TED BUTLER COMMENTARY

August 18, 2008

The Lessons of a Lifetime

(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.)

In order to understand where you may be going, it is important to understand where you have been. Nowhere is this more true than in silver. The historic price sell-off, coupled with the obvious shortages in almost all forms of retail physical silver present the lessons of a lifetime. I believe that how we learn from this lesson will determine our future financial situation, good or bad.

The drastic sell-off in silver (and gold) is further proof of an ongoing manipulation to the downside. My advice to own real silver on a fully paid for basis, has been borne out. Real pain exists among those who held silver or gold on margin. Many leveraged investors have lost their positions because they couldn’t meet margin calls. Meanwhile, no fully paid up investors sold because they had to come up with more margin money. That’s lesson number one.

The Anatomy of a Crime.

What we just witnessed in the historic sell-off in silver and gold was a crime. That’s not a crybaby complaint. There were no supply or demand developments that could account for the severity of the sell-off. The proof that this sell-off was criminal lies in public data provided in the Commitment of Traders Report (COT) and a basic understanding of how the futures market works. This has been the most extreme sell-off in the recent history of silver and gold. We are farther below the moving averages than at any point since I have been writing about silver. Price movements this severe are likely to be intentional and not accidental.

Every criminal act must have a motive and an opportunity to commit the crime. By the simple process of elimination, those responsible for this crime are the concentrated commercial shorts on the COMEX. No one else fits the profile. They had the means (through their dominant and monopolistic position), the profit motive and the skill to cause the sell-off.

I can’t identify the concentrated shorts by name, as commodity law protects their identity. But the regulators certainly know who they are and continue to choose to do nothing about them. (They also knew the identity of the SemGroup, which appears responsible for the recent run up and collapse of crude oil prices.) While I can’t identify the perpetrators by name, I can label senior management of the NYMEX/COMEX , as well as the commissioners and other high ranking employees at the CFTC as being complicit and involved in the manipulation. Incompetence can no longer be considered an explanation or excuse for them not enforcing the law. (While not the purpose of this article, I will list the e-mail addresses of the regulators at the end of this article, for those who want to make their feelings known.)

I am not writing this article in anger. I understand how many could feel angry, particularly if leveraged silver or gold positions were liquidated as a result of this sell-off. Not only does this episode confirm that these markets have been manipulated, it also strengthens my conviction that the termination of this manipulation is a certainty. The commercials know better than anyone how the markets function mechanically. This is their full-time business. They know when the markets are least liquid and when many traders are absent. Perhaps the most illiquid times, with few traders present, are in the overnight sessions. The most illiquid time is around 8 PM EST. On Thursday evening, right at that time, the price of silver suddenly plummeted by almost $1.50. It had never before fell by that amount so quickly in any overnight session.

So, how did the concentrated shorts pull that off? They waited until the most opportune time and threw in some relatively small, but aggressively placed sell orders. These sell orders caused the price to fall, touching off further sell orders from under-margined longs, which further caused prices to fall. The analogy I like to use is that it is similar to rolling a small snowball down a hill and watching it pick up size and momentum. As the sell orders began to snowball more and more, guess who was buying after prices dropped? Correct, the concentrated shorts.

How is it possible that the commercials could buy back short positions on thousands of contracts at times of steep sell-offs, without triggering a rise in price? There is only one possible and plausible explanation - through discipline and collusion. The commercials know the price levels that tech funds and other large speculators are likely to sell at on the way down. In addition, some of those large commercials do the clearing for these speculative traders. In that position, they know the finances of the large long silver traders better than anyone. The commercials know, in advance, the sell points and vulnerability levels of the longs as well as the longs themselves. So all the commercials have to do is trigger low enough prices at illiquid times in the market to manufacture an avalanche of selling. Then they sit back with low priced buy orders and wait for the desperate sellers to come to them. Previously, I have referred to the behavior of the commercials as a wolf pack. It is shocking that the regulators can permit this.

To those who claim that these are normal market games, and the commercials are market makers, let me point out that commodity law does not allow for market making. The markets are supposed to operate as an open outcry (now electronic) auction, not as a specialist system. Even assuming that the commercials operate as self-appointed market makers, what kind of legitimate market maker only caps price rises by increasing short selling. Then they create disorderly moves to the downside. That’s why all silver price rallies are contained and orderly and why we get vicious, out of control sell-offs. The commercials make markets only for their own financial benefit. Some market makers.

I promise you that I could prove this if I were privy to the trading records rather than just the CFTC and the exchange, whose mission is to look the other way. But that is impossible, so I have to prove it with public data. While the data for this Thursday-Friday sell-off won’t be available until the next COT, the last few COTs provide ample evidence to prove what I allege.

The most recent COT, for positions held as of 8/12, confirm that the commercials have been on a buying binge for the past month. In other words, they have rigged the sell-offs in silver and gold over the past month and used those sell-offs to collusively buy as many contracts as possible. The numbers are impressive. Since the COT of 7/15, the commercials have bought back and reduced their total net silver futures short position by more than 20,000 contracts (100 million ounces) In gold the commercials have bought back, as a group, more than 90,000 futures contracts, reducing their net short position by 9 million ounces. Undoubtedly, more contracts have been bought by the commercials in the current week.

In addition to this buying on the COMEX, I believe that the naked short position in shares of the silver ETF, SLV, have been bought back, either entirely or in large part over the past month. This was the plan.

However, the percentage of net buying by the concentrated shorts in COMEX silver and gold has decidedly lagged the overall pace of commercial net buying. In silver, the big 4 concentrated shorts only bought back 10%, or 2000 of the 20,000 silver contracts bought, while the raptors (the 9+ smaller commercials) bought 12,000 and the 5 thru 8 largest traders bought a bit more than the 6000 contract balance. In gold the big 4 only bought back 22%, or 20,000 of the 90,000 net contracts bought, with the raptors buying 40,000 contracts and the 5 thru 8 largest traders buying 30,000 contracts.

What this tells us, for sure, is that the concentrated short position of the big 4 in silver and gold, while somewhat reduced in total contracts over the past month, has grown more concentrated and manipulative. The big 4 in gold and silver have grown more and more isolated from the rest of the commercials and, therefore, more desperate. This fully explains the disorderly nature of the recent sell-off and will explain any further disorderliness. The very small amount of short covering by the big 4 increases the likelihood that they may be trapped in these short positions.

Remember, concentration and manipulation go hand in hand, and the more concentrated the short position becomes in silver and gold the clearer the proof of manipulation. Only those that refuse to analyze the public data and reject the very idea that silver and gold could possibly be manipulated can conclude that we are witnessing free market behavior and not a rig job. With the growing evidence of a retail investment shortage in silver, those who deny manipulation are about to look very silly.

The Retail Silver Investment Shortage

The growing and persistent retail silver investment shortage is becoming increasingly obvious. This segment makes up a small part of the total silver market on a daily basis. However, due to the large number of participants, on both the buy and sell side, the demographics elevate this segment to a more reliable barometer than daily volumes might suggest. With some 5,000 US retail dealers and perhaps 100,000 customers, there is much to learn from in this retail market.

What is happening is nothing short of astounding. For the first time in our lifetime, there is not enough silver to go around. Just about everywhere you look, dealers are sold out or low on inventories, throughout the entire supply chain. Delays in deliveries, the clearest definition of a commodity shortage, are commonplace. This is unprecedented. That this is occurring precisely at the same time of a sharp sell-off in the price of silver, should make your head spin.

I would suggest, if you have college-age children or that you borrow any basic economics textbooks they have. What you will read, is what you already know. The most basic law of supply and demand dictates that low and falling prices must be an indication of growing supplies or falling demand. You will find no suggestion that the price of anything could fall sharply with record demand, especially with the unavailability of supply. At least, not in any free market system.

Then I would suggest that you consider the only plausible explanation to silver investment shortages amid plummeting prices. That explanation is that there must be something wrong with the price of silver, not with supply or demand. After all, the actual supply or demand can’t possibly be "wrong." They are what they are. Only the price could possibly be wrong. To be exact, the price of silver is manipulated, something that I have maintained for more than two decades. The growing retail silver shortage confirms this manipulation.

I recognize that even if the true Prophet of any or all religions descended from the Heavens and certified that the price of silver (and gold) was manipulated, there would still be many who doubted it. That’s because one of the most powerful forces on the face of the earth, is the inability to admit that they may have been wrong. If that error is about something as basic as a market being free or manipulated, then the denial is likely to be more obstinate. In fact, as the evidence becomes more apparent, it’s actually quite humorous to read and listen to why the shortage doesn’t matter.

As regular readers know, the inevitability of a silver shortage (as a direct result of the long-tern manipulation) has been at the center of my message. If there is one thing upon which I have agreed with my good friend and mentor, Izzy, it is the coming shortage of silver. This has been an issue on which we have agreed for more than 20 years. But it is only recently that I have come to appreciate his true take on what shortage will mean to the price of silver. He has a perspective that few of us have, including me.

By way of review, the silver retail investment shortage emerged some six months ago, shortly after Izzy’s article extolling the advantage of buying US Silver Eagles. http://www.investmentrarities.com/12-03-07.html There is not the slightest doubt in my mind that his article jump started the huge demand for Silver Eagles and as a result the US Mint could not keep up with demand. They still can’t. Already, the Mint has sold more Silver Eagles in the first seven and a half months of this year than it sold in any full year in the 22 year history of the Eagle program. And we still have four and a half months. Clearly, Silver Eagle sales would have been higher were the Mint able to keep up with demand. I believe the demand for Silver Eagles subsequently generated sales for all retail silver investment products. Those not able to buy Eagles bought other forms that were available, until demand exceeded supply for other silver products.

Now many may doubt that a retired grandfather could write a single article that could launch a shortage of retail silver for the very first time in history, but I know better. I know that is exactly what happened. And the reason I know it is because I knew that was Izzy’s intent beforehand. Everything he wrote about the benefits of owning silver was the gospel truth. But, he also intended and set out to highlight just how tight silver supply had become by forcing the Mint into a position where they could not meet demand. He knew that the Mint couldn’t hide a shortage of Silver Eagles. There’s no way that someone sets out to accomplish such a specific objective and then achieves it by accident.

The reason I am recounting Izzy’s remarkable accomplishment is to give you a sense of the true meaning of his thoughts on the coming silver shortage. Even I raise my eyes when he offers his seemingly outrageous price projections, although I know better to dismiss anything he says. But there is something unique in his experience and background that gives him a perspective unlike most. In fact, it is a perspective one can achieve only through first hand experience.

Izzy has experienced the kind of shortages of basic goods only witnessed during war. He was present during communist take over in his native Romania. He has related to me how people would pay any price for a loaf of bread, a chicken, even a tool. You and I can’t conceive of such shortages because we have never experienced them first hand.

Perhaps you can mentally transport yourself to imagine such shortages, where price becomes secondary to availability,. If so, you may get a brief glimpse of Izzy’s vision and "crazy" price targets for silver in a time of true shortage. I can only do it for the shortest of times, before my imagination shuts down. If this persistent and growing retail shortage of silver develops into a true full-blown wholesale and industrial shortage (as I believe we may already be in), we will not be able to judge what price is truly crazy. Those most likely to gauge price correctly in a shortage may only be those who have been there and done that.

Lessons For Everyone

I realize I am running long here, but I ask your indulgence. This article is about the important lessons before us. Let me summarize the lessons to different segments of the silver market.

For investors, don’t let this opportunity slip by. I realize you are seeing something with your own eyes that you have never seen before, namely, shortages and low and sharply declining prices. This is contrary to everything you have learned and experienced. It is nothing short of extraordinary. You must rely on your common sense. Something has to give, either prices or supply. This can’t last for long. Continued low prices won’t increase supply. The only solution for shortage is higher prices. In the case of silver, sharply higher prices. Don’t hesitate in buying silver now.

Recently, I wrote that I thought silver was exceptionally low-risk, since it had fallen sharply. The price then went lower than I thought it would or could. But my basic premise is still intact, namely that the lower the price goes, the lower the remaining risk.

For those investors capable of switching gold owned into silver, this is a particularly opportune time to switch, as silver prices have been manipulated much lower than gold prices. Silver is cheaper, compared to gold, than it has been in a long time. That can’t last. Yes, gold looks cheap here and appears to be also tight on a retail supply basis, but the big difference is this; due to silver’s industrial consumption nature and deeply depleted world inventories, higher prices for silver will not cure a shortage for a long time.

Investors should recognize that the manipulative sell-off may have created the very springboard that will cause the price of silver to soar. This is not about some academic discussion on whether silver is manipulated or not. This is about identifying and taking advantage of a potential price explosion. It has been my long-held premise that before we took off to the upside, we were likely to get a super smash to the downside. I think this was the super smash.

For industrial consumers of silver, the lessons are even more compelling than for investors. That‘s because, investors don’t have to buy silver. They have the choice to buy or not buy. Users don’t have that choice, they must buy. Their only choice is when, how much, and at what price to buy silver. A few weeks ago, users were paying more than $19 an oz for silver. Since then, the price dropped more than $6. Users will not consume less silver just because the price declined.

If you know you must consume an item, price declines are the time to stock up. This is not complicated. If you consume a favorite type of coffee, when it goes on sale for 30% off, the reaction is to take advantage and buy more than you normally would. Likewise, some industrial consumers of silver will do the same. It’s called legitimate hedging, which is the economic justification of the futures markets.

A special note to users. For the past ten years or so, hedging has been a disaster for the producers who sold future production at too low of a price. But if there was one shining example of a good hedge, it was on the buy side by a user. I am speaking of Southwest Airlines, and their magnificent buy hedge of fuel. As a result of locking in low prices, those responsible for the fuel hedge are placed upon a pedestal at the company, and rightly so. Someday soon, there will be some great success stories about those users who locked in silver at current prices.

For mine producers of silver, the current sell-off presents unique risks and opportunities. Obviously, the low price presents danger to your shareholders. I don’t know of a primary miner that can operate at a profit at current silver prices. Producers can and should do something about it. At a minimum, producers should speak up about the sell-off and question its cause. They might threaten to withhold production. Such actions would meet with strong approval from shareholders. It would be a public relations bonanza. Shareholders don’t want to hear producers say everything is fine in the silver market, because they know otherwise.

A few years ago, a silver mining company, Silver Standard, appeared to take my public advice to buy some silver. The results were spectacular. Not only did the company and its CEO, Robert Quartermain, reap shareholder goodwill, it achieved a profit of roughly $25 million, when it sold the silver earlier this year above $20. I would suggest that this company (and others) take advantage of the sell-off and do it again. If they do, I think the results, both from a public relations and profit standpoint, will be even better.

Finally, the lessons to the regulators from this sell-off may be the most important of all. This year we have witnessed disorderly pricing in many markets. In oil and cotton, the disorderly markets were caused by speculator shorts, masquerading as commercials, who ran into trouble and had to buy back their short positions. While the concentrated shorts in silver and gold have not yet lost control, given the growing physical shortage in silver, it would appear to be only a matter of time.

In the meantime, the regulators are permitting a crime to remain in progress. This is shameful. Worse, I believe that their denial of the existence of a silver manipulation has, effectively, given a green light to the concentrated shorts to continue the manipulation. In other words, the CFTC is directly responsible for the recent silver and gold sell-off. That’s beyond shameful.

Any pretense that the concentrated short position in silver was somehow a legitimate hedge went out the window the minute that the price cracked below the cost of production and shortages started to develop. After all, who legitimately hedges to lock in a loss or hedges against nonexistent inventory?

Here are the e-mail addresses for the regulators. If you want to give someone a piece of your mind about the manipulation, this is a good place to start. While it may or may not do any good, it is the right thing to do, especially if you are disturbed by this manipulation, as you should be.

WLukken@cftc.gov

BChilton@cftc.gov

MDunn@cftc.gov

JSommers@cftcf.gov

Jnewsome@nymex.com