In Ted Butler's Archive


(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.)

The financial world is changing more quickly and radically than any of us has previously experienced. Unfortunately, losing money has become easy. At the same time, it’s more difficult to make a profit. For almost ten years I have championed the case for buying real silver. I have urged people to buy silver for the long term and to take the time to understand the facts behind my conclusions. Now that world financial conditions have become so dicey (including the 50% price drop in silver), what are the latest facts?

My greatest fear in writing about silver is that I will miss clear-cut evidence that silver is no longer a great investment. That’s why I’ve carefully examined my premises. I’ve gone over every aspect of the bullish argument I’ve made over the past years. There is no question that some facts have changed, but that doesn’t necessarily mean they have changed for the worse. I won’t beat around the bush. My examination leads me to the conclusion that silver is a better buy today than ever before. When I look at the facts straight on, they paint a picture of dramatic price gains ahead for silver.

The first thing to examine is the price decline itself. The 50% decline over a few months was the steepest decline in a quarter of a century. There is no way to minimize the severity of that decline. Did I anticipate the extent of this decline? I did not. I know there have been similar declines in other commodities, but silver’s decline is in a class by itself. Amazingly, there was no evidence of widespread selling of physical silver.

All public data sources, from ETF holdings, to government silver coin demand, to global wholesale and retail dealer premiums, indicate no net selling or glut of physical silver. All the selling was of the paper silver variety. It is no secret that leveraged speculators, including hedge funds, have been forced to de-leverage. That’s a nice way of saying there has been massive liquidation of margined paper silver positions. I doubt there has been a sale of any leveraged silver that wasn’t caused by a margin call due to falling prices. In other words, very little silver has been sold in the past few months because investors turned bearish on silver’s merits. What was sold had to be sold because of margin calls or because of charts and technical signals. That is why I have always publicly preached no margin, only cash on the barrel head.

The paper margin calls and technical selling in silver was intentionally planned and forced on us by those who held big short positions (JP Morgan Chase). There is no other plausible explanation. The big shorts needed to cause widespread selling from the leveraged longs so that the short sellers could buy back and cover their short positions. That the shorts succeeded in this induced sell-off is both good and bad news.

The bad news is that the shorts caused previously unimagined damage to innocent long holders of all types, including those with actual metal and those with mining shares. The masters of destruction, indeed. The good news is that the selling and short covering appears to be complete, as evidenced in the Commitment of Traders Report. This shows its best reading in many years for both silver and gold.

Silver is now so far below the cost of production that it will cause most primary silver miners to shut down production at some point. The shockingly low price of associated base metals, like zinc, lead and copper, are also below the marginal cost of production. They account for the bulk of silver mine output as a by-product. This is a circumstance not witnessed in recent history. Already a large number of world zinc mines have shut down and more are being mothballed every week. More than 200 million ounces of silver originate annually from zinc and lead mining. Another 200 million ounces of silver comes from copper mining. That’s 60% of world annual silver mining production. At current prices, the majority of world silver mine production will be shut down. The world cannot tolerate such a development. Clearly, the variable here is the price of silver. It must rise, and rise sharply, to maintain a reasonable level of silver mine production.

We are in the grip of a sudden severe world economic slowdown. This promises to result in a decrease, and perhaps a sharp decrease, in the amount of silver used in industrial applications. Does the fall in silver consumption mean the price of silver will be negatively impacted? In my opinion, it does not.

Even if industrial silver demand falls off, we already know that supply will fall sharply at current prices. If there is less industrial demand for silver, it is certain there will be decreased demand for industrial metals such as zinc, lead and copper. Very few people realize the extent to which silver mine production is “imprisoned” by base metal production. This silver production can only be released by zinc, lead and copper mining. As much as 60% of total silver mine output comes as a by-product of these three metals, plus another 30% from primary silver mines. A shocking 90% of all silver mine production is underwater profit wise at current metal prices. Throw in the final 10% of silver production that comes from gold mining, and it wouldn’t be misleading to say that 100% of all silver mining is currently unprofitable. I have never seen that in all the time I have studied silver.

It doesn’t matter if silver industrial demand falls off, as it will surely lead to significantly greater silver mine output losses. This vicious cycle could send silver skyrocketing. If nobody’s producing much silver, even the weakest demand would accelerate prices upward.

This is where silver’s dual role as an industrial and investment metal will come to be fully appreciated. Silver is virtually alone in its role as a vital industrial commodity and popular investment asset. A severe world economic slowdown will continue to drive increasing numbers of investors to assets that are not subject to failure or bankruptcy. Those assets that are no one else’s liability (gold and silver), will be desired all the more. Considering how little silver is available for investment, compared to gold, investment flows are likely to influence the price of silver more than gold.

The worse financial and economic conditions become, the better it should be for silver, given how much by-product output could be lost. Investment demand should more than compensate for any fall-off in industrial demand. This could create a real silver shortage more pronounced than the shortage already developing. And remember, it does not matter what overall economic conditions may be, a shortage of anything guarantees sharply higher prices.

Let me outline a scenario that looks increasingly probable. If silver does experience the shortage that I think is at hand, its price should move quickly to $20 or $30 or more, especially if the big COMEX paper short refrain from new short selling. But if base metal prices remain depressed, as is likely in a recession, there will still be a loss of by-product silver production, even though silver prices had moved sharply higher.

Lastly, the never-ending bailouts and stimuli by world governments, led by the U.S., are bound to have unintended consequences. Because there is currently a massive flight to quality underway by investors into government treasury bills and bonds, there is an ample current supply of funds, measuring in the billions and trillions, available for bailouts.

At some point, it seems reasonable that some investors currently rushing into government paper might begin to have doubts about holding all their money in government debt. For now, the immediate issue is to pump money into the system to save it from imploding. But at some point, a certain number of investors may seek safety beyond government guarantees. The only assets promising greater safety than government guarantees are tangibles, because they are liability-free. Given the rarity and scarcity of silver, even a relatively small movement of investment flows into silver can have a profound influence on price.

Throw in these additional factors. There’s still the likelihood of a major short squeeze. New used for silver are being introduced every day. The above-ground supply has never been smaller or held in such strong and diversified hands. More potential investors become aware of this bullish silver story every day.

No matter what future economic conditions may be, good or bad, it is hard to see how silver will not fare spectacularly well. At this juncture, it’s hard not to conclude that silver is a sure thing. For safety and peace of mind and for unusually high profit potential, silver looks better than ever.

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