In Ted Butler's Archive


What drew me to silver some thirty years ago (1985) was that its price appeared to be too low and not in conformity with the fact that more silver was being consumed than produced. This necessitated a steady drawdown in world silver inventories. In trying to reconcile this low price while demand was greater than production I stumbled on concentrated short selling on the COMEX. This discovery convinced me that silver must end up in a physical shortage. Excessive COMEX paper short selling couldn’t last indefinitely or it would invalidate the law of supply and demand.

If the price of any commodity were set too low, it would eventually crimp supply and encourage demand to such an extent that a physical shortage would develop and end the manipulation. I knew that the most potent force for driving prices higher was an actual commodity shortage. If there is not enough of a commodity to meet demand, then the price must go to whatever high level is necessary to satisfy demand.

The long term deficit in silver ended in 2006. But the damage to world silver inventories had already been done and to this day, world silver inventories are down more than 90% from where they were at the start of WW II. The price peak in 2011 was a result of a developing physical silver shortage. A deliberate price takedown nipped that shortage in the bud by disrupting investment demand.

When I speak of a coming silver shortage, I am referring to a shortage in the prime wholesale form of silver – industry standard 1,000 ounce bars. There is a current shortage in retail forms of silver, but a retail shortage only impacts the premiums on coins and small bars, not the price of 1,000 ounce bars. That’s not to say that there isn’t some connection between a retail silver shortage and a wholesale shortage. We are talking about the same substance, just in different forms. In the case of retail forms of silver, demand is totally made up of investment demand. Wholesale demand is made up of investment demand and industrial demand.

Of all the commodities, only silver has investment demand in addition to industrial demand. This doesn’t apply to gold, because so little gold is consumed industrially that virtually all demand is investment or jewelry demand. Whenever a shortage occurs in a commodity it’s invariably because of a supply disruption. Examples include a crude oil shortage as a result of a cutback in OPEC production, or a weather induced crop failure. Disruptions to the supply side of any commodity are more likely to occur than are disruptions on the demand side.

The highly unique dual demand feature in silver – vital industrial commodity and universal investment asset – gives silver something not present in any other commodity, the possibility of a demand surge capable of creating a physical shortage. This can be seen in the current shortage of many retail forms of silver. It’s not that the U.S. Mint has suddenly reduced its production of Silver Eagles. They have produced 200 million over the past five years. Yet there is a shortage of Silver Eagles. Clearly, the shortage in Silver Eagles is as a result of surging investment demand and not any disruptions on the supply side. Such a surge in investment buying in 1,000 ounce bars of silver is inevitable.

The dual demand for silver is met from mining, recycling and existing inventories. The silver available for investors comes after industrial and fabrication demands are met. This “left over” amount is no more than 100 million ounces annually, or in dollar terms at current prices, no more than $1.5 billion annually. New silver becomes available on a day to day basis as it is refined; whereas demand knows no daily limitation. Of the 1.3 billion ounces of silver in the form of 1,000 ounce bars, the percentage available for sale near current prices is quite small. The investment demand for silver can explode at any time (as has recently been seen in retail silver), while the supply side is much more constrained. It will only expand with time and at much higher prices.

If the coming silver shortage is as inevitable as I suggest, then why hasn’t it occurred yet? The answer is that COMEX futures trading has come to dominate the price of silver. It is depressed by a surplus of derivatives contracts. In essence, the artificial price emanating from the COMEX is short-circuiting the true functioning of the law of supply and demand.

How much longer can the COMEX delay the physical silver crunch and shortage to come? I don’t have the answer, I am confident that once a wholesale physical silver shortage kicks in, that shortage can’t be contained by derivatives trading and most likely will have to burn itself out at much higher prices. Silver will then probably overshoot. I claim it will be like an atom bomb, on a hydrogen bomb, on a neutron bomb. The profit potential is simply enormous. The trick, of course, is to be positioned before the physical shortage is reflected in the price.

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