TED BUTLER COMMENTARY

                                                    October 02, 2007

                                         Looking Back, To See Ahead

(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.)

As expected, there was severe deterioration in the COMEX gold market structure as the price powered higher, pushing the commercial net short position to a near record. The latest Commitment of Traders Report (COT), for positions held as of 9/25, indicated that the dealers sold net short almost 33,000 additional futures contracts, lifting their total net short position to a near-record 208,000 contracts (20.8 million ounces).

Silver followed gold’s deterioration, with the tech funds buying and dealers selling 13,000 contracts, more than I expected. While silver’s market structure is more neutral than bearish, coupled with the extreme negative COT readings in gold, my personal fear still remains that a dealer engineered (manipulated) sell-off in gold, will drag silver lower.

I’d like to take a moment to try and put this COT analysis into perspective. As long-time readers know, I have followed the COTs for decades. I use them in conjunction with supply/demand fundamentals. The COTs are for short-term analysis (weeks to months), while the supply/demand fundamentals are for the long term (years). As such, a purely long-term silver investor should not be overly concerned with the COTs, except as a guide to add judiciously to holdings. That’s because the best chance for success for the average investor is in a long-term approach, not through short-term trading.

Upfront, I do not believe that the COTs had much to do with the tripling in prices witnessed in silver (and gold) over the past few years. I think that price rise was caused by longer-term factors, revolving around a partial and continuing correction of a severe price under valuation (caused, in turn, by the long term silver manipulation). So why do I place such emphasis on a short-term indicator, if I am advocating a long-term approach to silver? Primarily, as a source of explanation and education. To me, the COTs are the most logical explanation for short-term price movements. And, because they explain, they educate and help prepare us for the future, as well.

It is written that to know where you are going, you must first understand where you have been. Trying to divine the future is always a difficult task, but that task becomes almost impossible if you don’t have a clear perspective of the past and present. Let’s face it, if you can’t understand or explain the past or present correctly, what basis do you have to predict the future? That’s why I am fascinated with the COTs. They explain, but not necessarily predict, just about every $50+ move in gold and $1+ move in silver. And through that explanation, the COTs help you understand and handle the long term better.

Going into the major lows of August 16, the COT market structure told anyone who was listening that certain markets, like gold, silver and the euro were structured to go higher. That means the commercials were holding a relatively small net short position and the tech funds were holding a relatively small net long position. It is no accident that gold and silver prices rallied strongly from that date. True, given that the COTs are not intended to be a precise timing tool, those signals were flashing for a number of weeks prior to the actual price lows were achieved. But that’s the nature of the COTs, they force you to be contrarian and sometimes early.

From the price lows of August 16, we have witnessed a subsequent $100 rally in gold and a $2.50 rally in silver. It is legitimate for market observers and investors to try to decipher the main reason behind the rallies. There has been endless press and commentary as to why gold rallied $100, including the weakness in the dollar, inflation and financial system worries. I don’t think that was why gold rallied. Now, if these factors actually drove many people to buy gold, then I could agree with those explanations. But I see no credible evidence that was the case.

In fact, when I monitor those objective data sources that would and should reflect widespread buying of gold, I find very little evidence of such buying. For instance, the US Mint maintains up to date data on their sales of gold and silver US Eagle bullion coins http://www.usmint.gov/mint_programs/american_eagles/index.cfm?flash=yes&action=sales&year=2007 It stands to reason that if many people were worried about broad issues enough to buy gold, it would be reflected in the sales data. Through the end of September, the year to date sales of gold coins are quite listless, and if the trend of the past nine months holds, gold coin sales will be among the lowest in the entire 22 year life of the program. Silver coin sales on the other hand, while generally uninspiring, are at least being sold at just about the highest rate, relative to gold coin sales, in history.

My point is that I have been unable to find any data that suggests that there was widespread grassroots buying of gold, which I think would be needed to confirm the reasons being given for gold’s rally. Instead the only glaring evidence that I have been able to find is in the COTs, the gold ETF and mining company hedge buybacks. By far, the data shows the technical and momentum type buying on the COMEX has been the biggest influence of all, with the gold equivalent net technical buying in COMEX gold futures being six times larger than ETF or hedge covering buying.

Moreover, since the record commercial net selling in COMEX gold futures occurred at precisely the same time of notable mining company hedge buybacks, the notion that the commercials were legitimately hedging is absurd. Let’s call it as it is – the dealers were selling short to make a market to the tech fund buyers, with the intent of taking the market down at some point and forcing the tech funds to sell and liquidate. It was as purely speculative selling on the part of the dealers as it was speculative buying on the part of the tech funds.