TED BUTLER COMMENTARY

September 25, 2007

Still Extreme

(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 unprecedented disparity between the respective market structures in COMEX gold and silver continues. The most recent Commitment of Traders Report (COT), for positions held as of Sept. 18, indicated continued severe deterioration in gold, and relatively minor deterioration in silver. In gold futures, the net commercial short position widened out more than 14,000 contracts, to a bit over 175,000. The net commercial short position in silver increased by fewer than 3000 contracts to just over 29,000. Silver remains bullishly configured in COT terms, while gold is structured bearishly.

Since the Tuesday cut-off, on further price rallies in each, more severe deterioration looks to have occurred. The gold futures net commercial short position may have increased by 30,000 contracts, through Friday, with silver up 8000, or so. If these guesses are correct, that would put the gold tech fund long/dealer short position at, or close to, an historic bearish extreme. The caution flags that were already flying in gold have been stretched taut by the gale-force winds of dealer short selling and speculative momentum buying.

I know many are convinced we will continue to move sharply higher in gold and silver, and that may prove to be true, but the COTs have a reliable enough record not to be ignored. Many reasons have been given for the almost $90 rally in the price of gold since the bottom on August 16. While there may be many valid reasons to explain gold’s price movements over the long term, the short term is another matter. The biggest reason, to me, for the recent run up in gold was the more than 100,000 net futures contracts bought on the COMEX by tech funds and other price-motivated speculators. The risk revolves around what those buyers do next.

While it is always possible for the COTs to be flat-out wrong, that has yet to occur in gold and silver, except temporarily. Certainly, I would not be interested in continuing to study an approach that was consistently wrong. And if you are going to pound the table at times when the COTs are bullish, like they were a month ago, you must be intellectually honest enough to acknowledge when they are no longer bullish. There is a difference between cheerleading and analysis.

My main concern remains that a sell-off in gold will be used to drag down silver. The extremely negative reading in the gold COT is still the main negative factor in silver. In fact, I am hard-pressed to even come up with other negative factors in silver.

I believe the manipulative short sellers in silver no longer wish to sell silver short as heavily as they have done in the past and are looking for ways to cause a sell-off in silver with other tricks, such as an engineered sell-off in gold. Whether they will succeed in this criminal strategy, is another question. Regardless, this is quite bullish for silver, as I think it represents a sea change, in that the manipulative shorts appear to want out of the long-term manipulation in silver. In the latest COT report, it was all raptor selling, with the big 4 shorts not responsible for the commercial net short increase.

In fact, everything I look at in silver points to a price explosion, either with or without a steep gold-induced sell-off first. Factors in the physical market, including a "stickiness" in late month COMEX deliveries, as well as ETF additions, the new 4 million oz addition by the Central Fund of Canada, and private reports of tightness in the wholesale distribution market, all point to the manipulators losing control fairly soon. In addition, the spotlight being shined on ScotiaMocatta recently surely has contributed to the silver shorts’ new plans.

While, admittedly, it is hard to document feelings, no matter how strongly held, I do have the feeling we are looking down the gun-barrel of a physical silver shortage in the wholesale market. I further believe the dealers certainly know this better than anyone, and they are preparing for that circumstance. The one thing that will blow the lid off the silver market is recognition of the physical shortage. When that occurs, the COTs won’t matter much.

The main point to remember is that if we do get a silver sell-off, it will have nothing to do with legitimate real world supply/demand fundamentals. It never does. It will have everything to do, as it always does, with the big silver shorts attempting to cover as many of their short contracts as possible. Such a potential silver sell-off, should it occur, may provide the very last buying opportunity before the final lift-off.

Postscript:

As I was submitting this article, a number of readers sent me an article that dismissed the likelihood of a physical silver shortage and criticized me for not understanding lease rates, the monetary nature of silver and other assorted failings on my part. I did read the article, and was not impressed or convinced by its substance or conclusions. More than ever, I am sure that silver will evolve into a worldwide recognizable shortage, due to its rarity and its strategic industrial importance. This will, undoubtedly, come as a shock to many.