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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 reported silver inventories in COMEX-licensed depositories have increased noticeably in the past few weeks, up some 12 million ounces to a total of over 118 million ounces. This is the largest amount of silver in these warehouses since 1998. As such, it has raised questions in people’s minds about the true supply/demand situation. Let’s see if we can analyze COMEX silver inventories objectively. As you may recall, I wrote two articles about these inventories in June, “The COMEX Silver Shuffle” and “COMEX Silver Warehouse Stocks”, so I’ll try to be brief. Forgive me if there is some repetition.

Before discussing what the inventory increase tells us, we must recognize what it doesn’t tell us. The first thing to remember is that any short term increase or decrease in COMEX inventories tells us very little in absence of other information. Sure, it feels like short term inventory increases are bearish, in that such increases suggest more silver available, just like decreases suggest less availability. But, in lack of substantiating additional information, such suggestions are incorrect. Long term increases or decreases might suggest something more meaningful, but short term changes suggest inventory rearrangement – from the unknown category to the known, or vice-versa. Even with the recent increases in COMEX inventories, we’re still not above my long quoted figure for world known silver bullion inventories of 150 million ounces, as I allowed for a such an increase in COMEX stocks. In fact, I expect COMEX stocks to continue to grow, as I’ll explain shortly.

There has been no sudden and dramatic changes in world mine or recycling production, or sudden changes in world consumption patterns to indicate that silver supply/demand fundamentals had been radically altered and account for increases in reported COMEX inventories. If anything, world economic activity, led by China, appears to be on the upswing, always good for industrial silver demand. By nature, world commodity fundamentals are slow and plodding, like stopping or turning a supertanker. One or two percent changes in annual supply or demand, are generally big news. I can assure you that the twelve million ounces did not come into the COMEX because the world suddenly produced 12 million more ounces than it needed in the past few weeks. The silver came in for a reason, not because there was a sudden surplus. In fact the real reason the silver came in is both bullish and good news for everyone, silver bulls and bears alike.

I see two possibilities for the recent increase in COMEX silver inventories, and these reasons are related. Quite simply, the silver came in because it had to come in. In other words, the silver was brought in by the shorts in order to make delivery against the upcoming December delivery month, the biggest of the year. The shorts had to bring it in because they knew a good number of longs were standing for delivery. This is the most likely reason the silver came in – there was a known demand for physical silver. Does that sound bearish to you?

What it tells us is that the 106 million ounces that were in the COMEX-approved warehouses prior to the 12 million inflow, is not all available for delivery. Just because we can see 100+ million ounces sitting in these visible warehouses does not mean this silver is available. I know plenty of people who store their silver at the COMEX warehouses and it is no more available for delivery at 5 dollars than silver held in people’s homes and safe deposit boxes is available at five dollars. The recent inflows of inventory into the COMEX proves that the vast majority of silver already there was not available for sale and delivery, because why go to the trouble to bring in new stuff if the old stuff can be delivered?

But there is another reason why I think there has been a recent inflow of silver into the COMEX, related to the first reason. I think the silver is being brought in to make the COMEX default-proof, in response to my recent efforts involving New York Attorney General Eliot Spitzer. The gist of my solution (please see “The Solution”) is to make sure the shorts have real silver in their accounts by first delivery day. It is clear that could be exactly what is happening. (Interestingly, the silver being brought in appears to be by one entity, most likely the big silver short, because it has been to one warehouse and one category – Brinks and registered.)

So we are looking at the real possibility that the NYMEX/COMEX is doing just as I suggested to avoid default. This is not surprising as the solution itself was on the money. That’s why you haven’t heard any objections from the CFTC and the COMEX, as there was nothing to object to. But, let’s be realistic – there was also no way that either the CFTC or COMEX would ever come out and publicly acknowledge that I gave them a constructive solution to a very serious problem, because that would open a possible Pandora’s Box of questions about my other convictions and analysis about the silver market. That’s OK, because the important thing is that the integrity of the market is being strengthened. Let me repeat – the silver coming into the market is great. It reflects new demand for real silver and weakens the chance of default. I hope it keeps coming in. It would not surprise me, at the end of the day, to see the COMEX contain well over 90% and close to 100% of all the world’s known silver bullion inventory.

One last thing in closing. I’ve heard from people who suggested that my solution to delivery default in COMEX silver (insist that the shorts have the goods and longs have full cash by first notice day) should be applied to other commodity markets as well. I agree, but have been hesitant to write about it, as I prefer to stick to silver. But recent activity in the Chicago Mercantile Exchange (CME) live cattle market prompts me to speak out. There was, in my opinion, much greater than necessary volatility in the recently expired October live cattle contract, that could have been avoided had my solution been in effect on the CME. The unnecessary volatility commenced around first delivery day and continued through the last trading day. There were more days of limit moves, both up and down, including expanded limits, than there were non-limit moves. Such extreme volatility can be blamed squarely on the enormous open interest in the October contract going into delivery, over 12,000 contracts on first delivery day. Since there were only 20 contracts actually delivered at the end of trading for the month, it is safe to say that both the longs and shorts were bluffing, and that neither ever intended to make or take delivery – just speculate until the very last moment. I’m certainly not against speculation, but it should not be the driving force in setting prices and enhancing the risk of default.

I’m not saying that cattle prices are at historic highs because of all the bluffing during trading in the October contract’s delivery period. I’m saying that the dramatic volatility witnessed during the delivery month could have been avoided had that bluffing been curtailed, by insisting that both longs and shorts were capable of delivery by first delivery day. No legitimate market or economic good was accomplished by permitting unbridled bluffing down to the wire. It’s a miracle that the result wasn’t default. This is just what I hope we avoid in COMEX silver.

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