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DECEMBER 29 2006 5:30PM PDT - Not much new today. COMEX open interest has dropped by a few thousand contracts once again without apparent rhyme or reason. One thing we do know is that those short of silver on the COMEX have been buying of late (if you don't understand this, please be sure to read to the end of today's commentary). And as I've mentioned in the past few days, the 9 million ounces of new silver in the ETF could also have been shorts buying silver. Indeed, maybe the recent positive bias in silver and gold prices might be explained by short covering. Or maybe not.

Shorts tend to cover around price bottoms except during a "short squeeze" but the latter would imply wildly rising prices and falling open interest whereas currently prices are subdued. Even without a short squeeze, current conditions are certainly favorable for a rally. The key to timing is determining when speculative interest is beginning an upswing. There are still few signs of that among the indicators that I follow but things can change in an instant.

Please keep in mind that my short term speculation that the situation with the silver ETF could soon lead to major price action is just that, speculation. It is based on a single factor -- the massive recent addition to the ETF's silver holdings combined with the nearby ceiling.

In the world of silver stocks, Impact, Arian, Silvercrest and Oremex were big movers today. Arian rose on management outlook although the stock has been a veritable yo-yo of late -- rising and dropping 10% on alternate days -- the trading of which somebody sharp could probably make a living off. In the case of SilverCrest and Oremex, it appears to be a normal reaction to recent selloffs. I'm assuming Impact has just received newsletter or advisor coverage or else some exciting news is on tap. In either case, Impact has room to run and I wouldn't be surprised by further strength after more than a month of being glued to C$1.60.

One other interesting development today. It was announced that Royal Gold has acquired a 2% NSR on the Penasquito project being developed by Goldcorp. Penasquito was basically Western Silver, which was bought out by Glamis Gold and in turn by Goldcorp. Penasquito is expected to produce over 20 million ounces of silver and 300,000 ounces of gold per year starting in 2008. But here is the interesting part. Silver Wheaton has the right of first refusal to buy silver production from Penasquito, which Royal Gold's NSR deal has somehow usurped. How can this be? I haven't done the math, but the 2% NSR for $100 million seems to be a pretty rich valuation and perhaps Silver Wheaton was unable so far to negotiate a fair price. Meanwhile, Royal Gold appears to be looking for "company defining" deals. And unlike many of their recent transactions, this Penasquito NSR does not appear to be capped, resulting in added upside leverage to Royal Gold's royalty portfolio. As for Silver Wheaton, I wouldn't say that the chances for a Penasquito deal have been eliminated by the Royal Gold transaction, but it certainly has become more complicated. Perhaps Silver Wheaton should be commended for its financial discipline in not blindly buying silver production at any cost, especially since Goldcorp is a related party. Such is the forte of companies which go on to greatness in the minds of many investors. Silver Standard comes to mind. In any case, the Penasquito NSR transaction seems to mark the triumphant return of the traditional royalty model to challenge Silver Wheaton's new-fangled approach.

Finally, I'm going to close this year with a hopefully timely discussion of the meaning of open interest as it relates to the futures markets. Those intimately familiar with futures and who therefore can easily explain why a drop in open interest is almost always the result of short covering can probably skip the remainder of this discussion. In upcoming installments, I will try to demonstrate how to properly use open interest and its breakdown, the Commitments of Traders (COT) Report, as an analysis tool in the silver market. I will also show how it is frequently misused to support various opinions and prognostications about silver.

First, a definition of open interest. Open interest is the sum at a particular point in time of all outstanding futures contracts (consisting of pairs of long and short positions) for every delivery month in a particular futures market such as COMEX silver. The term contract also encompasses options on futures as I describe below.

But first, it is important to realize when discussing open interest that futures are not the same as stocks or other financial instruments where (with the infrequent exception of naked shorting) the units of investment are limited by virtue of ownership. What I mean by this is that a share of stock represents ownership in a company, a bond represents ownership of debt, etc. such that the investors or traders cannot themselves change the number of underlying ownership units.

A futures contract, on the other hand, does not represent ownership of anything. Instead, futures simply represent the exchange-guaranteed right to demand future delivery of a specific commodity or instrument at a set price and date, or in the case of cash-settled futures, they represent the exchange-guaranteed right to receive the cash gains or losses of the price movement in an underlying commodity or instrument. By exchange-guaranteed, I mean that the ultimate exercise of the right depends on the exchange itself whether it is the COMEX, CBOT, CME, etc.

More on exchange guarantees later, but for now it should suffice that delivery is never the ultimate purpose of futures but rather one aspect of a much larger set of rules protecting market participants. This fact may be explicitly understood by just a few people but in practice it is assumed by the vast majority of exchange participants who conduct their trading activities accordingly. Those who try to force changes in the arrangement based on a particular interpretation of law are doing so purely out of self-interest and not for the general welfare of the futures markets. Sounds like a familiar theme found in many conspiracy theories, doesn't it?

In fact, exchanges were never meant to be a primary means to take delivery of physical underlying commodities and no futures exchange has ever guaranteed that physical delivery will always be available under all conditions. Instead, the exchanges have discouraged the use of futures contracts as the primary means to buy or sell physical commodities. Their facilities were not designed for this purpose and they are not the most efficient means to do so. The physical delivery process was meant to comply with regulations existing at the time, to instill confidence in a new unproven financial concept, and to encourage commercial hedging by tying contracts to a physical delivery mechanism.

Regardless, what is important here is that futures are derivatives of ownership in commodities and other financial instruments. They are neither actual claims on commodities nor absolute guarantees of delivery. Some people are confused by this. Others get mad when they try to use futures for a purpose for which they were never intended. The rational simply see the futures exchanges as regulated counterparty markets.

In fact, the entire over-the-counter derivatives market is just a larger, unregulated, private version of the futures exchanges. The main difference is that regulated futures are exchange-guaranteed whereas OTC derivatives have no counterparty guarantees. Thus, futures have very little counterparty risk whereas OTC derivatives have significant risk.

To contain this counterparty risk and therefore minimize OTC derivative premiums, several international banks act as de facto counterparty guarantors in the OTC markets similar to the guarantor role of the futures exchanges. This is one of the main reasons why OTC positions are concentrated in the likes of JPMorgan Chase, Citibank and a few others. It is still open to debate whether such concentration of derivatives exposure in a few players actually reduces systemic risk. The fact is, however, that the present arrangement has been able to absorb shocks like the bankruptcy of Enron and several hedge funds which were all major players in the derivatives markets. But I am getting far off the subject.

The main point to keep in mind is that derivatives are unique in the financial markets in that they are a zero sum game; one's profits are always equal to another's losses. From this observation flows several key distinctions between futures and derivatives and other financial markets. Some are obvious and others not so obvious, but failure to understand any one of them will usually result in falling prey to misconceptions which are likely to lead our analysis astray.

Let me provide an example using open interest, which is the whole point of this discussion. It may seem counterintuitive, but the act of buying futures or selling previously bought futures will have no determinable impact on open interest. Why? The simple fact is that buying a futures contract does not necessarily initiate a new futures contract. It all depends on the seller. It is the seller who determines whether the contract you are buying is an existing contract (which is the same situation as when it comes time for you to sell the contract you are now buying) or a "new" contract.

By new contract, of course, I mean a contract which the seller does not actually hold. When a seller shorts a futures contract, he or she is in effect creating a new contract out of thin air. Meanwhile, the buyer doesn't know the difference. In reality, this is a simplification of what actually happens at the back office of the futures exchange because the settlement process typically credits and debits contracts in a fungible manner much like how a bank records activity in a checking account. Account balance and open interest are figured by adding together the pluses and minuses. But these details are not relevant in understanding the big picture.

What matters is that every increase in open interest is always the result of a new short contract and every decrease the result of covering a short contract. Shorts can sell contracts they do not have to buyers and thus they create new supply, or they can buy contracts to cover their short position and thus remove supply. In contrast, longs cannot change the total quantity or supply of futures contracts -- as represented by open interest -- with their buying or selling. They may change open interest if the shorts "accommodate" them by selling short a contract. Otherwise, the long will buy from another long without changing open interest. Consistent, aggressive buying between longs without accommodation by shorts typically results in a fast rise in price. This may seem like a good thing at first except that very few longs are actually able to acquire futures on the cheap before prices rise very far. Thus, the action of shorts in selling to the longs is truly an accommodation -- more longs are able to acquire the futures at a desired price then would be the case otherwise. What makes futures and other derivatives unique is that such accomodation is impossible with financial instruments based on ownership.

This is all very interesting, but there is more. It is important to realize that it is the longs who actually initiate every trade in futures. Why is this? No sale occurs without a corresponding buy, that's why. A short always needs a long to complete a transaction. On the other hand, a long does not need a short since he or she can just buy from another long as I've described above.

What we really have in the futures market is a delicate balance of power. The shorts control the supply of futures but they need the cooperation of longs. Meanwhile the longs can theoretically buy and sell between themselves, making the very existence of shorts temporarily irrelevant, but in reality the longs can never truly know from whom -- a short or another long -- they are buying at any point in time.

Before you think that one side or the other has an unfair advantage in this relationship, remember that it is just the natural way the future markets work. Besides, the shorts actually have an arguably tougher time since their risk is unlimited (prices can rise to infinity) in contrast to the longs whose risk is limited (prices can only drop to zero). This is one of the reasons I personally almost never take a short position other than with a put option where my risk is limited to the option premium.

As I hinted above, the definition of contract in the futures market may include or exclude options on futures. Options are simply the right to buy or sell a futures contract at a particular price before expiration of the option. Options are bought and sold at a premium which represents both the actual and the potential profit in the underlying futures contract. Think about actual profit, which is called intrinsic value, as the right to pay less than the cost of a futures contract, sort of like a grocery coupon with a cash value equal to how much you save when buying a product. Think about potential profit, which is called time value, as the right to delay your purchase until (and if) the price of the futures contract changes so that you can pay less than its cost.

In reality, most options are actually purchased "out of the money", meaning that they don't have actual profits or intrinsic value, and the option buyer is simply hoping for future price changes to move the option "in the money". Using the grocery coupon example, It might be useful to think about an option on futures as a coupon with a fixed product price. For example, let's consider a coupon which allows the shopper to purchase a box of cereal for $3.00. If cereal today costs $2.50, the coupon has no intrinsic or real value. But if that box of cereal was $1.50 two weeks ago and $2.00 last week, the possibility that cereal prices may climb above $3.00 a box sometime soon means that the $3.00 coupon might in fact represent a future savings. And the more time to the expiration of that coupon, the more likely that cereal prices could climb above $3.00, and therefore the higher the "time" value of that coupon. Buying such a coupon for a few cents today may result in many cents or even several dollars of future savings if prices move enough in the right direction. This is precisely the same thing that option buyers hope will happen.

Okay, let's get back to open interest. In effect, options are precursors to futures contracts even though they rarely get exercised into futures. Similarly, futures rarely get held for delivery of the underlying commodity or financial instrument. There are times when it is valid to lump options with futures and times when it isn't valid to do so. Furthermore, there is often confusion about exactly what a particular open interest figure represents because the inclusion or exclusion of options isn't always identified. I typically include options when I use the term open interest without saying so and therefore I am also guilty of the prevailing confusing practice.

In conclusion, I've tried above to lay the foundation for my upcoming comments about the very important implications of the basic operation of the futures markets, open interest and Commitments of Traders Report for the analysis of COMEX silver. Many commentators who study this market have failed to keep these basic relationships in mind. Although I didn't point out specific examples of this yet, the above discussion makes several of the mistakes self-evident. Hopefully as more and more silver investors become aware of the improbable and faulty conclusions these basic mistakes have engendered, the quality of the true investment case for silver will become more and more apparent.

In the meantime, have a very Happy New Year and let's hope for silver to be triumphant in 2007!

DECEMBER 28 2006 1:00PM PDT - Subdued, positively biased action continues in gold and silver today. Sabina, Arian, Aurcana and Excellon are among the biggest movers with no news out so far in a week many investors and traders take off traditionally. I will keep today's commentary short but I did want to point out an alternate viewpoint to the BRIC (Brazil, Russia, India and China) consensus with respect to their ongoing and future influence on commodities - Will India Consume Commodities?

Lastly, my supposed schooling on monetary theory and related matters by Mr. Gnazzo has now invaded the far reaches of the Internet as it greets me everywhere I look. Other than the fact that Mr. Gnazzo tries to make me look like an idiot, which in due time necessitates a defense and counterattack, I am actually quite thankful for the publicity. Frankly, I wouldn't mind being known as the anti-conspiracy theory crusader in the PM circles although I really don't have the time or taste for it. Here is the thing about fighting conspiracy theories. Those who have become indoctrinated by them -- and are most in need of opening their eyes -- you will never convince otherwise. So why bother? There is no direct financial gain from doing it. But perhaps challenging it and offering alternate viewpoints may lead to the PM sector gaining respect as an investment asset class so that more people will become involved from every walk of life -- before the predicted manic blowoff stage. Some of these people might look for ideas and advice other than from those who currently dominate the Internet discourse - the Gnazzos, Sinclairs, Turks, Murphys, Embrys and their comrades in arms. I guess I could see how a challenge to this status quo could get Mr. Gnazzo and other conspiracy theory purveyors working themselves up in a tizzy.

So let me simplify all of this in a way that they cannot. The reason I would even consider a crusade is because I want more people like me to benefit from the investment opportunities presented by silver. Their success is my success. This is no big secret -- look at my mission statement below in the section "Dear Silver Investor".  In the alternative, I could be quite happy -- if not as successful -- trading against the conspiracy consensus should it endure.

DECEMBER 27 2006 1:15PM PDT - With oil down, industrial metals and the dollar waffling, gold and silver took advantage of their internal momentum and continued higher today. Not much new to report today fundamentally speaking as the silver ETF's travels continue to be ignored on a wide scale. I am maintaining a very short term speculative position in the electronic GLOBEX silver contract, having decided not to switch to the COMEX contract even though my protective puts are COMEX puts. It looks like this week will conclude with an upward bias for gold and silver prices and the beginning of the New Year should be interesting.

Not much to report on the silver stock front and this situation is likely to hold until next week. Quite a few silver stocks continue to be in a buying zone should the silver rally recommence next spring. One thing to watch out for is not to put all your eggs in one basket especially with any particular emerging junior producer. Some of these junior producers will have startup and production ramping issues, which are unavoidable even with the best laid plans, so to be overweighed in any one or two could be a risky proposition. Most operational problems which could pop up are likely to be temporary but it doesn't take much to make a particular stock a laggard in a hot market. The more aggressive the production goals of a company, the higher the risk especially with projects that lack a significant resource estimate. Again, this is only something you should think about -- without getting carried away -- in advance of a spring rally and then only in terms of making sure you are properly diversified in your silver stock portfolio. I am by no means suggesting you should avoid the emerging silver producers as a group since they should significantly outperform the average silver stock in the next 6 months.

Now to a topic near and dear to my heart (not!), the conspiracy theory debate. On December 19, I wrote a screed about the abundance of conspiracy theories which are "infecting" a perfectly healthy and normal bull market in gold and silver. I did this not because I had or have an agenda to disprove conspiracy theories, for which I neither have the time nor do I think there is a good reason to do so, but rather to persuade investors to ignore punditry, dogma and sensationalistic publications of personal credo and instead think for themselves. The argument is that a thinking investor who is able to put together the pieces of the market puzzle by him/herself will be able to take advantage of whatever opportunities are available at any point in time vs. waiting (and meanwhile being wrong) until a particular consensus theory seems to have been proven right -- solely by the passage of time. Well, I received a few e-mails from annoyed silver bugs who thought I was too harsh on the conspiracy movement when I used such inflammatory words as "nonsense", "weird", "lazy" and "cult-like". In response, I did not apologize but rather took the e-mailers to task by expanding on my argument to the point of causing mental fatigue, exhaustion and acquiescence. I refrained from debating the merits of a particular conspiracy theory since my very point was that there is no way to win against well-constructed circular logic. Instead, all I need to make the very argument irrelevant is demonstrate the circularity and speciousness in a brutal and honest manner, something that is exceedingly simple to do.

Well, lo and behold, one Douglas Gnazzo of Honest Money fame has taken me behind the shed for a public execution with his Szabo on Conspiracy Theory: A Rejoinder. I suppose this is revenge for an earlier sneak attack I had made against his Gold Reserve Audit 2005 piece with my timely reply. I should point out that I have nothing against Mr. Gnazzo who seems to be a perfectly nice gentleman, has apparently studied a lot of monetary history and economics and is quite well read. I also have nothing against honest money or any constitutional interpretation holding that only gold and silver coin are legal tender. Then again, I see little benefit to railing against modern economics or monetary gymnastics in an investor forum. Identifying possible outcomes and discussing the appropriate investment strategies, yes. Charades, lawsuits, slander, fabrications, sensationalism, self-promotion, pseudo-patriotism, moral relativism, no.

Here is the deal. I will not debate the detailed merits of any particular conspiracy theory since my December 19 commentary -- despite, in spite and because of Mr. Gnazzo's protests -- has proven the slippery slopes of that approach. My point was to prove that regardless of the logic of an argument against conspiracy theories, a seemingly logical response can always be made, to which one could counter-reply logically and get yet another logical response. Once the logic is exhausted on both sides, the burden of proof will have been reduced to truism or dogma, bringing the whole argument full circle, only to be repeated again. And again and again if one enjoys mental masochism. This situation exists because the two sides are essentially debating secret motivations, intentions and plans -- to wit, conspiracies -- which by definition are not personally known, or provable beyond a reasonable doubt, by either side. Yet it is the logic of the conspiracy theory itself which eventually becomes corrupted by the contradictory, nonsensical, self-serving and sometimes downright silly statements out of the other corner of the theorist's mouth. This is true whether the argument is at the philosophical level which is how I tried to demonstrate it or in respect of a particular piece of fact, evidence or information that is in contention.

I give credit to Mr. Gnazzo for his clever attempt to dissemble my point by disassembling my words but all he has done in fact is to prove the very thing that I have contended. For those who can't see this, I will try to post a more detailed reply in the next few days. And God I hope this doesn't turn into a conspiracy theory debate!

DECEMBER 26 2006 3:45PM PDT - With the dollar up and oil down, gold and silver nevertheless gained ground today apparently based on geopolitical concerns.

The silver ETF's addition of 9 million ounces late last week finally got some coverage from Gene Arensberg at Resource Investor in his weekly Got Gold Report. He says the addition to the silver ETF represents positive money flow and strong retail investor demand but I don't necessarily agree with that statement at this point. See, the silver ETF traded under 350,000 shares on December 21 and 22 and under 250,000 shares today. That is under 950,000 shares for three days and therefore less than 9 million ounces of silver. We must, however, also remember that most of the daily trading is back and forth and not the purchase of newly issued ETF shares from the dealers. In fact, normally it might take several weeks if not months to work off that many new ETF shares. So, why did the dealers acquire 9 million ounces worth of ETF shares if there wasn't immediate demand for them? That is where the real mystery lies and it is the key to understanding what this massive addition means. In my personal opinion, these shares were either used to liquidate existing short positions or acquired for the portfolio of a dealer or its client. This of course is pure speculation but if true, it could mean that the funds are positioning themselves for another run at silver.

With the latest COT report showing a decline of around 6,000 COMEX silver contracts, basis and futures spreads acting within a normal range, silver lease rates low with little variation, it appears all quiet on the silver front. But we shouldn't be lulled by these things into believing that a few indicators and measures are capable of predicting the dynamics of a market such as silver in which numerous forces operate behind the scenes. Instead, we should always look for the footsteps of these hidden forces which can become visible at times. Is the 9 million ounces of silver added to an ETF with only 9 million ounces of headroom such a footstep? Only time will tell.

In the meantime, I continue to look for other footsteps although more carefully after the Cannington mine debacle. There is one interesting thing about the Cannington mine, however, that perhaps still bears keeping in mind: its production of silver (and lead) has been apparently declining in the past year. Okay, so it's just one mine. But then we look at something like Mexico's silver production sharply lower in October and maybe it isn't an isolated incident. With silver production lower - although perhaps more of a temporary phenomenon and not a confirmed long-term trend - at both the world's largest silver mine and the world's largest silver producing country, we might want to be paying closer attention to possible disruptions to silver supply.

Two more topics for today. First, finally I've been able to track down some information on U.S. Silver and its acquisition of the Coeur complex in the Silver Valley, Idaho from Coeur d'Alene Mines in June 2006. Apparently, U.S. Silver has agreed to merge with a Canadian trading shell (Chrysalis Capital III Corporation) to monetize its equity presumably so that U.S. Silver investors can sell their shares down the line. Too bad U.S. Silver was unable to keep itself in the U.S. like McEwen's U.S. Gold. Oh well, Chrysalis (the quote is CYX-P.V on Yahoo!) or whatever it is renamed looks to be the next silver stock. Unfortunately, I don't have enough information to determine whether the recent trading at C$0.68 is a good price or not, although the merger with U.S. Silver looks to create around 150 million outstanding shares so without more information my present guess would be "no". I do, however, like companies with their asset base in the U.S. because a US dollar collapse against other currencies would be leveraged by operations on U.S. soil as opposed to foreign operations which would have little to show. More on this concept later as it requires a bit of explaining. But for now I plan to keep my eye on this U.S. Silver/Chrysalis development. Even though neither company seems to have a website or widely distributed news release, I was able to find this courtesy www.silverminers.com:

CHRYSALIS CAPITAL III CORPORATION PROVIDES FURTHER DETAILS ON THE ACQUISITION OF U.S. SILVER CORPORATION AND COMPLETION OF U.S.$6.9 MILLION PRIVATE PLACEMENT BY U.S. SILVER CORPORATION.

Second, I wanted to mention something here that I originally wrote on another venue because I think it is important information. It is about China, silver, the silver ETF and shorting silver.

China Short Silver?

Before I get to China, let me talk about a group of confirmed silver shorts. Rumors have started flying recently that the silver ETF has become a primary tool in the arsenal of silver shorters. These rumors are actually quite familiar to me since I am one of the people spreading them! I could spend days (and I have, believe me) talking about the silver ETF but after all the ugly and boring details it would simply come down to this. The silver ETF may be an in-demand product for retail and institutional silver investors but it is much more of a trading tool for the dealer pack. I don't see this as a nefarious thing but rather something to be aware of and to understand before concluding that the ETF is the greatest thing since sliced bread or a valid substitute for physical silver. The biggest mistake of all is to assume that the ETFs are a 100% positive influence on prices. In fact, there is a dark side to an ETF, which is that a dealer long position is almost always covered by a short. This should not be surprising to those who understand how the markets work.

Now let's get to China, which is much more difficult to establish as a silver shorting enterprise despite speculation by Ted Butler, me or anybody else. I personally believe China is short silver by virtue of having borrowed it on international markets. There is no factual data to support this, only indirect indications. But even if correct, we don't know how much silver is left in Chinese government and industry stockpiles and so whether the silver borrowing is backed up or will have to be repaid through future purchases of silver on the international market.

The Chinese apparently don't rely on bullion banks to intermediate many of their transactions so they could be truly net short the metal if the stockpiles aren't there. That would be incredibly bullish for future silver prices but would also be a rather unusual situation (being naked short silver). I know many so-called silver experts believe naked shorting is a huge problem in the silver market, but I'm not one of them. Instead, I believe the huge problem is a growing global position size amid a shrinking available supply of physical silver. To fully appreciate my position, please allow me to digress a bit.

Cartels, cabals, the ETF and China aside, being short in silver as in many other commodities is mostly a function of fiddling with or hedging forward production. For example, a typical transaction might involve a silver user or cooperative securing forward supply 6 months or a year out (this used to be 3 to 4 years) with smelters or directly with mining companies. Doing this would usually involve a significant premium (along the lines of contango in futures) but bullion banks will offer to cut this premium if you let them counterparty the transaction, so why not? This is where the arbitrage and derivative games start as the bullion banks will actually take the client's forward purchase as their own, creating a synthetic long position which is then hedged by an offsetting short position. In turn, the counterparty taking the short position -- who is now long silver -- might hedge all or part of that long position with a further short. And on and on.

If you understand this, you will see that essentially what happens is that one long position (the mine's or smelter's forward product) has created possibly several multiples of additional long and short positions. To the extent some short positions end up with a speculator as the counterparty, the chain is finally broken because the ultimate long position is not hedged. When the speculation involves the COMEX, TOCOM, etc., it becomes visible to the public. But much like the tip of an iceberg, most of the real mass is hidden below surface as a sort of derivatives pyramid which could represent an order of magnitude in open positions compared to the initiating transaction (the forward purchase) and the final speculative position. One of the problems with looking at just COMEX is we don't know what percentage of the total speculative pie it represents. The only true solution to this -- something unlikely to ever happen -- is to require full public disclosure of all OTC derivative contracts and whether or not each exchange position is hedged or unhedged.

The concern is not the naked shorting but rather that the numerous counterparties create a sort of "house of cards". So far, contractions and expansions (think accordion) in the chain of long-short positions have been handled without a problem but it is a quite delicate balance and has a significant risk of collapse especially with tightening silver supply where the margin of error keeps getting smaller and smaller.

The above is why I always say that Ted Butler is essentially right in his conclusion but far off on his mechanics. His short squeeze of naked shorts is the functional equivalent of a derivative collapse due to cascading counterparty failures to settle the end transaction with real silver (remember that it all started with a silver user purchasing forward production to secure future silver supply).

Back to the Chinese, I don't think there is a chain of long-short positions there. I also don't think they are so stupid as to be naked short in a big way, which leads me to conclude they have physical silver to back their borrowings. So why borrow then? Perhaps it helps to view China as a centrally planned system that has succeeded in convincing the rest of the world that various components of their economic machine represent distinct and separate counterparties. What I am saying is why use up the silver stockpile when you can create an entity to borrow which in the normal course of capitalistic business might fail to perform (i.e., go bankrupt) ? That way, you get to have your cake and eat it too!

Centrally planned capitalism may turn out to be the perfect manipulation tool right up until a systemic shock renders it useless. This is the real essence of the Chinese "miracle", once again something that has been missed by 99.999% of the so-called experts. Just look at the Japanese. 40 years of incredible -- and centrally orchestrated -- post-war industrialization and modernization followed by almost 20 years on a "treadmill" economy. Yes, China may have a lot of years left in its miracle if Japan is a guide. But when the fat lady stops singing, there could be a prolonged period of adjustment precisely because centrally planned capitalism is unable to admit its manipulating ways or cope with its mistakes. The U.S. itself is not immune from the risk of central planning (thanks to the Fed) as the exploding deficits in the public and private sectors can attest. Yet our adjustment is likely to be more painful, sharp, severe and consequently over much more quickly.

DECEMBER 23 2006 10:00AM PDT - Correction, Retraction, I was wrong! Cannington Mine did in fact reopen two days after shutting down so it is not really the explosive news story I gave the impression of it being. Everything else I said, however, shouldn't really change at this point, but who knows for sure.

So what happened? It appears Yahoo! Asia, which was the original source of the story, put out a false update on December 19 that claimed the mine was still closed, where in fact it had been reopened two days earlier. The correction appeared on December 21, two days after the false story and four days after the mine reopening. I suppose the lesson here is that news is only as good as the outfit reporting it and confirmation is important before making a significant financial or other commitment. This is something we all know but it helps to be reminded periodically.

And why exactly did I not pick up on the December 21 correction when I did a news search on December 22? The only thing I can think of is that I might have used a search term based on a preconceived notion of reality: "Cannington Mine closure" or "Cannington Mine shutdown". Since the correction was in fact related to the reopening of Cannington, my particular search terms could have influenced the search results. Perhaps this is even a more important lesson than the one above because the tendency for preconceived, prejudicial ideas to skew our view of reality is not something we all know and understand. Take for example my recent rants on the prevalence of conspiracy theories concerning the PM sector. In many of the conspiracies, it is a suspicion arising from an ingrained belief system which leads to a preconceived, prejudicial and selective search for the "truth". Not surprisingly, this often leads to insular, partial, biased and plain wrong conclusions which nonetheless seem to have an absoluteness to them thanks to the fact that the results were exactly what was expected. In these types of circumstances, it doesn't take much evidence or proof to convince ourselves of being right. Even trying to be careful does not guarantee avoidance of the perception trap since it is an integral part of how our minds understand the world around us. All we can do is be vigilant, open minded, self critical and willing to admit when we are wrong.

With that, once again have a Happy Holidays and hopefully I won't have to make another correction before next week!

DECEMBER 22 2006 2:00PM PDT - I did buy some CME GLOBEX silver futures this morning after the COMEX closed early. I haven't traded this product in a while and was pleasantly surprised at the speed of the fill. It's not a perfect offset to put options on the COMEX but it will have to do for now. Plus it is so darned easy to trade with it being open 23 hours a day and with instant fills right at the ask. I don't follow the depth and liquidity of this market but I might just have to consider moving some of my afterhours and electronic trading to this platform from CBOT. I'll let you know if I come up with anything useful but in the meantime I would appreciate hearing from you about any experiences, good or bad, trading silver either on the CBOT or GLOBEX.

Okay, here is what I have to say so far about the silver ETF today given the surprise 9 million ounce addition yesterday that was first reported here this morning. 121 million ounces is 9 million ounces short of the ETF's limit and there is no indication when the additional 150 million ounces will be available via the registration of 15 million more ETF shares. Since there are just 9 million ounces left to be issued, that means one more day like this and the ETF will enter into a very interesting and perhaps unique situation for the silver market. I don't just yet know the entire implication and it all depends on the underlying physical demand, but if I had to guess, there are probably some rather sophisticated individuals and organizations who are watching and they could easily irritate the situation with some concerted action.

How? Well, remember that the market makers have an incentive to arbitrage the ETF price to match the physical price of silver. But if they can't create new ETF shares because the share limit has been reached and if they also don't hold enough ETF shares in inventory -- which is possible given the current modest open interest on the COMEX remembering my earlier discussion about the market makers using the COMEX to hedge their ETF position -- the market makers' only arbitrage choice in the case buying enthusiasm gets out of hand would be to sell short the ETF shares. Interestingly, this creates physical demand because the market makers have to either go long COMEX contracts or physical silver in order to create the hedging offset. In turn, this could add to the ETF buying enthusiasm and create a vicious circle or vortex where ETF demand spurs physical demand and vice versa. All as a result of market makers shorting ETF shares because they have no alternative. This is completely unlike the situation where there are ETF shares available to issue because buying physical silver, creating new ETF shares and selling them to shareholders is a LAGGING process. On the other hand, shorting ETF shares could become a LEADING process as I just described. In addition, the short position will have to be eventually unwound, creating demand for ETF shares at a time in the rally cycle where normally there might be excess supply. Given all of this, it probably doesn't take too wise a trader to figure out how to take advantage of this to drive silver prices higher. Hedge funds live for this sort of situation. Keep in mind they lost the battle to squeeze silver supply this past May but I don't think they have given up on the war.

The alternative is a vast decline in ETF liquidity as bid and ask spreads grow too wide and market makers are unable or unwilling to do anything about it.

Or, maybe nothing at all with happen and this is all just a statistical anomaly.

Personally, I give odds to the first scenario and that is why I jumped into a risk free long futures position this morning. Then again, I don't have the conviction of taking an outright leveraged position on such idle speculation.

On the other hand, the fact that nobody so far today seems to have reported on these developments in the silver ETF is telling of the degree of timeliness and the level of understanding that so-called experts possess in this arena. Certainly if somebody was paying me for my advice about silver, I would feel an obligation to immediately point out what is happening here even if I couldn't construct a trading or investment strategy around it.

This is now the second complete miss this week by the silver community, both with the potential to be extremely bullish. The first, which I mentioned one week ago is the indefinite closure of BHP's Cannington mine due to a fatality and safety concerns, something that presumably should matter in the scheme of things since Cannington is the single largest producer of silver, although declining of late, at roughly 7.5% of the world's annual mine supply. This is the reason I originally included BHP as a "silver" stock even though it isn't really and why I even specifically mentioned the importance of having an inclusive methodology when discussing silver stocks (see Stocks).

Well, I scoured the 'net for the latest on Cannington and this is the most recent piece I was able to come up with: BHP's Cannington mine idle as worker death probe. It is from Tuesday but let me quote from it a bit:

"...mine remained shut indefinitely pending the outcome of company and police investigations, four days after a worker was killed.."

"...too early since the closure of the world's biggest single source of silver to determine if shipments of metal to customers would be deferred or the more serious declaration of force majeure would be declared."

"...too early to say how long the mine will stay shut because the investigations are now underway..."

Now, BHP may not be a silver stock but you can't tell me this situation isn't relevant to silver investors. Combine it with the latest mega-increase in ETF holdings of silver and it could even be considered a likely source for trading advice. Hello advice givers, anybody out there?

Personally, if I had a super short term alert flag (less than 1 month) for extreme speculators and experienced traders, it would be a firm shade of green at the moment. As it is, only experience and better judgment is keeping me from changing my short term alert flag to green. Things can change quickly.

Oh well, maybe everybody is off to holiday. Which reminds me, have a merry, happy one regardless of the tradition you follow!

DECEMBER 22 2006 10:00AM PDT - I got a late start this morning so imagine my surprise to see gold up a little but silver up strong with the dollar in midst of a substantial rally. Two seconds later I noticed that the silver ETF has just added 9 million ounces of silver. Not since its third day of trading, May 2, 2006 has the ETF added this much silver in one day, so this is a very interesting development. I have not had a chance to check any news or other indicators as I instinctively went to my futures account to establish a couple of long futures positions against in-the-money puts, which is my favorite (safe but not always very profitable) way to create a leveraged speculation in short-term silver price movements. Unfortunately, the COMEX is on holiday hours and closed early so if I am really serious about this I will have to use an electronic exchange. I will continue this discussion later.

DECEMBER 21 2006 1:30PM PDT - Metals weaker once more today with copper leading the charge having fallen below several support levels. And even though the metal declines have not been that bad, gold and silver stocks are not liking what they are seeing. That is, with a few exceptions like Impact which seems to be glued to C$1.60 and MAG Silver which is on a tear, now over C$6.50.

On the other hand, stocks like Mines Management don't look like such a hot area play at the moment, with falling copper prices and significant environmental concerns continuing to surface. In fact, there are rumors that Revett Minerals (in which Silver Wheaton recently took a stake) and Mines Management have recently become embroiled once more in an intriguing game of cat and mouse. The issues are whether there is space from an environmental perspective for 2 massive mines within a small area of pristine natural habitat, concerns about drainage of lake water into one or both mines, and just exactly who is ahead in the permitting process. An overtone to all of this is the apparent repeated past efforts by each company to explore a merger. Frankly at this point, only ego should be standing in the way since, logically speaking, pretty much any other alternative would be inferior. I currently own Mines Management.

An interesting blog appeared today in which the author explores the use of gold in coinage during the Roman Empire and concludes that in fact gold was not considered money but rather silver and bronze were. The implication is that gold is only money in the minds of men and there is nothing inherent about it that makes it the perfect medium of exchange, especially in today's world. I think this is a good one-sided argument but it fails to consider a number of factors, perhaps the most important of which is that gold is still considered as the de facto currency of last resort by the majority in the world's monetary authorities. So while it is true that gold (or for that matter silver) will never be used as pocket change to pay for milk or gas, the utility of gold (and silver) as monetary tools and exchange regulators is certainly bound to increase in the future.

At a minimum, gold and silver will likely be used in the future as a bridge between failing currencies and their replacement monetary schemes, unless of course the monetary metals become the world's reserve currency in place of the US dollar. In this regard, there is only one reason they should do so -- gold and silver are the only transportable form of wealth that citizens have consistently trusted throughout history, especially during social and financial crises. Even the blogger admits this while failing to see the implications in pointing out that Caesar bought the protection of his mercenaries with gold. Indeed, during times of war or cross-border strife, only one medium of exchange is respected by all combatants and readily accepted by third parties as payment for war materials -- the monetary metals, gold and silver.

So in fact there is no reason to expect gold and silver to function in the future as money during prolonged periods of peace AND public confidence in government. But if there is war (whether the weapons are guns and bombs or merely financial) and public confidence falters at the same time, having 10% of your net worth in physical gold and silver in your own possession is the best -- and possibly the only available -- insurance. Ideally that gold and silver should be hidden, confidential and spread between a few secure locations. Now I will be the first to admit that the probability of this insurance paying off (hopefully) is remote during any one lifetime, but I guarantee that it will pay off for someone at some point in the future. Therefore, it is very important to instill the discipline of "10% gold and silver" in the minds of family and friends if you wish to leave behind a lasting financial legacy.

DECEMBER 20 2006 10:30AM PDT - Dollar firming at the moment with gold and silver off slightly. Not much new to report. MAG Silver is on a tear as it continues to have success hitting veins at depth and strike. Along with Esperanza and Silvercorp, this is a solid group of silver stocks to watch for fantastic drill results. You are paying up for them but quality comes at a price these days. I wouldn't overindulge but these companies certainly deserve a look. Esperanza is back in a buy range with no recent news at San Luis. Things can change quickly. I currently own all three.

Today I would like to discuss some common misconceptions about the silver ETF. Often it is mentioned that Barclays added silver to the ETF, but we should remember that Barclays is only the sponsor. The actual selling of physical silver would be done by the dealers after they redeem baskets of ETF shares (50,000 shares or roughly 500,000 ounces at a time) acquired from retail investors. But the fact is, we cannot determine whether trading on a particular day represents retail investors selling to, or buying from, the dealers or whether the volume represents trading between retail investors. And even if shares are sold to the dealers, the dealers will not automatically redeem those shares for silver. In fact, on a net basis dealers have rarely decided as a group to redeem their ETF shares for physical silver. We know this because the silver ETF's holdings rarely decrease and that includes the past few days.

Now here is the interesting part. Suppose that in fact retail investors sold to the dealers. In that case, the dealers may -- instead of redeeming ETF shares for physical metal and selling the silver into the market -- decide to hedge their acquired long ETF positions by means of paper only. They could do this a number of ways, perhaps the simplist being a commercial short position in silver futures on the COMEX. This may, in fact, have a very similar effect to selling the physical silver backing the ETF shares. The same concept obviously works with the gold ETF (GLD) as well as several other ETF products. I even personally confirmed this by speaking directly to some of the trading firms doing it.

I don't know why, but it seems very difficult for many so-called experts to grasp the simple concept of dealers holding ETF share positions acquired for arbitrage against paper short positions on the COMEX and elsewhere. Every PM site and just about every newsletter continues to publish supposed expert analysis in which it is shown that the gold and silver ETFs rarely reduce their official holdings. As if that should come as a surprise once you truly understand an ETF's mechanics! Worse, almost everyone makes the mistake of assuming that ETF holdings remain steady during falling metal prices because ETF investors are a new breed of long-term super investors who cannot be easily shaken from their positions.

To repeat, dealers probably accumulate large ETF share positions during metal price declines which they are loath to redeem for physical metal because of the cost, time delays and effort involved. Instead, the dealers do what they always do best: hedge and arbitrage using paper. It is way more efficient and profitable for them to do so. Understand the implications of this and you will be ahead of 99.999% of your peers in this investment arena. More on this later including possible ways for retail investors to take advantage of the ETF and the dealer arbitrage.

DECEMBER 19 2006 1:00PM PDT - Our obligatory PM bounce continued today as expected with the dollar heading south. This is actually curious given the huge increase in PPI for November (2%) at least appears inflationary. Then again, September and October showed a combined decrease of 2.9% so at this point the PPI is still in the hole by 0.9% on a running three month average.

Silver did bounce off $12.30 cash basis again this morning but it's probably not the double low to confirm that a bottom is in. Meanwhile, many silver stocks are having a great day today as people are apparently buying "the dip that never was".

Today I would like to talk a little about being a contrarian and conspiracy theories. Unfortunately, the widespread indoctrination of conspiracy theory as a way to understand the gold and silver markets has led to a lot of lazy, muddled analysis. Every correction brings out commentary from all corners along the lines of "the cartel is at it again" or "central bank manipulation is back". I'm not sure the people who peddle this nonsense are aware of the fact that these conspiracy theories are creating a dangerous "groupthink" where alternate viewpoints become more and more ignored while the general public is kept at a distance by this weird, cult-like behavior.

But there is a useful angle to the conspiracy theories abounding in the PM sector. The key to this is that ongoing manipulations of the gold and silver price are supposedly so obvious as to be egregious and sickening. Now consider that being a gold and silver bug these days is still to be a contrarian. Couldn't then the manipulation theories be seen as a consensus of the contrarians, or a contrarian consensus? Yet to make real profits in the markets, don't we need to trade against the consensus? But wait a second, isn't the opposite of the contrarian consensus -- contrarian to the contrarian if you will -- really just the same as the general market consensus, i.e. gold and silver are horrible investments? Confused yet about where I'm going with this?

Well, you shouldn't be. What I am saying is that these are really three different things -- the general market consensus, the contrarian consensus and what I'll call the independent contrarian (some refer to it as a "true" contrarian). Out of these three, the only one which can beat the markets in the long term is the independent contrarian. That means not being married to any particular idea, being open-minded and flexible, avoiding obvious or irrelevant truths, thinking for yourself, etc.

Look at it this way. The general consensus is a big crowd. By definition, not everyone can be a standout winner in a big crowd. In contrast, the contrarian consensus starts out as a small crowd so everyone can be a big winner for a while. But sooner or later a successful contrarian consensus, by definition, becomes a bigger and bigger crowd until perhaps it becomes the general consensus. At that point the former general consensus becomes the contrarian consensus. But that doesn't mean the former contrarian consensus has switched beliefs. They have just become part of the general consensus by popularity. Meantime, the new contrarian consensus is actually made up of the old general consensus which has also not changed its mind.

In fact, only the independent contrarian, not married to any particular beliefs, has the ability to straddle both sides. Thus, only the independent contrarian has a chance at making money in the markets all the time. This is the reason why conspiracy theories in gold and silver are the independen