TED BUTLER COMMENTARY

July 10, 2006

Shorts To CFTC: Drop Dead

(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.)

Old-timers (yes, I’m one) will know the title of this article is a play on the famous headline, 30 years ago, in the NY Daily News, which angrily described President Ford’s refusal to offer aid to New York City during a financial crisis. ("Ford To City: Drop Dead") It has been said that the headline contributed to Ford being unable to carry New York in the subsequent election won by Jimmy Carter. The author of the headline, William Brink, passed away last year at age 89, but his five words will live on.

I thought of the headline as I reviewed the latest Commitment of Traders Report (COT), which indicated that the largest 4 silver traders had increased their already bloated net short position in COMEX silver futures. As of the close of business on July 3^rd, the big shorts increased their net short position by almost 2400 contracts to an equivalent of over 178 million ounces, up from 166 million the week before. If these big traders didn’t increase their short position the silver price would have exploded. If that’s not manipulation, I don’t know what is. In my opinion, this position increase was a slap in the face to the CFTC by the big shorts, the ultimate disrespect. It also exacerbates an already dangerous situation in the silver market and raises the probability that they will try to rig sharp sell-offs.

I know some, maybe even the CFTC and the COMEX, think I am the one being disrespectful with my constant warnings about the silver manipulation. I don’t see it that way. I know, for sure, that the silver market is, and has been, manipulated and armed with this knowledge it is my solemn responsibility to convey this, much like a weatherman warning of a coming hurricane. I haven’t done anything to create or cause the manipulation and its impact will be felt independent of my warnings. Besides, the CFTC is free to explain why my allegations of concentration are off base, but they haven’t exactly been beating the door down with an explanation.

The largest short traders have created the manipulation and are the ones dissing the CFTC and destroying what integrity is left in the silver market. Either the shorts don’t care what the CFTC might do, or the CFTC has no intention of ever doing anything about this increasingly obvious manipulation. That’s too bad, as these large traders are becoming more trapped and it’s hard to envision how they will avoid default and bring great shame to the CFTC.

As I was preparing to submit this article, the big concentrated shorts resorted to their favorite trick and opened the market 40 to 50 cents lower this morning. You may ask, how did they do that? The answer is simple. The big short traders wait until the market is most illiquid and can be moved by the lowest number of contracts, Three or four o’clock in the morning is such a time and I am certain that the big shorts traders picked precisely that time to sell maybe 100 contracts aggressively to intentionally move the market lower and create a sharply lower open on the regular open outcry COMEX session, when they could harvest hundreds and maybe thousands of stop orders. It also sets a defensive tone for the rest of the day. This is not price discovery, this is price fixing.

In spite of these illegal trading tricks, the big concentrated shorts are having great difficulty in meaningfully reducing their position. In fact, it has recently occurred to me that I have been vastly understating the concentrated share of the market that big short traders control. The true level of the concentrated short position is much more severe than recently alleged by Carl Loeb or me. Please allow me to explain.

There is certainty in computing the total net short (or long) position of the largest 4 or 8 traders to the single contract. This week, for instance, the largest 4 traders held 35,626 futures contracts net short (178.13 million ounces equivalent) and 3.4 times what the largest 4 longs held net, the biggest mismatch of any commodity. Likewise, the largest 8 silver traders hold 44,435 COMEX futures contracts net short (222.18 million ounces) and 3 times more than the largest 8 longs, also a more lopsided short to long ratio than any major commodity. Clearly, if a concentrated position and dominance and control are pre-requisites for any manipulation, silver can only be considered to be manipulated to the downside, as previously written.

But what may have been understated is the percentage of concentration truly held by the biggest traders. You see, the percentage numbers given in the COT report allow one to get the actual number of contracts and equivalent ounces held by the largest traders, but further calculations are necessary to gauge the real percentage of the total market held by these traders.

For example, the current COT states that the largest 4 traders hold 36.4% of the total open interest of 97,874, or 35,626 contracts net short. Likewise, the largest 8 traders hold 45.4% of total open interest, or 44,435 contracts net short. Multiplying by the 5000-ounce contract size gives you the figures in ounces. So far, so good.

But as alarming as a 36.4% and 45.4% share of the total market may be, especially when considering that these amounts are an unprecedented 3 times larger than the corresponding big long holders, these percentages are understated because the total open interest, 97,874, includes all spread transactions.

Since spread positions are market neutral on a flat price basis, they must be subtracted from the total open interest to get to a "true" level of open interest. Basically, spread positions (a combined long and short position) can not be used to manipulate the price of a commodity. No matter how large the spread position may be, since it includes a simultaneous long and short contract, spreads have very little impact on the overall price of the commodity. Therefore, if one wants to determine the true level of concentration in a market, all spreads must be removed first. Even the CFTC recognizes this and separately publishes the spread position of the non-commercials in the COT for every commodity.

(Let me take a moment here to alert all readers that the CFTC is now conducting an open public comment period, through Aug 12, seeking comment and suggestions on the COT Report. http://www.cftc.gov/foia/fedreg06/foi060621a.htm They are actually considering discontinuing the report, which in my opinion would be a great loss. I have written to them about this opinion and suggesting that they include spread data for the commercial traders, as they currently include for the non-commercial traders. I recommend you do the same and if you’d like a copy of my e-mail to them, drop me a note at info@butlerresearch.com and I’ll forward it to you).

If you subtract the non-commercial spread amount (16,185 in the current report) from total open interest, the remaining open interest is 81,689. This increases the 4 traders concentrated net short position from 36.4% to 43.6% and the 8 largest traders from 45.4% to 54.4%. In other words, the CFTC’s own data shows 4 short traders control almost 44% and 8 traders control over 54% of the entire total true open interest.

But I’m not done yet. Even though the CFTC does not include spread data for the commercials (see my suggestion above), we can only guess what the commercial spread position might be. In my experience, it is probably every bit as large as the non-commercial spread position, precisely because the commercials are the market makers when the non-commercials trade the spread market. Therefore to get to the bottom line "net-net" open interest, one must also subtract the commercial spread position.

In my opinion, and only the CFTC and COMEX know for sure, the bottom line true open interest in silver futures, minus all the spreads, is under 66,000 contracts. If I am correct, the 4 largest traders control 54% of the entire market and the 8 largest traders control 67% of the market on a net basis, not the 36% and 45% amounts listed in the COT. This is outrageous and clear proof of dominance and control and manipulation.

Let me put this in perspective, as I don’t want anyone to misinterpret how I view silver as an investment. The control and dominance that the large short traders maintain does not make me bearish about silver’s long term potential, and instead the current depressed level makes silver more attractive. However, only a fool would fail to recognize that on a short-term basis these dealer manipulators could set any price they want, and we must be prepared for that. When prices suddenly sell-off for no good reason, it is always because the dealers have caused it. They will be over run soon enough, and the sure way to beat them is by buying and holding real silver. Real silver immunizes you from the manipulation.

A couple of quick notes. The silver ETF is turning into the "Death Star" that Loeb labeled it. It is up to 88 million ounces and based upon delays in adding silver and COMEX warehouse movements, I am convinced that they have effectively run out of available silver in London for the ETF and must get it elsewhere. If I’m correct, that is bullish beyond belief and may help balance the short-term games being played on the COMEX.

Once again, I admit to underestimating how much silver could be available to the ETF, at prices seen to date, but there is a much more important issue now obvious. That issue is that all silver investors should be profoundly grateful about the amount of silver going into the ETF. Not only does it clearly prove that institutional investors recognize the great value in silver (remember the concerns that there wouldn’t be enough demand for silver?), but the clear fact is that the silver going into the ETF has taken years off the time we must wait until the price of silver breaks free of the manipulation. Whatever time we still must wait, it is a helluva lot shorter than it would have been without the ETF.