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A practical definition of the word shortage as it pertains to
a tangible commodity would evolve around supply being insufficient
to meet demand. A more precise definition would refine the meaning
of that insufficiency to apply to the inability of current production
to meet current demand. Since all commodities have some sort of
inventory, any imbalance of current demand exceeding current production
will automatically necessitate a draw down of inventories, almost
always by increasing prices. This is the essence of the supply/demand
equation. Inferred in this basic definition of a commodity shortage
situation is the inherent temporary nature of such a shortage. After
all, a tangible commodity can not operate in a persistent deficit
condition, once inventory is depleted, new production must at least
equal current consumption, and more likely exceed it, in order to
replenish inventory. With no inventory, it is impossible for demand
to exceed supply, period. Shortages are, by definition, always temporary.
So is the title of this piece an oxymoron - how can there be a
permanent shortage? Not to get too abstract, it depends on your
definition of the word permanent. For me, meanings like continuous,
durable and enduring come to mind, or simply, something that lasts
a long time. Since most commodities have a seasonal production/consumption
cycle, shortages are typically corrected in a growing season or
two. Minerals are not bound by the seasons, so it may take longer
to erase a deficit, but a few years has always been sufficient.
Surpluses could continue for prolonged periods, but deficits can
go no further than practical inventory depletion. Then the inevitable
cycle of inventory replenishment must begin. But if it took an extraordinary
period of time to balance a tangible commodity deficit, say instead
of a year or so, something like fifty years, then I would apply
the term - permanent shortage. And I see, clear as day, a permanent
shortage of silver straight ahead.
Fifty years is an incredibly long period of time when talking about
commodity cycles. How could I reasonably substantiate my statement
that silver will be locked in a deficit supply/demand position for
50 years? A permanent shortage. Please hear me out.
The model for determining the length of the continuing silver deficit,
as it would be for any other commodity, is to determine the price
level it would take to encourage sufficient new production and choke
off demand, once inventories are depleted in a practical sense at
the then current price level. While the model may be simple, because
there are varied and numerous producers, consumers and inventory
owners, and potential new owners, all of whom have a specific price
which will alter their behavior and ownership, figuring the net
effect on the market at any time/price is more challenging. This
is, in fact, what commodity analysis is all about. But where do
I get off calling for a shortage situation in silver to last for
the rest of our time on this earth?
It is said that to see the future, we must study the past. Fortunately,
the historical record of silver is rich and well documented. Taking
that rich historical record and applying it to the model for normal
commodity analysis, a shocking future vision emerges for silver.
To look ahead 50 years, it would be appropriate to look back fifty
years to gain a sense of perspective. Half a century ago, at the
end of World War II, total known stocks of silver amounted to ten
billion ounces (with the US government holding 4 billion ounces
of that total amount). At that time, we were just entering an era
of unprecedented global economic expansion that has lasted to the
present. In this era, silver was consumed in a variety of vital
modern applications at a phenomenal rate. Today, known stocks of
silver have shrunk over 95%, to maybe a half a billion ounces. The
nine and a half billion ounce draw down in total silver inventory,
was the result of the persistent shortfall between supply and demand,
which continues to this day. Not coincidentally, the current 200
million-ounce annual deficit in silver mirrors the long-term trend
line average. This continuing deficit is remarkable in that there
has been decent growth in world production of silver over the past
50 years, but obviously not enough to satisfy the surge in industrial
demand.
Herein lies the crux of my permanent shortage argument. If the
world has consumed 95% of total known inventory of silver over the
past 50 years, what will the future hold when the last practical
inventory of silver is depleted at current prices, and supply from
current production must satisfy current demand? If you think I'm
alluding only to sharply higher prices, you are not getting my drift.
I am talking about massive market dislocations that will dominate
the silver landscape for the rest of our collective lives. Here's
why - there is no practical price that I can imagine that would
allow silver inventories to grow by virtue of current production
exceeding current demand. I'm not talking about producing an extra
10 billion ounces, like we had 50 years ago; that will never happen.
After all, that massive inventory buildup took the world thousands
of years to accumulate because there was no industrial demand to
that point. I'm stating we couldn't even produce 1% of that (a real
100 million ounce surplus) under the most extreme conditions. We
are in a box.
Because so much silver has flowed from inventories over the past
50 years (a lot of it uneconomic, as in US government releases at
the bequest of the Silver Users Association, and the leasing scam),
there has developed a structural imbalance between the free market
forces of supply and demand. This structural imbalance is so great
and so well formed that it is impossible to think in terms of a
rational equilibrium price that would balance the supply/demand
equation in a normal sense. I know that higher prices will have
a probable effect on total supply in terms of changes in ownership
of existing inventory, but I am hard pressed to come up with what
the equilibrium price would have to be to balance the deficit once
inventories are truly depleted. This depletion of inventories is
certain because we are in an obvious deficit, but the timing is
uncertain. You can't judge the moment of truth of inventory depletion
in normal economic analysis terms because the main supply at the
margin comes from an uneconomic source - the fraudulent central
bank leasing of silver. Tell me when the leasing ends (as it most
certainly will), and you will probably see a double or triple on
silver that day. But a double, or triple, on silver in a day would
only go a small way to altering the structural imbalance between
ongoing production and ongoing industrial demand. Maybe such a quick
price move may induce some holders to sell, but you can't be sure
of potential buyer behavior. Depending on any number of unknowable
factors, conditions at the time may induce new buyers to overpower
old sellers. So the real question is, what effect would a quick
double or triple have on the behavior of the real producers and
consumers?
We often hear how the supply and
demand for silver is inelastic, that is, changes in the price of
silver do little to alter the amounts used and produced. But there's
a different way of stating that fact. Imagine you are a mine producer
or industrial consumer of silver and you see the price double or
triple. One thought will flash through your mind - what price will
I stop using (or start mining) silver? Say you are Eastman Kodak
and the price goes to $15 quickly. Since there are no substitutes,
is there any price at which you will deliberately shut down your
company instead of passing on costs, albeit reluctantly? If you
are Asarco or Barrick, at what price do you commit years and hundreds
of millions of dollars to open a copper or gold mine to get at the
by-product silver?
This is not to say that there will
not be any response taken by real producers and consumers. There
most certainly will be changes in producers and consumers behavior
that will have an impact at the margin temporarily. But running
down inventory or modifying the refinery mix are short-term reactions.
In a just- in-time world, how much can you run down inventories
by delaying purchase? Besides, this only strengthens my thesis that
a double or triple would result in little if any change to the structural
deficit, and in fact, would prolong it. You see, it will be only
changes in the short term aspects of the market such as uncovering
previously unavailable inventory, delays of purchase and the refining
for silver instead of gold or copper in response to quick gains
in price. The structural deficit will be largely unaffected for
a very long time. The bottom line is the silver market will remain
tight for many years to come, regardless of changes in inventory
ownership and violent price action.
In summary, we have an indispensable
ingredient of modern life in a structural supply deficit that has
been fifty years in the making, with no chance of real balance except
at prices many times current price levels, which in turn are at
an inflation adjusted 50 year low. That alone would represent a
scenario that was bullish beyond extreme. In order to distill my
message I have intentionally avoided reference to the things people
normally discuss in the debate on silver, such as, inflation, currencies,
war, the stock market, hedge funds, Y2K, world economic crises,
etc. I've tried to stick to bedrock fundamentals, industrial production,
consumption and inventories. Silver to me is like the shrinking
water hole on the African plains. When the elephants and lions (Kodak,
Dupont and Fuji) come to drink, all others will be deprived.
Even in trying to stick to one point,
the industrial fundamental situation in silver, any objective analysis
would be woefully incomplete if it did not mention the short position
and the leasing scam. As I have attempted to point out in prior
articles, silver has the largest listed and OTC short position the
world has ever seen, well over a billion ounces. This position is
well in excess of either annual world production or known inventories.
It is absolutely amazing that The CFTC or any banking authority
has not questioned the economic incentive of the shorts. In addition,
another, and separate, billion ounce short position exists via the
leasing scam, which will never, ever be paid back. To this day,
ongoing leasing by the central banks of silver continues to frustrate
the laws of supply and demand, and deepens the structural imbalance,
guaranteeing the permanent shortage.
Aside from the obvious danger to
the shorts, I think it is the paper longs that are in real jeopardy
from the huge short position. How so? With the real silver long-term
situation so tight as to leave you in awe; the last thing this market
needs is the largest paper short position in history. Given the
historical precedence, when the crunch comes, paper longs will not
be able to convert to physical, as their contracts proclaim. It
is just not possible. There is too much paper and too little real
metal. In the crunch, at the watering hole, paper won't hold up.
Not COMEX paper, not any paper. Then we will learn the difference
between paper silver and silver. I can't say when this will happen;
only that it will happen. In fact, I can guarantee it will be the
biggest force majeur in history. Now that I think
of it, holding physical silver offshore would be the most prudent
step a prudent investor could take to further prevent emergency
confiscation of physical stocks. Have you ever wondered why Warren
Buffett went to the trouble of buying physicals held in London?
In the long run, your only defense against the shrinking watering
hole, the permanent shortage, is real silver in a real safe place.
For the record, allow me to state
a couple (not all) of the reasons why I post these articles on the
Internet. One is somewhat selfish, the other is not. First, I am
looking to establish an unquestioned record of what will happen
in silver, based on the true fundamental situation, well in advance
of the market violence I see ahead. There will be plenty of commentary
after the fact, most of which will continue to miss the real story.
Instead, the focus will be on lawsuits, forced liquidations, market
emergencies, accusations of manipulation by the longs, and defaults
on previously sacrosanct contracts. Everything but the real story.
Maybe by stating the true situation up front, the intentional confusion
will be less successful. Second, if my writings convince anyone
to convert even a small amount of money into real physical silver
at current levels, I know I will have done them a favor. If things
get ugly, it may be what keeps them alive economically. If things
stay rosy, the permanent shortage will bestow a windfall. In any
event, the long-term risk reward is spectacular. A thousand ounce
cash position can only lose a negligible amount in the worst, worst
case. In a best case it could buy you a car, or even a house.
Ted Butler
14 November 1998
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