Ted Butlers latest..............WEEKLY COMMENTARY
March 1, 2004
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Transformation
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.)
The silver market is changing so much so that you have to step back to really appreciate the significance and magnitude of the change. I'm talking about a sea-change in significance. The most profound change is on the part of the silver investor. It has recently occurred to me that the typical silver investor truly "gets it." More so than in any other asset, I believe that the silver investor has become the ultimate educated investor.
Within hours of the statistical release of the delivery and open interest data, I was reading in-depth analysis and reporting of the data on Internet chat sites, in e-mail's and in various articles. This analysis was measured, accurate, and quite good. This has been a developing process, but it is still surprising to me to see how advanced and sophisticated silver market participants have become. Compared to the research emanating from the establishment analytical community (where, in a recent survey the consensus was that silver had already seen its highs for the year), the thinking of Internet silver participants and regular investors is miles ahead. This is truly remarkable.
Also remarkable is the quality and caliber of the content of the letters that many have sent to CFTC and the COMEX, some copies of which were sent to me. The same applies to the comments and sheer number of names on the Internet silver petition. This, too, represents a significant change. This is a type of empowerment that comes when a large, previously unorganized group of people, come to understand and grasp the truth about the pricing and manipulation of the silver market. Too many people are asking too many questions for this issue to go away, as the regulators would prefer. The fact is, that once you come to understand the real story in silver (the twenty year price manipulation of a commodity in a structural deficit), that understanding will be with you for the rest of your life. The coming termination of the manipulation will enhance your understanding and appreciation of the scope of market history we are witnessing. It is an experience you will relate to your grandchildren, hopefully to go along with their increased inheritance.
Another change is in the actual price of silver. An Internet friend of mine told me something the other day that set me back a bit. He told me that silver just had its highest monthly closing price in sixteen years. I checked and he was right (Thanks Gregg). Even though silver did close the month higher than any monthly close in 16 years, it is not that far above its average price for the last decade and a half. More importantly, the price of silver is still manipulated. While I am sure that the regulators will be quick to jump on the price rise in silver as proving silver is responding to the forces of real supply and demand, and is, therefore, not manipulated, that's hogwash. The CFTC and the COMEX would love to have you forget how silver was depressed for decades ,in spite of a known and documented deficit, because of the recent rally, but I think the educated silver investor will see right through that concocted argument.
There is only one thing that will tell you when silver is no longer manipulated. That’s the elimination of the excessive and uneconomic dealer short position on the COMEX. The key word here is excessive. The manipulation began in 1982-83 with this excessive dealer short position, and the manipulation will only be pronounced dead when that short position in no longer excessive. What's excessive? Simple - a short position out of line with every other traded commodity; a short position greater than annual world production; a short position several times greater than known world inventories. If you take the time to compare the silver short position on the COMEX with world production and known world inventories, and do the same with every other US exchange-traded commodity, you'll see, clearly, that silver stands out like a sore thumb.
While a few have short positions greater than total inventories, none share the dubious distinction of COMEX silver, which regularly sports a short position greater than world production and total world known inventories combined. This is truly an absurd condition, having a short position many times greater than all the known silver in the world and greater than all the silver that could be produced in an entire year. Your common sense should be screaming - how can you be short more than what exists or could be produced? And if it's no big deal, as the regulators contend, why doesn't this bizarre condition exist in any other commodity?
This excessive short position is a big deal. So big, that it is easy to pinpoint the start of the silver manipulation, and its ultimate end, by looking solely at the extent of the short position. In fact, it was what led me to discover the silver manipulation in the first place, almost twenty years ago. I was a commodity broker/analyst for Drexel Burnham Lambert looking for my next investment play. I had just completed (successful) plays in soybeans, orange juice and US Treasury bonds, both on outright and spread positions, as well as conducting a straddle options writing program on the OEX. A client suggested I look at the fundamentals of silver, because he knew I liked to look under the hood. He claimed there was a deficit in silver and that it had peculiar and attractive price-inelastic production and consumption characteristics. The client, who later became my silver Godfather (Izzy), gave the suggestion in the form of a challenge. The challenge was to explain silver's low price, in spite of the deficit, and no voluntary inventory dishoarding.
Even though I had traded silver over the years, I never really studied it, so I took Izzy’s challenge, and was hooked. For almost a year, I pondered the conundrum of a commodity in a deficit with no sharp price increase. I read and reread everything it was possible to read on silver. At first, I thought it was strictly a perception problem, with investors just not seeing the facts. I went so far as to challenge the statistical reporting agencies, because I thought this might be the problem. I succeeded in getting the US Bureau of Mines (now the USGS) to revise how they calculated industrial silver demand, from voluntary reported demand from members of the Silver User's Association to one that used the more statistically correct apparent demand method. This is still in use 20 years later. But this did nothing to resolve the low price.
Then, one day it hit me. I was looking for something that was different about silver from other commodities that would explain why the silver price was out of line with its fundamentals and with other commodities. In scanning the Wall Street Journal's commodities page, it looked like silver wasn't out of line in terms of volume and open interest with other markets. Then, it jumped out at me. Rather than just look at the open interest in terms of the tens of thousands of contracts, I converted just what those contracts meant in terms of ounces of silver. I did the same with all the other commodities. Then I compared them to their respective domestic and world production totals. I was stunned. When I converted the number of contracts into ounces, and pounds, and tons, and bushels, and barrels, a completely different picture emerged. All the commodities, then and now, shared something in common, namely, all had a total long and short position well below world annual production. All, that is, except one - silver.
While silver's COMEX total short position was greater than world production, other commodities didn't come close to that size short position. For instance, crude oil, had a total short position of many hundreds of thousands of contracts. When you converted those contracts into equivalent barrels of oil, the short position came to only 2% or 3% of world production. The COMEX gold short position did make up 30% to 50% of world production, but when you factored in known world gold inventories of billions of ounces, the short position was back in the 2% range. Only silver had a short position greater than inventories and production.
This same pattern of all commodities having roughly the same short position vs. production/inventory ratios (except silver) has prevailed since I discovered it in 1985. What does this mean? To me, it is the clearest verification of the silver manipulation. It can't be a coincidence that silver's price has been noticeably depressed for the same two decades that silver has had the shockingly large comparative short position. If a small group of short traders got together to sell massive amounts of anything short, like they have done in silver, the price of whatever they sold would be in the gutter. (Whether it would stay in the gutter, like silver, is a different story, due to the uniqueness of silver leasing.) Imagine what would happen if a group of concentrated shorts got together to sell millions of grain contracts, or tens of millions of oil contracts, or billions of shares of a company's common stock. There would be obvious price dislocations of an extreme nature. Yet this is precisely what has happened in COMEX silver. Tens of thousands of COMEX silver contracts are equal to hundreds of thousands and millions of contracts in other commodities, when converted to real world equivalents.
What does this mean for the future? The price of silver has been, and is, manipulated because of the excessive short position in COMEX silver (and leasing). The price of silver will stay manipulated, even if it moves higher, as long as the COMEX short position stays at excessive levels. When the COMEX silver short position falls in line with the short vs. production ratio of all other commodities, the manipulation will be terminated. (If you're looking for a number. I'd guess when the futures open interest on falls to 30 to 50 thousand contracts.)
Until the Comex silver short position declines to levels comparable to all other commodities, we won't see the major top in the silver price. That does not mean we will not see bone-jarring sell-offs, but that we will have not seen the top. It may turn out that the top will come well after the excessive and uneconomic short position is largely eliminated, but certainly not before. But don't turn your back on the concentrated dealer shorts. As long as they are short, you must be prepared for their tricks to trigger sharp sell-offs, designed to cause liquidations. When these guys are in the same room, you must hold on to your wallet. That means only fully-paid for positions, or strong backing to anything leveraged. Get used to the volatility. It isn't going away.
Just a quick update on the March delivery situation. After two delivery days, there was a relatively small number of contracts delivered, and a relatively large amount remaining, but nothing shocking at this point. What was more telling to me was that AIG didn't show up for the delivery process, so far, either as an issuer or a stopper, for the first time in my memory. This is a further confirmation to my theory they may be abandoning the short side and maybe the silver business completely. There is still a very large, and very manipulative total dealer net short position of some 463 million ounces, as of the latest COT, but numbers still suggest that this big short is nowhere as aggressive as he once was. Without the big short's protection the other dealer shorts may start to break rank.
We are at a critical junction, and I don't think we'll stay near the $7 level for long. The dealer short community is under severe financial pressure, not just from silver, but a whole host of other commodity shorts, as well. But, like a cornered rat, they are not to be underestimated. They will exploit any avenue or news event to cause a sharp sell-off. Against their desperation, the overwhelming evidence of strong industrial demand and shortages for almost everything, dictate that it's just a matter of time before the silver manipulation is broken. Now, more than ever, the no-brainer is real silver.
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