TED BUTLER COMMENTARY

May 29, 2007

Raptor Update

(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.)

In last week’s article, The Raptors, I described how that term applied to the smaller commercials that seemed to be outmaneuvering the largest commercial traders which I dubbed the T. Rexs. I speculated that the T. Rex commercials looked increasingly trapped in their massive concentrated net short position, and how this might portend profoundly bullish implications for the silver market. My reasoning centered on this increased dealer competition as an indicator that the long-term manipulation in silver might be on its last legs.

As a result of the article, which I thought long and hard about before publishing, I anticipated the upcoming Commitment of Traders Report (COT) with some trepidation. That’s because if the recent decline in silver (and gold) prices indicated that the raptors were reducing their net long position on the sell-off, then my premise might be wrong, or at least ill-timed. In that case I would have egg on my face and some explaining to do. The COTs, thankfully, were not personally embarrassing. Instead, they confirmed the premise.

The latest COT, as of the close of business, May 22, indicated in the clearest terms to date, just how powerful a force the raptors have become. In both silver and gold, the raptors accounted for the lion’s share of the week’s large dealer net buying. While the biggest traders in gold and silver (both the 4 or less and 8 or less) still have sizable concentrated net short positions, the raptors have sizable net long positions. In fact, the raptors in silver moved to their largest net long position in history this past week – almost 14,000 contracts (70 million ounces).

This aggressive buying by the raptors has highlighted the problem of concentration on the short side by the largest traders. The latest COTs in both COMEX silver and gold futures showed that the largest 8 or less traders had more than 131% and 119%, respectively, of the total net dealer short position. Incredibly, the 4 largest traders in silver had a net short position slightly larger than 100% of the total net commercial short position. Please think about that for a moment.

What this means is that without these 8 large traders in both silver and gold, or just the 4 largest traders in silver, there would be no commercial short position at all. Or stated differently, without these very few traders holding these super-concentrated net short positions, the price would be shockingly higher. You will never see clearer public documentation of manipulation than this. Make no mistake, that this situation, particularly in silver, has been allowed to persist is the single greatest regulatory failure in the history of financial markets. I do not choose these words carelessly.

To be sure, the recent sell-offs in gold and silver have improved the market structure impressively. In spite of the concentrated short position, the market structure is flashing all green. We are in the best COT structure in silver in seven months. The market structure is indicating low risk and high reward. Any further sell-offs will only improve the market structure. This is not a time to be timid, in my opinion.

The only question is that when the coming rally commences, how far will it carry? That will depend on the selling behavior of the raptors and T. Rexs. If they behave like they have in the past, and sell aggressively on the way up, the rally will eventually be capped. But even then, it could run one to two dollars or more in silver. If they don’t sell aggressively, then the rally will carry much further, perhaps morphing into the big one. No one can know the outcome at this point, save perhaps the dealers themselves. The logical way to play it is to assume it is the big one, unless and until the data says otherwise.

A Little Help From My Friends

Since my last post, I have received emails and calls from readers wanting to understand how I arrive at the trading positions of the three categories of commercial traders reported by the CFTC.  Here is how it’s done, courtesy of Carl Loeb.   

1.      The data you need comes from the long form futures only CFTC Commitment of Traders Report, which can be found at http://www.cftc.gov/dea/futures/deacmxlf.htm .

2.      Determine the Commercial Net Short position:  Subtract the Commercial Short position from the Commercial Long position to determine the Net Short position of all Commercial traders.  From the May 22nd report this is 44,471 contracts net short by all reporting Commercial traders.

3.       Determine the number of contracts net short of the big 4 (the ‘T-Rex group’):  At the bottom of the report, you will see that as of May 22nd, the ‘Percent of Open Interest Held by the Indicated Number of the Largest Traders’ is shown as 41.4% for the 4 largest traders, for net positions.  This is the percentage of the total Open Interest held net short by these traders, which for May 22nd, was 41.4% of total open interest of 108,612 contracts, or 44,965 contracts net short.

4.       Determine the number of contracts net short of the 5^th through 8^th largest traders (the ‘T-Rex wannabees’):  In the same section, you can see that the ‘8 or less traders’ were net short 53.7% of total open interest.  This translates to 58,325 contracts for the 1 – 8 largest traders.  If the largest 1 – 4 traders are net short 44,965 contracts, then the 5^th through 8^th largest traders must be net short 13,360 contracts.