In Ted Butler's Archive

October 29, 2002

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Two Kinds of Silver

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.)

About a month ago, in response to question raised by a reader, I wrote an article titled, “Make The Switch Now” In that article, I attempted to describe how there are maybe billions of ounces of silver represented in bank certificate form that have no real metal backing, and how bad things may happen to the owners and issuers of those unbacked silver certificates when the price of silver explodes. I mentioned that banks all over the world, but particularly European banks, and especially large Swiss banks, had issued many of these silver certificates. My conclusion was that you should, if you owned silver in any questionable paper form, switch to an unquestioned form.

Last week, I received a communication from an employee of a very large and well-known Swiss bank which confirmed my basic premise. Out of respect and concern for his privacy, I don’t want to reveal his identity, and I will tell you what he said in my words, but it would be easy to verify his basic story. What he told me is that there are two different types of silver you can buy from any Swiss bank, each priced differently. If you want the cheapest form of silver, you would buy silver in a metal account. He explained that there were no charges (fees or storage) in a metal account, just cash payment for the agreed upon price at time of purchase. There was also no real metal backing whatsoever, just a private agreement between the bank and the client. The other form of silver certificate would be a deposit account, where by Swiss banking law, the metal had to be physically stored by the bank, on an ounce for ounce basis. Silver owned in a deposit account incurred a fee of 20% ( plus, I assume, storage fees, although he didn’t spell that out. I also think a good portion of the fee is due to the VAT, although this was not spelled out). He indicated that the banks would, obviously, prefer that clients deal in the all-paper form of silver, and would steer clients to that form, the metal account. While it wasn’t indicated in his message, another advantage to the all-paper metal account, was to ability to borrow on margin (for an interest charge, to be sure) and increase the leverage of the account. I can see why these all-paper accounts, ironically called metal accounts, would be so attractive to silver investors. That’s too bad, as I think that apparent attractiveness could prove very costly in the long run.

I know that I have raised this issue in the past, but it goes right to the heart of why silver is priced where it has been, namely, at exceedingly depressed, and almost incomprehensible price levels. And where silver will be priced at in the future. It’s something that all silver investors must be aware of – there are two kinds of silver. Paper and real. Whether we are talking about COMEX silver paper, Swiss bank certificate paper, OTC silver paper, leasing silver paper, or “pool account” silver paper, we can see a couple of clear differences between paper and the “real McCoy”. For one, there is a heck of a lot more paper silver in existence than real silver. Many, many times more paper silver exists than real silver. Maybe five times as much, maybe ten times, or even more. This should be clear to anyone who cares to look. Because this paper mismatch in silver has existed for such a long time, and because I have written about it so much, I think people have been lulled into a sense of complacency about what this really means. Because people have been buying paper silver, and not the real thing, this goes a long way to explaining why silver hasn’t moved up in price. It’s a lot easier for someone to sell paper silver, created out of thin air, than to sell real silver, which must first be possessed. People buying silver in paper form make it easier for the shorts to manipulate the price.

Let me try and make this as clear as I can. To have a larger quantity of paper obligations of any physical item, than the quantity of that physical item in existence, is an aberration and financial deformity almost beyond description. I say “almost”, only because this very situation does exist in silver. It does not, and cannot exist in any other physical item. Not in gold, not in copper, not in oil, not in diamonds, not in real estate. Not in anything that exists physically. I can show you that just in COMEX silver futures and call options alone, with a combined open interest of over 750 million ounces, as of 10-29-02, that one segment of silver paper is greater than all the known silver inventory in existence. That’s leaving out all the other silver paper obligations. This is why I complain to the CFTC and the COMEX – having more paper in existence than the real item itself is a financial abomination and perversion beyond description. It’s like having! more than one deed to a house. How could that be anything but fraud?

I’ve tried to describe how this unique and preposterous situation has developed in silver, and only in silver, namely, that you get so much physical mass for your money, that storage becomes a problem. That’s why the COMEX and the Swiss and European banks, and pool operators and “depositories” stepped into the void. People need to store silver if they buy large quantities. Any reasonable solution to that basic need will be deployed. Futures contracts, bank and storage certificates sound reasonable. Ergo, people use them. The problem is that too many people have used them. Because silver is “owned” by so many people, we have created a monster – more silver is owned on paper than exists. I don’t think this started out as the absurd collective fraud that it has evolved into, but so what? It doesn’t matter that it may have developed innocently enough, over many years. What matters is that it is a massive and absurd collective fraud. What matters is that it makes the ownership of real silver much more valuable and more of a sure thing.

The other difference between this flood of paper silver and the paucity of the real thing is pricing. In most, but certainly not all, cases, real silver costs more than the paper variety. The case of the Swiss silver certificates is a clear example of this price difference. So is the premium one has to pay for certain forms of physical silver. But even more remarkable is the lack of a price difference between other forms of paper/real silver – COMEX paper Vs real, for instance. Or those bank certificates (not Swiss certainly) where one can switch from pure paper to real silver for reasonable storage and/or conversion fees. It was to investors who owned these forms of paper silver that I aimed my original article. If you are lucky enough to own silver paper that can be switched, for reasonable costs, to real silver, please do not hesitate to do so.

Let me give you another clear reason to make the switch immediately, if you can. Since we know there is more silver paper in the world than there is real silver, it is only a matter of time before all silver paper reflects this not widely known current fact. Whether it’s because of changes in exchange rules (as has happened before) restricting those holding paper from taking delivery, or because the issuers of silver paper certificates demand much more than 20% to effect the switch to real metal, or whatever the specifics may be, more paper than physical guarantees a problem for paper owners at some point. This is not rocket science. This is common sense. If you wait to make the switch until the problem is widely known, the terms you will get will be much worse than before the problem is well known. And if you haven’t bought real silver yet, in spite of the fact that only silver, of all items in the physical realm, has more paper obligations than real metal, you’re missing a bet that is dead solid certain. Please make sure you own the right kind of silver.

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