Past Moneychanger Articles

Lately a subscriber forwarded me a 1998 Internet article, "The Permanent Silver Shortage" by Ted Butler. It was one of the most profound articles about silver I have ever read. Why hadn’t I ever heard of Ted Butler?

Because he is primarily a private investor & trader, & writes only occasionally on the Gold Eagle website, http://209.41.12.102/cgi-local/shoptmc.pl/SID=088297/page=http://www.gold-eagle.com/research/butlerndx.html. He will soon begin publishing a monthly newsletter For $180/year. To subscribe, visit his web site at http://209.41.12.102/cgi-local/shoptmc.pl/SID=088297/page=http://www.butlerresearch.com/.

Ted has nearly 20 years’ experience in commodities & futures. Originally from New York, he now lives in Florida. We had a great time in this interview, but I failed miserably as "devil’s advocate." What else do you expect? Two silver bulls get together, & they can only fuel each other’s fires.

Mr. Butler very kindly gave me time for this interview on Wednesday, June 14, 2000. The Moneychanger’s questions are in bold italic type, Ted’s answers in text.
 
 

MONEYCHANGER Based on your experience trading commodities your argument in "A Permanent Shortage of Silver" is, "This is crazy!"

BUTLER Yes. It negates everything education & experience teach us about supply & demand. When you consume more than you produce – the definition of a shortage – you have to attract balancing supply to the market from existing inventories. We’ve all been taught that you can only entice that inventory out with higher prices. For 11 years running the Silver Institute has reported a physical deficit in the face of flat to lower real & nominal prices. That is crazy!

When silver rises a dollar, no one will install a $100 million mining complex the next day. However, as supply shortfalls show up, then logically the price should rise, encouraging more production.

You are putting the cart before the horse. All that happens when we get higher prices, but why don’t we have higher prices already? The only solution to the severe structural silver deficit facing almost non-existent remaining inventories is sharply higher prices to induce more production. The market has to balance supply & demand. It is one of nature’s rules.

The alternative is for silver prices to stay flat until one day – a year, two years down the road . . .

. . . or two weeks…

…the people go to work in the photographic film industry or in the electronics plating industry & the man at the door says, "Don’t bother coming to work today, we’re out of silver. We can’t work."

Absolutely.

In most industrial applications silver is not optional. There is no good substitute over a wide range of prices. In photography, God made nothing else with silver’s sub-atomic characteristics. Barring some fantastic new discovery, there is no substitute for silver.

And there’s very little room to reduce usage. In the 1970s when silver’s price began to rise manufacturers of medical x-ray film & other films began tosqueeze silver out of their product. Then the 1980 silver spike taught every manufacturer a painful lesson. They all began to squeeze down their use of silver. That process has carried on now 20 more years. The photographic industry, e.g., has managed several huge silver reductions, yet total photographic usage still rises every year. Moreover, rising incomes in China & India will keep on feeding that demand. Those people will not buy a $900 digital camera as their first photographic experiment.

And the $2,000 computer that you need to run it. They are going to buy a $5 disposable camera.

So silver usage has already been squeezed down & it is absolutely essential in the industrial applications where it remains. There is no wriggle room.

It is a long-term structural problem. At some point they will be forced to raise prices on silver-containing products high enough to price them out of many consumers’ reach. By the time it gets to that point, I shudder to think what the price of silver might be.

Because usually the amount that is used in any application contributes only a very tiny part of the end-product price.

In 1990, Charles Rivers Associates did a study for the Silver Institute that intimated there was plenty of silver, but it was unlikely to be sold at any price under twenty bucks. Today CPM & GFMS theorise that 1.5 billion ounces came to market during the 1980s, & for the past 10 years the market has been using that up – at $5.00 an ounce.

How would such a massive transfer occur over such a protracted time without the price fluctuating? Silver has flat-lined on a long term monthly chart at $5. That’s the craziest thing I have ever heard. I tell you, it is impossible.

One theory was that old silver bulls who had buried silver in their basement were dying & their estates were being liquidated.

You mentioned the theory that we have 1.5 billion ounces. As time goes on, people forget so they can manage & massage these numbers any way they want. You were in the market in 1980 & afterwards. We didn’t have those extraordinarily high silver prices for long. Sure, people were waiting in line to sell their silver, but how long did that last? Was it physically possible to bring that much silver to market in that short time?

Some liquidation has occurred, but how could we possibly uncover 1.5 billion ounces & not see it in inventory or refining statistics. They would have needed to double, triple, or quadruple refining capacity to handle that amount. It didn’t come in as 1,000 ounce Comex registered bars, it came in as knives & forks & hollowware. Who refined all that? Meanwhile, Handy & Harman, the country’s biggest refiner, goes out of business. How can people accept these kinds of statements without thinking about them?

Was it a billion & a half ounces that they got in a year, or ten years? Did that much silver come to market? Where did it go when they refined it? Somebody just hid it all these years & let out 100 or 200 million ounces a year in the middle of the night so nobody could see? This is just stupid.

The latest World Silver Survey shows about 112.5 million ounces as the total silver producer hedging position. Of that, the latest World Silver Survey breaks it down so that the vast majority is forward positions & options delta. Just a little bitty sliver, 200 tonnes, comes from silver loans.

In a recent article, "The Great Silver Lie," I addressed this very issue. That can be found on the Gold Eagle site under my name.

GFMS spend more time collecting data than you & I, so let’s not even argue with their numbers. Still, the way they portion out silver leases & forward sales among categories isn’t much more than an opinion on their part. Having created the whole pie, they cut it into pieces without really offering much substantiation

They never do.

I know. I fought with them before this report came out. The big theme this year was the sale from China. How can they document that? I don’t doubt for a minute that the silver did come from China. After all, somebody had to make up that physical deficit, but in the name of common sense who in his right mind would sell at these low prices?

The Chinese are smart enough to steal every nuclear secret we ever had, but they can’t figure out that $5 silver is too cheap? The Russians have worked platinum & palladium to whatever price they want, but the Chinese are dumping silver accumulated over so many years?

If the silver came from the Chinese, they are leasing it, not selling it. That is the only possible way to explain how you could get 61 million ounces – let alone 156 million ounces -- from anybody under the price of $5. They don’t think they are selling. Maybe it’s a political quid pro quo, but it makes no economic sense at such low interest rates. Lease rates on silver & gold range around 1% per annum. The whole thing is so preposterous that it is hard to discuss unemotionally.

There is more that doesn’t add up. China was the last country in the world to abandon the silver standard. Roosevelt’s manipulation drove silver so high that in 1935 the Chinese had to drop silver.

A 1980 Wall Street Journal article highlighted smuggling silver into China. At that time China was undergoing an underground economy boom & the Chinese wanted to be paid in silver. Besides China’s ancient adherence to the silver standard, there’s a long history of Mexican silver dollars (in particular) financing the China trade. Even as late as 1980, they preferred those pieces of eight to any other kind of money.

We are asked to believe that these people with this history looked around at world markets & suddenly asked themselves, "Gosh, why are we holding on to this silver? It is $1.80 cheaper than it was a year ago. Let’s sell now."

It just doesn’t make sense, but you can’t disprove it. So you get stuck in this quagmire, distracted from the central issue. It makes no difference who provided the silver to make up the shortfall in 1999, the transfer still doesn’t make sense. If there’s no good economic reason then you’re acting from some non-economic reason.

If the lender is willing to accept a return that low, then it must be an asset he plans to keep anyway without any return at all.

Give the benefit of doubt to these central banks. A notion dreamed up 15 years or so ago attracted them. "Don’t leave gold & silver lying fallow in their vaults. Do yourself a favour. Loan it out to us & we’ll get you a return. It won’t be a big return, but it will be a return & you don’t have to report it, because we will call it a lease transaction. You can still keep it on your books & show a small return."

I think central bankers originally fell for that line, & they’ve loaned more & more every year. By now central bankers have to be wondering, "How am I going to get my silver back?" At least, any rational person would think that.

There is no cash settlement for these leases. The borrower must pay back physical silver, not its value in paper dollars.

Right metal, not currency. Metal is loaned, metal has to be paid back, but they have loaned maybe a billion ounces. (I can defend a billion easily, but I think it’s closer to two billion.)

Metals are anonymous. There’s no central registry where all silver & gold owners must register. That is one of the main attractions of metals, they are nobody else’s liability.

Ten or 15 years ago analysts never realised central banks had one or two billion ounces to lend. Unlike gold, silver is not counted as a monetary asset. They report on their gold holdings, but not the same way on silver because it’s not considered monetary. (The US is one of the few that also reports silver in its monetary statement.) Without reporting, they can loan it out without their citizens knowledge.

But where will a billion ounces of silver come from to pay back these loans? Talk about impossible. These loans can’t be paid back. They will default. Leasing has been the mysterious source of the phantom silver, & leasing has brought us to our present position. Sure, it sounds unbelievable, but it is the only logical answer that explains how silver could stay at these prices so many years into a structural deficit.

By the latest World Silver Survey, the cumulative deficit from 1990-1999 was 1.22 billion ounces. This was the shortfall of supply versus demand. Silver, unlike gold, is consumed.

Right. It is an industrial item, more than a jewellery or monetary type item.

Fabricated silver disappears. It is washed down the drain or it goes to the landfill in the form of . . .

. . . uneconomically recoverable amounts.

Express that 1.2 billion ounce cumulative another way: 1.2 billion ounces have been taken from some inventory. It had to come from some place. If it had come from individuals voluntarily selling, we would see tremendous evidence of that. We would see silver donation centers on every street corner, like Red Cross blood banks. All we’ve seen is sleight of hand with these silver reports. I don’t know how Gold Fields & the Silver Institute could publish these with a straight face. What they say has happened is impossible. You can’t have a voluntary inventory liquidation of 156 million ounces, nearly 1/3 of total world mine production, come to market with flat prices for ten years.

At some point the market runs out of silver owners who are willing to sell for $5 an ounce. Logically the world can’t be that full of them, but over the ten years their tribe has known no limit.

We’ve become so accustomed to it that we react like zombies. ‘Oh, another silver deficit this year – big surprise." Commodity deficits are so rare that you have to really dig them out of market history. A commodity deficit for almost a year is unheard of; A commodity deficit for a decade is impossible. It just defies every law of free markets & free economics.

From the tone of your articles, you are much more optimistic about silver than gold. Why?

I am speaking strictly on my experience as a commodities broker & analyst. I’m not a hard money man, though I’m not against it. I look at things with an eye towards fundamental analysis, weighing supply & demand & their interaction with price.

Most companies can profitably mine gold in the $300+ range. At $500-$600 an ounce, most companies will make a ton of money. People will be out looking for it day & night. Since gold is mostly used in jewellery, you might have some resistance in demand if prices go up 100%.

Gold has been suppressed, too, for many years, but not to the same extreme as silver. When this leasing fiasco finally explodes, chances are that gold will overshoot its equilibrium price. Markets generally operate that way, but I don’t think you need $800 to get mining companies working around the clock.

In spite of all the gold leasing central banks still have quite a bit of gold left. Like silver, gold has a structural deficit; leasing balances the shortfall. If they wanted to fight to the death, they could continue to keep the gold price suppressed a while longer.

That emergency stash doesn’t exist for silver. For those fighting a fire in silver’s price, there is no water supply left. Twenty or thirty years ago whenever silver perked up, a rumour or government statement would emerge, hinting the US government might sell 100 million ounces. In 1940 the US government held over two billion ounces of silver. Today, how much do they have left? Fifteen or 20 million ounces. So there is nobody & nothing to fight a silver price fire. That is the difference between gold & silver. You have to conclude that silver is more explosive.

For many years the question mark hanging over silver was what price would induce Indians to sell their silver. From ’68 forward, Indian economic conditions under a Socialist government were very bad. Also, agricultural times were hard. (About 60% of the people in India still live on the land.) In 1985 that turned around & those sellers became buyers. The way Gold Fields Survey portrays it, millions & millions of Indian peasants sit around at their TVs all day . . .

. . . watching the Comex price . . .

. . . so that if silver goes up a dime, they can dash out, strip those silver baubles off the wife, & run sell them.

If you focus on higher prices drawing out Indian or any other supplies, fairness as an analyst demands that you examine the other half of that equation. When the price rises, some companies & investors will want to build inventories. They will view the rising price as the confirmation they were waiting for.

A great example of that behaviour stares at us every day from the stock market. People want to jump on bandwagons. In any market they tend to buy as the price rises. That is normal human behaviour.

A lifelong silver merchant in Bombay told me something else pertinent. These Indian farmers use silver as their savings account. Momma may be wearing it on her arms & legs, but that is their savings account. The only reason that they will liquidate that permanent savings account is crop failure.

Common sense should make us ask one more question. Will a higher price cause these people to stampede out of silver into – rupees? Into paper money they didn’t trust in the first place? If silver rises, the rupee is falling. That convinces them more than ever that they are holding the right thing.

Compare real estate. When a house appreciates, not everybody unloads. They count it, they spend it, they borrow against it, but they don’t necessarily sell it.

About twice a year Walter Frankland of the Silver Users Association publishes a negative assessment of silver, to keep talking the price down. However, in his spring piece this year there was one valid question that any silver bull has to be able to answer: why has the price gone nowhere for ten years in the face of persistent deficits? You answer that silver loans have advanced supply to the market, but with eventually disastrous results?

The deficit-satisfying supply of silver has come onto the market on an uneconomic, non-free market basis. It was borrowed from central banks under the impression that they will get it back. In fact, a 12-year old could look at the equation & tell you it won’t work. If you loan something out to someone, & that someone sells it to an unrelated third party or consumes it, & you have no security for that loan & there’s no more of that material around, that loan will not be paid off as called for. It is manipulation & fraud because there is no physical inventory available to satisfy these loans. Collectively taken, they are fraudulent instruments.

The lack of substance behind the loans is exactly the recipe for a financial panic.

Absolutely. You can’t keep a shortage going forever. By definition, it is temporary. When it is terminated, it will be among violence & panic.

You wrote something that really summed it up well. "Silver is like a shrinking water-hole on the African plains. When the elephants & lions -- Kodak, DuPont, & Fuji -- come to drink, all others will be deprived."

When? That’s the big question. A lot of our silver customers bought for Y2K, & now they want to sell. Invariably I tell them the same thing – I’ll be glad to help you, but I really think you’ll come out a lot better if you just hold onto it. I doubt you’ll lose money; in fact you’ll probably make money.

Some questions are unanswerable. Projecting existing trends is analysis, but picking dates is prophecy. I’m not a prophet, I’m an analyst.

I’m surprised it has taken this long, I tell you that. I’m surprised silver hasn’t exploded before now. However, just because the market doesn’t accommodate your expected time frame doesn’t really matter.

Fundamentals, can remain out of whack for a long time. Precisely that long preceding imbalance builds the pressure to drive prices up violently when the market reaches for a more rational equilibrium. That’s why you can’t wait until silver crosses $10 to buy. It won’t lounge around at $10 the way it has at $5.

The important issue is not when silver will move, but how. When the real move comes, it will be very violent. How I should position myself now to profit then.

That is knowable. You can structure your financial arrangements to your individual needs. Do what you have to do, just do it now. Don’t worry about when it will happen, just know that it won’t give any second chances to hop aboard.

The most salient characteristic of silver’s personality is its extreme volatility. I can remember June 21, 1982 when silver hit a low of $4.85. By February, it stood at $15.

Then the government announced they were going to sell 50 million ounces of silver & dropped it $5 in one day.

On April 27, 1987 silver was as high as $11.25 & as low as $7.25 -- a thirty-five percent one-day price range. That $4.00 variation almost equals the entire price today!

When the move comes, it won’t be important when you bought it, unless you didn’t buy it. It’s better to be three years early than one day late.

Ted, thanks very much for your time. 

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