In Ted Butler's Archive

Funny Business

By Theodore Butler

In my last piece, an interview with Jim Cook just prior to September 11, I discussed three main themes – the Commitment of Traders (COT) position on COMEX silver, the current and prospective impact of supply and demand on silver and the deficit, and silver as an investment relative to the other asset classes. I’d like to look at those three themes, in reverse order.

First, how has silver fared vis a vis other asset classes, since the tragedy, and how does September 11 affect silver vs. other investment classes going forward? My premise was that silver was better than any other class of assets. As I write this, silver has retreated from its recent rally, but a month after the tragedy, it is still higher than just about everything else. I bring this up, not to trumpet short term moves as validating my premise. It’s that sometimes not losing is the best you can hope for.

One reason I say silver is better than any other asset class is because, in dollar terms, the silver market is tiny compared to other markets. Stocks, bonds, and real estate have already experienced large investor inflows over a long period of time. Because the remaining world inventories of silver are draining towards empty, there isn’t a lot of silver left. Because the current price of silver is so depressed, the “market capitalization” or total worth of all available silver, is puny compared to the other classes of assets. I make a big deal that there’s only 125 million ounces, or less, of identifiable silver bullion inventory in the world. While true, I think there is more silver out there than that, maybe 8 times more, or one billion ounces (counting coins and private bullion). That means that all the realistic silver inventory in the world is worth $5 billion. That doesn’t mean it’s available at today’s prices, it’s just what it’s currently worth. Now, $5 billion sounds like a lot of money, but is it, compared to other asset classes? In contrast, the world stock markets are valued, or have a market capitalization measured in the tens of trillion of dollars. It’s the same with bonds, real estate, bank and money market accounts. Tens of trillions compared to $5 billion (a trillion is one thousand billion, ten trillion is 10,000 billion.)

Even gold, using a conservative world bullion inventory of 3 billion ounces, has a market cap close to a trillion dollars. Silver’s market cap is tiny next to every other asset class. My point is that small is better, when it comes to potential upside moves, or percentage gains. It is a lot easier for a $5 billion market to increase to $10, or $20, or $50 billion, than it is for a ten trillion dollar market to double or triple, or jump 10 times in value. You just can’t bump a ten trillion dollar market to a 100 trillion dollars. But ten times in silver, a $5 billion market is much easier. In fact, it already happened, 20 years ago. Bottom line – if you’re looking for a home run, you need the right swing and the right bat. Other asset classes, because they are too big, can’t give a tenfold increase. Silver can. Sure, certain stocks are bound to soar in the years ahead, but not all stocks. You don’t have the problem of stock selection with silver, just as long as you buy real silver, not paper silver. If you are looking to hit a home run, then silver is a fat pitch thrown down the middle, screaming low risk and high reward. You should swing at this pitch.

My second theme in the last interview was the price of silver in a recession. Silver stacks up best in an economic slowdown. This is due to silver’s unique production, in which 75% of all newly mined silver is as a result of copper, zinc, lead, nickel, and gold production. Yes, for the umpteenth time, silver industrial demand suffers in a recession. It has to. It is used in thousands of industrial applications. But my point is simple, we are already in a structural deficit in silver. We consume more than we produce. Will the drop in silver demand eliminate the deficit? That’s the key question. I, and others (such as the CPM Group and the Silver Institute) say no. That’s because, even though demand may be falling, supply is falling just as fast, if not faster. Already we have seen notable silver mine closings, such as the flagship Sunshine Mine and Hecla’s Lucky Friday. This was due to the low price. But the big fall off in silver mine supply is going to come from base metal mine shutdowns, which provide the lion’s share of silver mine production.

How can I be so certain that copper, zinc, nickel and other base metals will experience mine shut downs ahead, thereby reducing silver mine production? It’s really simple, look at the growing stockpiles of base metals. Look at the expanding inventories. That tells the whole story. In a surplus, more metal is produced than is consumed. Inventories grow. Current industrial demand for all commodities is less than projected due to soft economic conditions. If you look at the rise in reported base metals inventories since Jan 1, 2001, here’s what you will see. At the London Metals Exchange (LME), the world’s largest base metals exchange, through Oct. 10, 2001, in nine and one half months, copper inventories have doubled, zinc inventories have also doubled, and nickel inventories have climbed over 70%. On the Commodity Exchange, Inc. (COMEX) the world’s second largest copper exchange, copper inventories have tripled, to the highest level in years. And remember, these are officially reported levels. There’s more inventory growth that’s not reported, as not all base metal surplus is automatically deposited in exchange warehouses. Clearly, copper, zinc and nickel are in surplus production. That means inventories will keep growing, putting further pressure on base metal prices. The only thing that can break the pattern of weak pricing and growing inventories is mine production cutbacks. There is no way mine production cuts can be avoided. It’s just a matter of time before we get base metal production cuts, to prevent inventory growth. When we get this reduction in inventories silver production will be automatically cut.

When silver production gets cut the silver deficit will balloon. Then, the only way the market can cope with a ballooning silver deficit is to increase production or decrease demand. There is only one way to do that in this world – sharply higher silver prices. This is just one more powerful reason for you to buy silver.

But what about silver inventories? What have they done while base metals’ inventories have doubled or tripled? Well, all known silver inventories have remained basically flat (COMEX up a bit, 10 million ounces, the US Government down about that amount. TOCOM, CBOT, LME and LBMA unchanged.) That, at least confirms that silver is not in a surplus situation, like the base metals. And the only reason the silver warehouse stocks haven’t shrunk, to reflect the documented deficit, is because of leasing. I’m not going into leasing now, but silver leasing has brought enough metal to market to prevent reported warehouse inventory declines. In reality, we know that leasing reduces inventory, just not reported inventory. In any event, my point is this, if silver inventories haven’t grown while base metals’ production has been excessive, what will happen to silver inventories (reported and unreported) when we curtail this excessive base metals production? Available silver will drop and the price should dramatically rise.

In the last interview, I talked about the Commitment of Traders (COT) in silver, and how it was configured for a certain rally soon, because the technical funds were massively short, and the dealers weren’t massively short. We got the rally, the biggest in over a year. I also said, to watch the rally to see if the dealers let the funds off the hook, by selling into the funds’ short covering, aggressively. Unfortunately, the dealers sold aggressively, and the rally dissipated. But that development is not just a temporary disappointment. It is much more to me. Let me be clear here, the Commitment of Traders report is not the end-all and be-all for the silver market. It has nothing to do with the deficit, the real reason to own silver. But, the interplay between the dealers and technical funds are why silver prices move in the short term. You’ve heard me say that I think that it violates the most basic of commodity laws, namely, that speculation should not determine price, real world fundamentals should determine price. Anything that interferes with the real fundamentals and free markets is price manipulation.

I have to tell you, the most recent COT, released Oct. 5, 2001, actually made me quite angry. I try to avoid that emotion, but I couldn’t help myself. That’s because this specific report proved so clearly and blatantly just how manipulated the price of silver is, that I was moved to try and do, once again, something about that clear cut manipulation.

I’d like to tell you what made me so angry, and what that means to you. What the COT showed was that a small group of dealers (they’re called commercials in the report) sold naked short over 175 million ounces of paper silver contracts net, in a three week period. This period was from when trading was resumed on the COMEX after the World Trade Center tragedy, until Oct. 2, 2001. The key here is naked. Naked means no backing or no covering, as an uncovered body would be naked. In other words, they weren’t hedging silver they owned. I know these dealer short sales were naked for two reasons. One, even with the rally, silver’s price was too low for a mining company to hedge. The miners are shutting down because of the low price, they’re not thinking of locking in these low prices. Two, 30% of the entire COMEX silver inventory of 103 million ounces was buried in the Scotia Mocatta warehouse at World Trade Center 4, a building in the WTC complex destroyed when the Twin Towers collapsed. In fact, since COMEX has over 90% of total world known silver inventories, the 30 million ounces buried in the Scotia Mocatta warehouse represents a full quarter, 25%, of total world known silver inventories. Think about that for a second. A significant percentage of world silver is taken off the market, suddenly and for a time period unknown, and insider COMEX commercials rush to sell 175 million ounces of silver that they don’t own. Does that smell right to you?

To me, it’s clear manipulation, because there is no good answer as to why the dealers would sell short so heavily in such circumstances, other than the obvious – to control the price. To keep the price from reflecting market realities; to keep the price from exploding.

Here’s a few paragraphs from a letter of complaint I wrote to the New York Mercantile Exchange: “There is no way that a reasonable person would not conclude that the commercials’ silver short position is both manipulative to the silver price and an extreme danger to the very existence of your exchange.” Then I added, “The additional 175 million ounces sold short in just three weeks is more than any country can produce in two years or much longer. It is more than all known silver stockpiles in the entire world. It is not possible for the short selling of 175 million ounces of silver in a three week period not to manipulate the price.” Then I went on to say, “It is obvious that the large commercials are masquerading as hedgers – they are speculators, pure and simple. By pretending to be hedgers, these large commercials seek protection from basic commodity law which prescribes that speculators not influence prices unduly. To be clear, the four or less traders in the commercial category are manipulators, or represent manipulators. There is absolutely no economic purpose to their naked short position, save to depress the price of silver. You must put an end to this manipulation.” Here’s another important paragraph. “The sheer mismatch between the extreme and concentrated commercial naked short position, jumping 350% in three weeks, and the suddenly-reduced available physical silver inventory, is most alarming. Inventory is effectively sharply reduced, and the insiders short position explodes 350%. A reasonable person would contemplate default. This is your notice, that if we do have a default in COMEX silver or any market emergencies related to restricting the rights of bona fide long contract holders, it will be because of the concentrated commercial COMEX-insider shorts.” I explained to the exchange that their rules expressly forbid speculators manipulating the price of a commodity. I’m sure you know this and it’s my hope that they blow the whistle on what’s going on.

While my anger prompted me to do what I knew I had to do, what does this mean to you? It means that the silver shortage has become extreme and the price should move higher, but the only thing that prevents the price from rising, is a large manipulative paper sale by some of the world’s largest financial firms. Ask yourself this – if the 175 million ounces wasn’t sold short by the dealers, what would the price of silver be now? Keep in mind, 175 million ounces of silver is more than the two largest producing countries, Mexico and Peru, produce in an entire year. It is much, much more than all the known silver in the world. Let me assure you, that has never happened in any other commodity, just COMEX silver. Other commodity contracts outstanding amount to a small percentage of the world supply. Clearly, the naked short sale by the dealers kept the silver price from reaching its free market level. Their actions contravene the free market. That is the essence of pure price manipulation. So, what does this mean to you?

Bottom line, it means the only thing holding back silver is the easy to see price manipulation by parties whose names you would immediately recognize. The silver situation is so extreme that the manipulators’ actions and very identities can be plainly observed and ascertained. That should tell you the jig is just about up. When people use such heavy-handed tactics that are so easy to spot, a large number of people see this blatant manipulation and they begin to counter it. You can’t have such a non-free market activity without repercussions. I believe these tactics will explode in the manipulator’s face. If you haven’t bought physical silver yet, or if you haven’t converted your paper contracts into real silver, you may be denied that opportunity shortly. The paper contracts may not be as easily converted into real silver because of the great mismatch between real silver and paper silver, or you may be able to get it but at a much higher price. Remember, all these manipulative games on the COMEX can’t affect you if you own real silver. In fact, these games should prove to you that real silver is the only way to go. The manipulative short sellers are handing you a gift , the chance to buy real silver at dirt-cheap prices. Don’t hesitate to accept this gift and buy silver now at these low prices!

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