WEEKLY COMMENTARY

January 11, 2005

Same As It Ever Was

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.)

Repetitive, that’s one word. Another is manipulative. I’m talking about the price action in silver (and gold). Once again, significant price movements were dictated by the trading tango between mechanical technical funds and the New York dealers. This is what moves the markets. In the short to intermediate term, it is the only thing that moves the markets.

Specifically, the dumping of thousands of contracts by the tech funds on the COMEX caused the latest drop in gold and silver prices. Certainly, nothing changed in the real world of metals that justified the price movements, just paper trading on the COMEX. Nothing new here.

Also, there is nothing new in the lack of reaction by government regulators, Exchange officials or silver mining CEOs, who all pretend nothing is wrong with pricing being controlled by speculators. As I said; repetitive.

But it would be wrong if you thought I was complaining. In fact, I’m ecstatic. The good news, of course, is that the dealers have been covering short positions aggressively. This, alone, is great cause for optimism about eventual higher prices. When the dealers have covered their short positions in silver, the risk is removed. I think we’re there.

The latest Commitment of Traders (COT) report is revealing. First, there was massive, massive liquidation in gold by the technical funds, with commensurate dealer short covering. More importantly, the massive liquidation continued in earnest from the Tuesday cut-off. I would estimate that we now have much less of a tech fund long and dealer short position in gold, than we had at the bottom in September, when gold was at $400.

From the top, I would estimate that the funds have liquidated 100,000 long gold COMEX contracts, with a big chunk coming in the current reporting week and the three trading days from the cut-off. It should be clear to you that this is what foretold and caused the almost $40 decline in gold from the top. That there are still gold promoters that don’t see this, or refuse to see it, is stunning. This sell-off should have been no surprise to anyone paying attention. On the positive side, gold should be cleaned out, or close to cleaned out, to the downside.

In silver, there was an unexpectedly small reduction in this week’s COTs. There had been a 30,000 contract (150 million oz) reduction in the dealer net short position in the weeks prior to this current report, and I had been expecting a further 10,000 contract reduction in this week’s report, indicating a major low-risk buy point. Instead, the report indicated only a 2500 contract reduction in the net dealer short position and no decrease in the tech fund long position. Or more correctly, no decrease in the non-commercial gross long category, which is where the tech funds are classified.

So what does this mean for silver? While the report could be correct in that the tech funds didn’t get completely liquidated yet, and we still need to witness further tech fund selling amid lower prices, my sense is that is not the case. Also, while it’s possible there may be errors in the current report (we’ve seen that before), my sense is that something else has happened that is of the utmost significance to the near term direction of silver prices.

This is obviously speculation on my part, so please treat it as such. I think that the tech funds were completely liquidated in silver, but the reason the latest COT report doesn’t reflect that, is because some other large (non-technically oriented) traders took their place. I base my speculation on daily price, volume and open interest data for the time period covered in the report.

If my speculation is correct, it could mean that some very strong hands have come into the silver market. This would be a sudden and very bullish development. Accordingly, I see very little reason not to embrace a full bullish tilt towards silver. This is another mother buy point, maybe The Buy Point.

If you still have any doubt as to what really moves the silver market, I invite you to reread prior articles to grasp this Commitment of Trader market structure phenomenon. If you’re short on time, just start with skimming the articles describing the previous major lows in gold and silver in September, staring with, "The Set-Up?" when the dealers had a relatively small short position. This market structure allowed the resultant $60 price rally in gold and an almost $2 rally in silver, which were ultimately capped and reversed with historic dealer scale-up short selling.

As happy as I am to be presented with another one of those "dimes to the downside, dollars to the upside" buy points, there is something even more compelling about the current set-up. It’s hard to pinpoint it, but there seems to be a confluence of factors suggesting that this silver buy point will be the "big one". The one that will make history.

For one thing, there is a widespread tightness in all mineral commodities, thanks particularly to China that just doesn’t seem to be going away. Inventories of all the industrial metals continue to drop, some, like copper, to alarmingly low levels. In addition in copper, the COMEX delivery situation still appears critical. I get the feeling the exchange just barely made it through the December copper delivery process by the skin of its teeth, with behind-the-scenes jaw-boning and private workouts. The COMEX will be lucky if it can make it through the next few months without a copper delivery problem, in my opinion. I keep mentioning this, as a delivery problem in COMEX copper may quickly shine the light on COMEX silver, given that COMEX silver has the largest naked short position in commodity history; a clear invitation to an eventual delivery problem, for a commodity in a structural deficit.

Further, actual silver deliveries to investors are still being delayed. The Central Fund of Canada will not be getting the silver it purchased a couple of months ago any time soon, and I have even heard reports that the other big Canadian institutional investor still hasn’t received all the silver it has been waiting for since early last summer. Remember, delivery delays are a symptom of shortage. While I can’t substantiate it, I get the feeling that the dealers are delivering silver to industrial users, ahead of investors to prevent problems from surfacing. Sort of like emergency room triage.

Silver Eagle sales for 2004 were strong, at over 9.6 million ounces, making it the 2^nd best year in the past 15, and 3^rd best since the program began. All told, when you add in Proof Eagles and other coins and all the commemorative issues by the US Mint, the government is buying a million ounces of silver a month on the open market. This demand should remain strong as far as the eye can see; or at least until a price emergency occurs in silver.

One final note – the gold exchange traded fund, GLD, has seen some impressive real gold accumulation on the gold price swoon, adding one million ounces in a few days. Coupled with the drastically improved COTs, gold could be set for an impressive bounce. As I’ve said before, if there was no such thing as silver, gold would be an attraction for me, particularly now. But with the COTs set up as I believe in silver, plus the always- improving fundamentals, why go fishing when you can shoot fish in a barrel?