Still Unresolved – Part II
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.)
When I first picked the title for this article, I had this nagging thought that I had used it before. Sure enough, I looked in the archives and there it was, dated September 2, 2003. I just think I had forgotten about it because I have written about 60 articles since then. Just to make sure I was recycling the title in the proper context, I reread a few of my articles, starting with that one.
It’s amazing how similar today’s situation is with the situation then. I’m referring, of course, to the market structure, as defined by the COTs. As we were at the time of the original article, we are still in what has been a high-risk zone, with extreme technical fund long positions and dealer short positions in silver (and gold). Also just as we were then, there is no way of knowing for sure how it will be resolved. Will the dealers get overrun (for the first time), or will the funds again fold and liquidate positions at lower prices?
If it does get resolved in the manner it has always been, then we should also be presented with another “mother” buy point. Of course, it may not play out that way, as the fundamentals in silver are so powerful and compelling that it’s hard to imagine these COMEX paper trading games continuing to manipulate prices. Whether we get that one last sell-off before we explode in price, or we just explode, remains to be seen. You must be prepared for either event. Real, fully paid-for silver is good, no matter what.
The big December COMEX options expiration has come and gone (today), with no big fireworks. It was somewhat unusual to see so many call options in gold and silver expire in the money, but my best bet at this point is that all it has done is confirm and accentuate the extreme COT position. The resolution of this extreme mismatch between the funds and the dealers will dictate short-term price action. While these positions are open (which they are), it is premature to declare which side, funds or dealers, as the eventual losers or winners. Picture it as a giant poker game in which the pot keeps growing, due to raising and re-raising, but all the cards haven’t been turned over yet. Let’s declare the winner when the last card is turned.
We know that the usual resolution would be if the tech funds start selling at lower prices in the relative near future. In that case, the dealers get to cover many of their short positions and this gets them “off the hook.” But what other resolutions could there be? Well, for instance, events in the cash market could become so tight that some dealers could break rank with the wolf pack and stop selling short or even begin to buy back short positions. Then prices would rise, either explosively if a dealer short-covering panic erupts, or more gradually if the rest of the wolf pack maintains discipline. In either event, the tech funds could eventually close out their long positions at current or higher prices, and would be declared the winners in gold and silver for the first time. My point is that regardless of the outcome, that outcome is not here yet.
Although I write much about the COTs and the short-term resolutions, I hope everyone recognizes that this is divorced completely from the long-term resolution of the silver situation. One is concerned with short-term gambling, the other with the long-term certainty of the law of supply and demand. The very last thing that a long-term silver investor should do when the COTs suggest potential short-term trouble is to even think of selling. While the temptation may arise to sidestep a temporary downdraft, it is not a temptation to succumb to, except for the most speculative. (By the way, there is nothing wrong with short-term speculation, just don’t let it disrupt long-term commitments). $7.50 silver is cheap on a long-term basis. It’s not the price that’s the potential short-term problem, just the big poker-pot sitting in front of the COMEX paperboys.
Lately, the markets seem to be dominated by talk and price action of the dollar against other currencies. It is hard to deny the apparent connection between movements in the currency markets and gold and silver. Yet, long-time readers know that I comment little on currency movements. I can accept the notion that if the dollar falls tremendously against other currencies, or in purchasing power, items bought with dollars will tend to “rise” in price. This is an argument that is widespread and logical. And I have previously admitted that it can be a bonus reason for buying silver. While this argument is important, one reason I don’t write about it much, is precisely because it is a widespread argument and I wouldn’t be bringing anything unique to the table by writing about it. I do try to confine my writings to those things I think would be most educational and thought-stimulating.
Secondly, I don’t write about the dollar and currencies because they are not unique to silver (or gold). Admittedly, currency adjustments can and do impact the value of all commodities, including the metals, precious and base alike, but these adjustments are macroeconomic in nature, and are not peculiar to the specific supply/demand of any commodity. If someone buys any commodity solely because of expected dollar weakness, for instance, he would be better served, in my opinion, to skip the commodity and confine the bet to the currency he thinks will appreciate the most against the dollar.
Most importantly, I don’t focus on the dollar because to do so would shift the focus from where I feel it should be – on silver’s very special supply/demand fundamentals. This is akin to my reluctance to write about silver in terms of charts and technical analysis (the COTs excepted). My reasoning is as follows; if one allows currency (or chart) considerations to be the main determinant for buying silver, then one must also abide by currency or chart signals to sell silver. That is something I’m not prepared to do. As long as the real supply/demand fundamentals of silver suggest it is severely undervalued, currency and chart signals matter little in the investment decision process.
Finally, great investor interest has been generated in the new gold ETF (Exchange Traded Fund) introduced for trading on the New York Stock Exchange. For those not familiar with the issue, this is a securitization for gold bullion, or in other words, the creation of an investment vehicle in which gold can be bought and sold in common stock form. I am going to confine my comments as to what it may mean for silver. Because of this new gold ETF, there has been speculation as to whether an ETF will be created for silver.
On one hand, because silver is cheap and you get so much physical mass for your money, silver would be ideal for an ETF – professional storage combined with the ease of purchase in common stock form. No worries about where to keep it and in a form open to every type of investment account, retirement and custodial included. In fact, an ETF actually makes more sense for silver than gold, inasmuch as storage is much more of a problem in silver. After all, $100,000 worth of gold weighs less than 20 lbs, while $100,000 worth of silver weighs about 1000 lbs.
But I doubt we will see an ETF for silver soon, or ever, mainly because it would be too disruptive to the price. A legitimate silver ETF, in which real silver was purchased for the fund, would launch the price skyward. In the first three days of the gold ETF on the NYSE, more than 28 million shares (translating into 2.8 million ounces) were outstanding, and the fund reported it held over $1.25 billion worth of gold. Now, there’s no way that a silver fund could match the gold ETF’s first days’ numbers.
Even if you allowed for a year’s worth of trading of a silver ETF, and not just the first three days as in the case of the gold ETF, there doesn’t appear to be enough real silver in the world to enable anyone to buy $1.25 billion dollars worth, or 168 million ounces. Not unless the price were shockingly higher. Seven years ago, Warren Buffett bought 130 million ounces of silver, causing the price to almost double in six months. Due to the structural deficit, we have about a billion ounces less in world silver inventories than then. Ask yourself, if Buffett’s purchase caused the price to double seven years ago, what would a larger purchase do to the price today?
This highlights one great difference between gold and silver, namely, that silver is much more price-sensitive to investment flows. More than a billion dollars flowed into gold in the first few days in the gold ETF on a remarkably orderly price basis. If that were attempted in silver, the impact on price would be incalculable, as the entire visible silver world inventory is currently valued at less than a billion dollars. Considering the real facts about silver, common sense would seem to dictate that it’s only a matter of time before serious investment money discovers it. Make sure you get there first.