TED BUTLER COMMENTARY

April 15, 2008

Super Concentration

(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

On the surface, there was nothing particularly remarkable in the latest Commitment of Traders Report (COT). For positions held, as of the close of business April 8, there was little change in the total net commercial short position in either COMEX silver or gold futures from the week before. Basically, the commercials, as a group, have bought back around 14,000 net contracts in silver (70 million ounces) and 50,000 contracts in gold (5 million ounces), on the engineered sell-off over the past few weeks.

But beneath the surface, an entirely different picture has emerged. In spite of the recent reduction in the number of contracts held short in the commercial category, the true concentrated short position held by the largest traders in COMEX silver and gold, in percentage terms, has reached a dramatic new level. Never have the four and eight largest short traders in COMEX silver and gold held a larger percentage of these markets. Please allow me to explain how I arrived at this conclusion and why this super concentrated position not only continues to prove an ongoing manipulation, but also continues to represent a clear and present danger to the integrity of the market itself.

In order to fully appreciate the extent of the real concentrated short position, one must first reduce the total gross open interest down to the truest net open interest possible. This is done by subtracting all existing spread positions from the total open interest. (A spread position is a simultaneously held long and short contract held in different months of the same commodity). This is a valid exercise because spreads have no bearing or influence on the flat price, namely, whether the price may go up, down, or stay the same. Spreads only reflect and influence the change in the differences of the various futures months traded.

Unfortunately, the CFTC only provides spread positions for one of the three categories of classified traders, the non-commercial traders. Spreads are not separately broken out for the commercials and non-reportable traders. But, since we know that the commercials and non-reportable traders undoubtedly hold spread positions, we must calculate the likely amount of spreads held by these two categories and deduct those assumed spread positions also from total open interest.

Without getting bogged down in the specific details, my calculations show that by removing all the spread positions of all three categories of traders in the current COT for silver and gold, the true net futures open interest in silver is 85,000 contracts (or less), while the true net open interest in gold would be 267,000 contracts. Applying these true net total open interest figures against the net concentrated short positions given in the COT for silver and gold, one can easily deduce the true concentrated net short positions in percentage terms. Those percentages, quite clearly, are unprecedented and simply astounding.

Net of spreads, the concentrated net short position of the four largest traders in silver is 66% (and almost 64% in gold), with the eight largest traders at 80% for both silver and gold, for the entire market. Let me restate that - the four largest short traders in silver hold and control 66% of one side of the entire market (64% in gold), while the 8 largest traders in silver and gold hold 80% of the entire market. (For those curious about concentration on the long side of silver and gold, the longs hold less than half the concentrated positions of the shorts in silver and gold. In other words, there is no unusual concentration on the long side).

To my knowledge, the current silver (and gold) short positions, expressed in percentage terms of the true net open interest, are the highest concentrations in history of any major market. How the regulators can turn a blind eye to this obvious manipulation is shameful.

A few months ago, the CFTC responded to one of my (many) complaints by saying they didn’t consider the concentrated short position in terms of days of world production, even though that normalized the comparative concentrated short positions of all commodities. By inference, they concluded that they only considered the concentration data in terms of the percentages of the total market, since that is how they calculate and publish the data. Fine.

All I am presenting (as I have previously) is that they should disregard all the spread positions to determine the true net total open interest upon which to base their concentration percentages. This is logical and very easy for the CFTC to do. This methodology will present a truer picture of real concentration. This should be a worthwhile and more meaningful measurement for the regulators. I shouldn’t have to keep pointing this out to them.

Look, I understand that these concentration calculations of mine cause most people’s eyes to glaze over, no matter how simply I try to present them. But they shouldn’t cause the regulators’ eyes to glaze over, even if I am the only one raising the issue. This goes to the very heart of manipulation and market integrity. There can be no issues more important.

Concentration is at the heart of every manipulation. There can’t be a manipulation without a concentrated position. The root cause of every manipulation throughout history has been a concentrated position. Therefore, clear evidence of concentration should raise regulatory awareness and attention to the highest levels possible. What evidence could be clearer than source data from the regulator itself?

The threat to market integrity is equally clear. Integrity is all about being truthful, open and fair. A large, uneconomic and concentrated market position distorts the price and the market itself, especially when concentrated position holders are allowed to hide their identity. It is the antithesis of the qualities of a free market.

Ask yourself this - how could 8 or less traders holding 80% of an entire major market not be manipulation, in and of itself? And considering the collusive and dirty tricks these big traders regularly pull off, how could their motive be economically legitimate? Further, if it turns out (and the CFTC has certain current knowledge of this) that the big 8 shorts in COMEX silver are largely, or identically, the same as the 8 largest shorts in gold, then it should be obvious to all that these traders are crooks. Period.

On a more positive note, I have reason to believe that all this may not be completely ignored by the regulators for much longer. As I wrote previously, I won’t hold my breathe waiting for the regulators to do the right thing. But neither do I intend to withhold praise if they do take steps to forge a constructive resolution to what is a very difficult market situation.

Too Good To Be True?

Some of the saddest experiences of my life have been in witnessing those unfortunate situations where innocent people lose a big chunk of their life savings in some type of financial scam. I know many would say that people always get what they deserve, or that the victims should have done their homework, but I don’t think that’s always true or possible. Maybe I just have a soft-spot in my heart, but often I think the victims were innocent and were unfairly taken advantage of by a slick con.

Remarkably, the biggest scams seem to be those that promise just a little bit more of a return than legitimate investments. I guess the lack of really outrageous promised rewards tend to put many at ease. I think more have lost money in fraudulent schemes that promise just one percent greater interest than could be achieved in conventional deposit alternatives.

Whether it’s by reaching for that extra one percent, or falling for more of a pie in the sky return, there is much truth in the expression that if it sounds too good to be true, it probably is. The only real defense that most people have to protect themselves is common sense and investigation.

This is a lead-up to pool, certificate and unallocated storage accounts of silver (and gold). I am troubled that there has been no apparent follow through to my constructive solution that investors in these programs should insist that serial numbers for all 1000 oz silver bars be published by the issuers. I am aware of no acceptance or rejection of my proposal. I distinctly remember that within days of my public suggestion that Barclays list the serial numbers and weights of the silver bars held in their ETF, I was receiving e-mails from readers who attached confirmation from Barclays that they would soon do so. This time, nothing.

Let me be open and clear in my motivation for continuing to raise this issue. I write extensively on the merits of silver as an investment. As a result, I know that may have influenced many to buy silver. But I also know that if someone buys the wrong form of silver, he or she could lose everything. That must be avoided.

Common sense should tell you to be wary of programs that don’t charge any fees to store your metal. After all, it costs money to store and insure metal. There is no legitimate reason why anyone would do it for free, other than there is no metal being stored for you.

Even the payment of storage fees does not guarantee that real metal exists and is being stored for you. We all got confirmation of that in the Morgan Stanley class-action settlement. Don’t be lulled into complacency by the payment of storage fees alone into believing actual metal is being held for you.

There is only one fail-safe method to insure real metal exists - the serial numbers. We are fortunate that all 1000 oz silver bars have a unique serial number and hallmark and specific weight. Use your common sense and get those serial numbers on every bar stored for you. No exceptions, or excuses or alternative explanations of any kind for any type of storage program. To not insist those unique characteristics be provided to you is simple personal negligence on your part. If you can’t get the serial numbers, I assure you that the silver does not exist.