(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.)

I would like to comment, in-depth, on an e-mail sent recently to Jim Cook, President of Investment Rarities.

Subject: Mr. Butler's end of structural deficit

Mr. Cook,

At the bottom of the first page of your Mid-February 2007 issue, Mr. Butler clearly states that in his opinion the structural deficit has ended. This is an extremely significant happening! From what I have been reading from Mr. Butler before, an unexpected event to me. Over the past few years it looked like the overall consumption rate and the production rates were fairly constant and not easily changeable. I believe your entire readership should receive a detailed explanation by Mr. Butler as to how the structural deficit has ended. A listing of estimated annual productions and consumptions for the last few years would be very enlightening. An explanation of how the deficit was reduced would be helpful. What brought an end to the drawdown; and from a timeline standpoint how did it progress? The importance of this happening demands a thoughtful and detailed discussion.

Sincerely,
Richard B.

Richard raises a valid point, namely, that a more detailed explanation should be given by me for what is a very significant event, the ending of the structural silver deficit that has existed for more than 60 years. After all, I have stated on numerous occasions that a commodity deficit (more consumption than current production) is the most bullish circumstance possible and guarantees an eventual price rise to end the deficit. I can see where it would be easy to assume that I am now saying that the most bullish circumstance possible in silver, the structural deficit, has been terminated and, along with it, the most bullish prop to prices. That assumption, however, would be wrong, as I am saying something else completely.

Commodity deficits are always temporary affairs. Surpluses (in which production exceeds consumption, creating growing inventories) can last for extended periods of time. But deficits (where consumption exceeds production, draining previously-produced inventories) can only exist until inventories are drawn down completely. Once inventories, which are finite in nature, are exhausted, the deficit must end, forcing the price alone to balance consumption and production. At this point, prices can surge dramatically higher. That’s the essence of the law of supply and demand. There is no limit as to how high inventories can be built up in a surplus, but there is a limit as to how low inventories can be drawn down in a deficit. It is impossible to go below zero inventories.

In simple terms, I am of the opinion that the structural silver deficit of the past 60 years is over, because that which enabled the deficit to last so long, the accumulated inventory of thousands of years, has been effectively exhausted. In other words, I am not saying the world is suddenly producing silver in surplus amounts, I am saying we have just about run out of available inventories to feed the long-term deficit.

There are only two variations for how a commodity deficit can end. One, prices rise high enough before inventories are effectively exhausted. Demand is discouraged by the high price, and production is encouraged in sufficient quantity so that inventories can begin to be restored again. Prices peak near the bottom of inventory liquidations, and prices bottom at inventory peaks. This is the normal cycle of the law of supply and demand that we all should understand.

Sometimes, a commodity inventory can be exhausted before the law of supply and demand and price are allowed to take effect. These occurrences are usually temporary, and local in nature. As an example, we have, and probably will again, experience this in South Florida in the event of a hurricane. Everyone rushes out to buy gas and ice and batteries and foodstuffs. Most supermarkets and gas stations (due to price-gouging laws and good will) don’t ration their inventories by price, charging much more in response to the surge in demand. They simply sell at their regular prices until they run out of supplies. Then everyone must wait for the inventories to be replenished. This is clearly a case of the law of supply and demand being subverted and altered temporarily by a very visible extraordinary event – an act of nature.

While these acts of nature occur from time to time in geographically limited areas, it is very rare for a commodity to exhaust inventories on a worldwide basis before a price peak. That’s because many tens of thousands of individuals (producers, users, analysts and investors) are involved in monitoring all major world commodities. It’s hard to imagine world inventories of any major commodity being exhausted before rising to a price peak. While it may be very rare, that is precisely what I am suggesting is the case in silver.

Before I give you my rationale for silver, let me first cite an example of a world commodity exhausting its inventory long before a price peak – the metal nickel. (Please see my article "First Nickel, Then Silver?" http://www.investmentrarities.com/08-21-06.html). Last August, nickel inventories on the London Metal Exchange (LME) had fallen roughly 90% in just 8 months, with the price climbing by 250% in that time. More than six months later, inventories remain the same (effectively near zero), while prices have climbed a further 25%. Someone from another planet would look at this and conclude that the law of supply and demand didn’t exist. After all, how could record nickel prices not ration demand and encourage production before inventories were exhausted? How could six full months go by without any build in inventories? How could so many thousands of producers and users and analysts and investors be caught off-guard by this event?

The answer is that the law of supply and demand and price only applies to free markets, not controlled or manipulated markets. Clearly, nickel was not in a free market. It is impossible to run out of world inventories before, or coincident with, a price peak in a free market. There can only be a price peak long after an inventory bottom in a manipulated market, because free markets anticipate and discount (except in sudden and shocking events, which did not exist in nickel.) Besides, when the LME defaulted on its nickel contract and absolved the concentrated naked short sellers of the obligation to deliver that which they had sold short, that act certified to the whole world that nickel was a manipulated market. The fact that the price of nickel has climbed after inventories were long-exhausted just proves how manipulated the nickel market was. The default was just the proof.

What about silver? There are some remarkable similarities between silver and nickel, as well as some notable differences. Both are important industrial metals, vital to the needs of a growing world economy. Both have witnessed world inventories decline by 90%, nickel over the past year, silver over the past 60 years. Both have been clearly subject to manipulation, nickel on the LME, silver on the COMEX and CBOT.

The differences are more striking. Nickel’s manipulation should be obvious in hindsight, with price peaks after inventory lows and the LME default. Further, it is possible that nickel is now in a free market state, although the low level of transparency on the LME makes that impossible to determine. Silver’s manipulation, while real as rain, is not yet obvious to all, and any possible default lies in the future. Due to a verifiable and current concentrated short position on the COMEX, it is not possible that silver is in a free market. Silver will be a true free market when the concentrated short position no longer exists.

But the major difference between nickel and silver is that nickel was never a true investment asset. It is a very valuable and vital industrial metal, but not an investment asset. Silver, in addition to being a vital industrial metal, is very much an investment asset, hopefully held by every reader.

It is this dual role of silver that sets it apart from any other asset. No other industrial commodity can be owned and held in one’s personal possession by large numbers of the world’s population. (Not even platinum and palladium). Gold can certainly be held, but gold is not largely used industrially, given its high price. It’s funny to hear many speak somewhat disparagingly of silver’s dual role as an industrial and investment asset, implying silver can’t quite make up its mind which it is. That’s silly. It is precisely this dual role that makes silver so special. No other industrial commodity can possibly be subjected to worldwide grassroots demand for actual ownership. And this is central to the end of the structural silver deficit.

Sixty years ago, there were roughly 10 billion ounces in world silver inventories, with the US Government holding about half of that total. Today, most analysts quote a world inventory measured in the hundreds of millions of ounces. I try to be conservative and use a higher number of one billion ounces of silver bullion equivalent. Whatever the number, we are down 90%, or 9 billion ounces, from what we formerly had, thanks to the structural silver deficit.

You don’t have to be a rocket scientist to conclude that we can’t take another 9 billion ounces from inventory in order to balance the silver deficit, since we have no more, and quite possibly much less, than one billion ounces remaining. This is the reason I say the silver structural deficit is largely a thing of the past. But this raises two points.

What about the hundreds of millions, or one billion, ounces that remain? Won’t they be consumed, like the 9 billion ounces of inventory was consumed in the past 60 years? Maybe, but not at artificially depressed prices. This is a key point in my thinking. The 9 billion ounces of inventory previously consumed were basically dumped on the market, principally by the US and other governments. Those hoards of silver are almost all gone. Therefore, no more dumping. The remaining silver inventory is almost entirely privately owned. This means that silver will only come to the market when economically enticed. In other words, silver’s availability will come at much higher prices, rather than dumped uneconomically by bureaucrats.

I am not saying silver deficits are forever a thing of the past. I am saying that the silver structural deficit is a thing of the past. This may sound like a word game. Since the inventory that enabled the silver structural deficit is gone, the silver structural deficit is gone. That’s different from a regular deficit in silver. Like any market, if there is more consumption than current production, there is a deficit. This can (and probably will) happen to silver in the future. When silver consumption exceeds current silver production, there will be no big release of government owned silver at uneconomic prices. The only silver inventory available will be silver that is economically sensitive, that is, silver available at only sharply higher prices.

One of the big misconceptions about silver is that inventories must go to zero before prices explode. This requirement is not placed on any other industrial commodity, like oil. When is the last time you heard anyone say that oil inventories must run out completely before prices can go higher? The zero inventory requirement is truly absurd when applied to an investment asset like silver. When is the last time you heard anyone say that gold will go up only when all gold inventories are depleted? Or IBM, T-bills and real estate will only go up when all their inventories are obliterated? Why just silver? Anyone waiting for silver inventories to get to zero before buying will be waiting in vain.

Thus, my conclusion is that the end of the silver structural deficit marks the end of one phase and the beginning of another, potentially much more bullish, phase. Just how bullish this new phase in silver will be is hard for me to describe without going over the top. It marks a phase none of us has ever experienced. It marks the beginning of a true free market in silver. A phase that spans many decades doesn’t end abruptly on a specific day, it evolves. Sure, we still must contend with the naked short selling manipulation on the COMEX but, just like the structural deficit, its days are also numbered. For the long term silver investor, the magical phase, the age of profits, is about to begin. Sell-offs should be welcomed for the great opportunities they present.

I’ve condensed a recent article by Congressman Ron Paul. It’s called "The Coming Entitlement Meltdown."

"David Walker, Comptroller General at the Government Accountability Office, appeared on the show ‘60 Minutes’ to discuss the federal budget outlook. Mr. Walker’s theme was simple: government entitlement spending is like a runaway freight train headed straight at American taxpayers. He singled out the Medicare prescription drug bill, passed by Congress at the end of 2003, as ‘probably the most fiscally irresponsible piece of legislation since the 1960s.’

When it comes to Social Security and Medicare, the federal government simply won’t be able to keep its promises in the future. Our entitlement system can’t be reformed – it’s too late. And the Medicare prescription drug bill is the final nail in the coffin.

The National Taxpayers Union reports that Medicare will consume nearly 40% of the nation’s GDP after several decades because of the new drug benefit. That’s not 40% of federal revenues, or 40% of federal spending, but rather 40% of the nation’s entire private sector output! The politicians who get reelected by passing such incredibly shortsighted legislation will never have to answer to future generations saddled with huge federal deficits.

The official national debt figure, now approaching $9 trillion, reflects only what the federal government owes in current debts on money already borrowed. It does not reflect what the federal government has promised to pay millions of Americans in entitlement benefits down the road. Those future obligations put our real debt figure at roughly fifty trillion dollars – a staggering sum that is about as large as the total household net worth of the entire United States. Your share of this fifty trillion amounts to about $175,000."

Fifty years ago defense spending was 60% of the budget and entitlements were 20%. Today defense spending is 20%. Social programs are 60%. To pay for all this we are going to get tremendous pressure from liberals to raise taxes. They would never think of cutting benefits as long as they can soak the rich. This short-sighted policy has limits – tax shelters, tax cheating, offshore investing and switching citizenship can eventually cost the government more than they gain by raising taxes to intolerable heights.

A better way is with a hidden tax. This hidden tax procures billions for the government and nobody complains. Hardly anyone catches on. Some even like it. It’s called inflation. The government prints money and expands credit, creating billions of new purchasing media. It pays its bills with the new money. This waters down the current money stock making its purchasing power less. As the money goes down, there’s an offset. Assets increase in value and everyone rejoices over their gains. In reality, much of these so-called profits are simply the new money chasing assets and making them dear. The value going up is the same as money going down.

The government collects more from capital gains and also collects more money from the business boom created by the new money. But, most of all, its debt is reduced by inflating. I believe the inflation rate is far worse than anyone imagines. It’s a terrible threat to the financial health of every retired person. This funny money is the perfect system, enabling the government to dupe its citizens by depreciating their savings. Given the gargantuan spending excess, you can expect plenty more of the same.

When I started Investment Rarities 33 years ago, the big name in silver was the Constitution Mint. Unfortunately, they guessed wrong in silver futures and went bankrupt. Over the years we’ve seen many bullion dealers get caught up in futures trading and go broke. Frequently they take their customer’s money and their metal down with them.

When gold started to rise in the late 1970s, my main competition was Jonathan’s in Los Angeles. They would sell Krugerrands for a buck a coin markup and beat everyone’s price. Jonathan even had his own radio program. When he eventually failed and was charged with a crime, I was not surprised. It’s impossible to run an honest business without charging enough to make a profit. That’s why 90% of all coin dealers fail every decade. Invariably they take their customers money with them. I can count at least fifty coin dealers who have failed in the city of Minneapolis alone since I began in business.

Another company that flourished in the silver business was Bullion Reserve. Everyone used to tell me how smart their president was. One time, a PR guy I knew in California called me to tell me how clever the Bullion Reserve president was. It was like, "too bad you’re not that smart". It got old hearing about the guy. Then one day he brought his motorcycle inside his house, into his rec room. He hooked a hose up to the exhaust and ran it into his sauna where he sat until it killed him. When they audited the books, investors were out sixty million.

Then there were the Alderdice brothers in Fort Lauderdale. They operated International Gold Bullion Exchange. What a splash they made. They had a bunch of railroad ties in their vault painted gold that everybody thought was bullion. They sold gold 4% under spot, but they held the gold for six months. I knew it was a fraud from the beginning. I wrote the SEC, the State securities department of Florida, the Federal Commodities Trading Commission, the Wall Street Journal and Barrons, where they advertised. Nobody even responded. Unfortunately, most of their clients never got any gold. The loss to customers was supposedly 200 million.

I mention all this because the other day a man called to tell me he bought 15 one-thousand ounce bars locally and the dealer was storing them for him. The chance of this dealer lugging around sixty-pound bars and actually having them in stock are remote. Time and again, I’ve heard stories like this. I know the pitfalls because I’ve been asked to help hundreds of investors get their silver and gold back, all to no avail. When the bullion market heats up, as it appears to be doing, the marginal operators spring up like poison mushrooms in the spring. Many established businesses seem to lose their bearings in a hot market. They get greedy and they speculate. You cannot name any other company that has survived for thirty years and continues to flourish in the bullion markets. Not one. Half the battle for us (and for you) is not doing anything stupid. Follow our advice closely and you will be okay. You will never ride the bullion markets up and then find out you have nothing, as so many have done before you. We are looking out for your interests and that’s as straight forward as I can make it.

We recommend bags of 90% silver coins. You get 715 ounces of silver in the form of 10,000 Roosevelt dimes, 4,000 Washington quarters, or 2,000 Franklin or Kennedy half dollars (your choice). All are dated prior to 1965. A bag weighs 55 pounds and we ship it to you in two plastic buckets, each weighing 28 pounds. We ship by U.S. mail.

We also have bags of older, historical silver coins, such as Walking Liberty half dollars and Mercury dimes. Occasionally we have uncirculated bags of Kennedys, Franklins, Washington quarters or Roosevelt dimes. We also have great sets of U.S. silver eagles from 1986 to 2007, as well as rolls of silver eagles and Canadian maple leafs. We have one ounce silver rounds. We also have 10-ounce bars and 100-ounce bars. All these coins and bars are carefully inspected for authenticity and quality.

If Ted Butler is right, all these great silver items are only going to increase dramatically in value as time goes on. Put 10% to 15% of your net worth into silver. It will hedge you against economic problems and give you a chance at truly significant gains. Call us now at 1-800-328-1860.

All Rights Reserved © 2002 Investment Rarities, Inc.
For Web Site Questions Contact the Web Master
Disclaimer