TED BUTLER COMMENTARY

July 24, 2007

Still The Same

(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.)

The recent sharp rallies in the price of gold and silver have confirmed, once again, the importance of the market structure approach to determining price moves, as defined by the Commitment of Traders Report (COT). Recent extreme readings in the COTs did, in fact, pinpoint low-risk/high reward set ups in both gold and silver, culminating in the near $50 climb in gold and $1.25 increase in silver from the lows of a few weeks ago.

Now what? Well, there has been deterioration in the COT structure as tech fund buying has powered prices upward, and that buying has been met with dealer selling. That deterioration does increase the odds of a sell-off. Will we sell-off? I don’t know. We are at COT levels that have resulted in other sell-offs recently, but we’re nowhere near extreme historic negative levels where you knew a sell-off had to come.

My own sense is that we are decidedly neutral in the COT structure, with room to go either way. If the dealer manipulators are determined to create a sell-off, then we will get a sell-off. It won’t have anything to do with the free market, or real supply and demand. That’s the reality of a manipulated market. But sell-offs, even if they come, should be temporary, as the fundamental picture in silver continues to improve. That suggests that the big play is still to the upside. At times of COT-neutrality, like now, it may be important to focus on other issues (aside from the all-important long-term fundamentals). I see two such factors currently in silver.

The first is the continued unusual movement in COMEX warehouse inventories. Over the past month, there has been unprecedented movement, both in and out, of the COMEX silver stocks. While there has been a small overall increase in total net warehouse stocks of a few million ounces of silver during this time, the gross turnover has been somewhat frantic. In tracking COMEX silver inventories for more than 25 years, I have never observed such movements. I’ve seen, on rare occasions, 25 million ounces come in over a month, and other times a movement out of 25 million ounces. But I have never seen 25 million come in and 25 million go out at almost the same time.

I don’t have enough data to tell you what this all means for sure. My sense is that it could be very important, for the simple reason that the silver price will ultimately be determined by a battle over physical silver by big players. And make no mistake; these movements involve big players. I have previously speculated that the in movement could be a camouflage designed to blunt the attention that a big movement out would attract. My friend Izzy suggested the silver was first being put into the COMEX to assure it was "good" silver, due to the COMEX’s rigid grading specifications. Then the (foreign) buyers were taking it out. In any event, either of us has never witnessed such turnover.

The second current issue is the business of the extreme concentration on the short side of COMEX silver futures. It is remarkable to me that I have remained so alone in highlighting this issue. Regardless, this is, by far, the most important current issue in the silver market. Because of that, I want to explain, once again, why I find this issue so important.

The most recent COT, for positions held as of July 17, showed a concentrated net short position by the 4 largest traders of 51,187 futures contracts, or the equivalent of 255,935,000 ounces. This indicated an increase of almost 1000 contracts in the latest reporting week and is the largest concentrated short position since the record set on February 27, 2007 (52,730 contracts). It is among the very largest concentrated positions in history. Clearly, the four or less largest short traders are not decreasing their concentrated strangle hold on the silver market.

This concentrated short position of almost 256 million ounces represents more than 109% of the total net commercial short position in COMEX futures and is the equivalent of 146 days of total global mine production. No other commodity comes close to such extreme and obscene measurements. Let me explain, in the clearest terms possible, why this is manipulative.

Let’s say 50,000 unrelated individuals or entities went out and bought or sold a contract each of COMEX silver. Any resultant impact on the price, no matter how great, would have to be described as a normal free market reaction. The same conclusion would be reached if 10,000 separate individuals bought or sold 5 contracts each, or if 1000 individuals bought or sold 50 contracts each. Even if just 100 entities bought or sold 500 contracts each, as long as they were not acting in concert, the resultant impact on price would have to be attributed to normal free market behavior. Large numbers of participants cannot ever be accused of manipulation.

But if just one entity bought up the entire 50,000 silver contract position, then it would be obvious to all that any impact on price could hardly be considered free market in nature. You wouldn’t need to be an economist, or a regulator or an exchange official to see this for what it really was, namely, that this would be the clearest possible case of monopolizing the market and manipulation.

50,000 or 10,000 or 1000 or even just 100 independent entities (if not acting in concert) would not be considered manipulative by virtue of their collective long or short position. But if only one entity held, singularly, the same 50,000 contracts that would clearly be manipulative.

This is the essence of why concentration is the most important element in determining manipulation. This is why the concept of concentration is at the heart of commodity law and why the CFTC (supposedly) monitors it so closely. Too much concentration is manipulation. Period. And it can’t possibly get more concentrated than having just one entity holding a dominant market position.

But what about 4 or less entities? (And I have a very hard time imagining that these 4 or less entities holding the dominant short position in silver could not be acting collusively). After all, we have, quite literally, many thousands of independent participants on the long side of COMEX silver, all arrayed against just 4 traders who are short what the thousands are holding long.

Twenty-seven years ago, the Hunt Brothers were found to have manipulated the silver market to the upside by virtue of a concentrated long position held by them and a few associates. The simple fact is that the current concentrated short position in COMEX silver futures is twice as large as what the Hunts held on the long side and more concentrated, since it is held by fewer entities (4 or less). That the CFTC does not apply the law fairly and consistently diminishes the law and us all.

Recently, some have tried to cast this issue as to whether the short position is naked or not, that is, whether there is real silver or bona fide hedging contracts backing the concentrated short position. That completely misses the point. It does not matter if real silver backs the concentrated short position or not. That’s because holding a large quantity of any commodity does not grant to anyone the right to manipulate the price of that commodity. In fact, the essence of commodity and anti-trust law is to prevent dominance and monopoly power from accruing to the largest market participants.

I’d like to state some things about the silver manipulation that I believe are factual, and then speculate a bit. It is clear to me that the documented COMEX concentrated silver short position is manipulative beyond reasonable doubt. This concentrated short position is held by one or more clearing members of the NYMEX/COMEX, either for their own account or on behalf of a customer(s). All positions in every futures market must be ultimately held (cleared) through a clearing member. Clearing members are those large financial firms that guarantee that all contracts will be honored and not fall into default. If an individual customer fails to stand by his contractual obligation, the clearing member must step in to fulfill those obligations. These clearing members are, largely, household names. Here’s a list of NYMEX/COMEX clearing members - http://www.nymex.com/cleari_member.aspx

Therefore, one or more of these large financial firms must be deeply involved in the COMEX silver manipulation. I consider all this to be factual.

Because the consequences and punishment would be so severe for a large financial firm to engage in any way in the manipulation of any market, there is no way it would be knowingly tolerated by senior management of any such financial firm. Therefore, the silver manipulation is being conducted without the direct knowledge of the senior management of the large financial firm(s) involved. Of this, I am sure.

If you review the names of the firms who clear, or guarantee, contracts on the COMEX, you will quickly see that most are very large financial organizations. If you realize that silver is a very small market, you must conclude that trading in silver futures makes up a very small part of the total revenues of such large financial firms. It is easy to conclude that the profit from manipulating the silver market is not the main thrust of the profit and business motive for such large firms.

Therefore, it is my conclusion and speculation that, up until now, the senior management of the COMEX clearing firm(s) involved in the silver manipulation are completely unaware of the manipulation being orchestrated by the metals departments of their firm(s). As such, senior management is not guilty of any direct involvement in the silver manipulation, yet. The good news for them is that, because metals dealings make up a small part of total revenues, they can move to close out the manipulative short positions with manageable financial loss.

But the bad news is that the minute they are notified of this manipulation and do not act upon it, senior management becomes personally culpable. Then it is not just financial loss, it may become criminal. It always comes down to what you knew and when you knew it. Perhaps most serious of all is the damage to reputations that will occur if it turns out the large financial firm tried to sweep evidence of the manipulation under the rug.

Any attempt by a large financial firm, which discovers evidence of internal involvement in the silver manipulation, to rely on assurances from the CFTC that all is well in silver will prove futile. A government agency cannot be held liable and the government workers who gave those assurances of no manipulation could either be gone or forgetful.