Motor Company panicked on palladium, because it threatened the very continuation of its business. The silver inventory business panic is not about having an extra loaf of bread or gallon of water in the pantry, or waiting a few weeks until your size of shoes is available. It is about staying in, or going out, of business. It is corporate life or death. And there’s a truism that will become a lesson to these businesses in the coming silver inventory crunch, if you’re going to panic, panic early. That’s because the first few businesses that react to the growing signs of a physical silver shortage, will further tighten and exacerbate the shortage. This is the same reason the supermarket runs out of bread within hours of a hurricane warning. One business moving to build up an adequate silver inventory may deprive ten others from their normal shipments. Panic begets panic.

But, unlike a supermarket panic that will disappear when the hurricane passes, this silver inventory panic will not blow over in a few days. Once this silver inventory panic begins in earnest, as it must, it may last for years. That’s right, I said for years. That’s because it has been over 20 years since businesses began adjusting to the Japanese-inspired no inventory model. There’s no way that can be undone in days. As silver prices rocket higher, inventory will be coveted more and more, reinforcing inventory-building strategies in the face of world silver inventories at multi-century low levels. That’s right, we have the lowest total world inventories in hundreds of years, at precisely the same time we have the lowest individual inventory levels in millions of businesses, and all of this at the same time as a chronic structural deficit between real supply and demand. I couldn’t make this up if I was on LSD.

The culprit in this almost unbelievable setup, of a certain inventory buying panic, is leasing. Leasing has allowed material, at the margin, to flow and fill the gap between supply and demand, with no influence on the price per ounce. The market has been tricked into the coming buying panic. Leasing has allowed us to slip into a collective world silver coma that can only be shattered by the mother of all buying panics. There is nothing much more I can do, in terms of warning the authorities. It was this exact panic scenario that prompted me to warn the Department of Defense about the coming shortage. Now, I can only warn you. Get prepared. Get all the silver you can. Now. Don’t wait for the price to start its run. You will be competing against every silver-consuming business in the world. Take advantage of the current low prices. Shop early.

The remarkable thing is that I am talking about only one aspect of the silver demand equation. I haven’t even mentioned the historic record short position in silver, greater than any short position ever seen in the world. I haven’t mentioned the hundred of millions of ounces of COMEX futures and options held short, that must be covered someday, nor the OTC short position and European bank certificate shorts that run in the billions of ounces. Nor have I mentioned the billions of ounces promised to be returned as a result of leasing. This represents pure raw buying power, completely in addition to the silver business inventory panic that will unfold soon. And this is just the demand side of the equation.

The supply side of silver looks more constrained than ever. Since I last wrote about silver, as a byproduct, many months ago, burgeoning base metal inventories, particularly in copper and zinc, have made the situation worse for the base metals, and therefore, impacted silver. Remember, fully 70% of silver mine production comes as a byproduct of base metal and gold mining. Copper warehouse inventories on the COMEX and LME, from January 2001, have risen from around 400 thousand tons to 1200 thousand tons, with rarely a day going by when inventories don’t increase. Will copper miners ramp up production of copper, in order to get more silver production, when silver prices begin to rise? I’m not so sure. Even if silver mine production (byproduct or primary) does increase, there will be a time lag of years before big new silver production comes to market. Do you think the businesses trying to build inventories to protect their companies, in full panic-mode, will be comforted and calmed by talk of supply being available years from now? And anyone waiting for the U.S. government to bail out the panicking industrial silver buyers will be in for a long wait. That’s because the U.S. government doesn’t own any silver, for the first time in its history.

The choice for a silver investor appears clear. Get your silver before the inventory panic begins. The industrial silver users and businesses dependent upon silver are in for a rough time ahead. That’s reality. What’s also reality is that prudent investment discipline demands that one buy low and sell high. You have to do the first, in order to do the second. Beat the panic. Buy real silver now.

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