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The Tech Funds Run

By Theodore Butler

(The following essay was written by silver analyst Theodore Butler. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

We certainly didn’t have to wait long to see how the giant computer-driven mechanical technical fund short position in COMEX silver was going to be resolved. The Commitment of Traders Report (COT), released Friday, May 2, indicated active short-covering by the tech funds. The price and volume statistics since the cutoff date, on April 29, suggests the tech funds have finished covering the bulk of their short position. The silver market’s near 50 cent rally occurred precisely because the tech funds bought back their outsized short position.

My past few articles have emphasized the low risk in the silver market and the near certainty of a price rally because of the near historic short position of the mechanical tech funds. I even went so far as labeling their short position as one of the dumbest trades ever. My guess is that they lost around $40 million on this trade.

The dealers did not take advantage of the trapped funds, setting off the dormant silver volcano. Once again we have been given a clear lesson on how the silver market really works. (It’s too bad the CFTC doesn’t want to learn). There is a regular cycle in the silver market that you can set your watch to. When the tech funds get massively long (with the commercial dealers correspondingly short), the market always experiences a significant decline. When the funds are heavily short (dealers long), up we go. If you think I’m just talking about a reliable trading signal, you’re missing my drift. It’s much more than that. I’m talking about illegal control of a market.

The very premise of our futures markets is that prices should be set in the real world of supply and demand, and not be determined by speculation on futures markets. It should be clear that the exact opposite has occurred. The worldwide price of silver is set only by speculation on the COMEX. You only need look at this last price rally in silver for confirmation. There was no outwardly bullish fundamental news, only supposedly “bearish” news (such as declines in photo usage due to the SARS-related travel slump in Asia and the reports of a declining deficit). Yet silver experienced a spirited rally. A reasonable observer would conclude that the sudden purchase of some 20,000 short COMEX contracts (100 million ounces) by the technical funds was the obvious cause of the price rally. How the CFTC has allowed the silver (and other) market(s) to be taken hostage by a small group of technical funds and an even smaller group of speculating dealers is one of the great regulatory failures of our day.

So where do we stand currently, with regard to the COT market structure in COMEX silver? Well, we’re certainly not where we were a few weeks ago. We’ve lost the certainty of low risk and a coming rally, based on the tech funds’ short position. It’s possible, to experience lower prices if the dealers engineer the tech funds back into a full short position. That’s the bad news. The good news is that the tech funds have not built up a massive long position (yet). So, we’re not bearish. We’re neutral in COT terms. It could easily turn out that this tech fund short-covering rally could serve as a first stage, booster rocket on a long-term upward price trajectory. The key might be whether the tech funds are allowed to get a big long position. The controlling dealers may permit the price of silver to go high enough to prevent the tech funds from building a big long position. The dealers have a copy of the tech funds’ play book, and the dealers know the funds won’t buy if the price is too far above the moving averages. That could portend a rapidly rising market.

Indeed, there are other signs of encouragement in the current COT. For the first time in my memory, both large and small speculators liquidated long positions on the rally. Apart from this being different from past speculative behavior (and I confess to always being on the lookout for possible changes in the decades-long pattern of control), it suggests less potential long liquidation on price weakness.

Outside the COT, I couldn’t help notice that we rallied strongly (25 cents) in the three days commencing with first notice of delivery day of the big May COMEX contract. While there has always been a pattern of the controlling dealers swapping (issuing and stopping) large quantities of COMEX warehouse receipts on first notice day, this time they outdid themselves, with regular dealer kingpin AIG issuing over 99% of the first notice day’s 17.5 million ounces. How is it possible that one entity could legitimately deliver such a large percentage of a freely traded commodity? One of these days, maybe the CFTC will get around to checking whether these dealers are really involved in economic transactions in these silver delivery daisy-chain games. Or is it just a case of these dealers making it look like plenty of real silver is available? This is a modern day, financial Potemkin Village.

It’s important to keep my COT and COMEX-related comments in perspective. As I’ve indicated in the past, when the tech funds are short big, like they were a few weeks ago, then buying silver is like shooting fish in a barrel – it’s hard to miss. When the tech funds are long big (not now), some caution in aggressive buying is advised. But, remember, my only public recommendation has been to buy real silver with no leverage, or margin. In no way would a negative COT (if it comes) warrant the sale of physical silver, especially if we’re still stuck around $5. Let’s face it – it is real supply and demand and the structural deficit in silver that matters the most. It is this deficit that guarantees the price of silver must move substantially higher.

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By James R. Cook

Virtually all of America anticipates an economic recovery and renewed boom later this year. Unfortunately, there is only one thing booming in this country, and it’s credit. In the past five years private credit growth amounted to $10 trillion. Meanwhile, the economy grew $2 trillion. In addition, the consumer took on $2.00 of debt for every dollar of new income. Uglier still is the mountain of corporate debt that now translates into $200 billion of interest payments. Not only does this choke off business profits, it forces a wave of new borrowing to cover the interest. All this indebtedness goes for naught. The most fantastic money and credit expansion in history has failed to revive the stagnant economy.

With financial institutions borrowing a trillion a year, the highly leveraged financial system has decoupled from the real economy. This massive amount of credit goes for speculation and consumption rather than all-important investment spending. More recently, credit growth has spun so out of control that $10 of credit brings about a meager one dollar of GDP growth. This equation cannot last. Furthermore, 90% of GDP growth comes from consumer spending. This too is unsustainable. There’s no improvement in the fundamentals of the economy and nothing in sight to indicate a viable recovery. Corporate profitability is the worst in history, and profit margins are at their lowest. The more you look at the numbers, the more you are forced to conclude that the monetary authorities have set their policies on a collision course with financial disaster. This crisis threatens to be of a magnitude so enormous it can’t now be comprehended.

If the falling dollar keeps falling, if capital inflows lessen, if interest rates have to rise to reverse those trends, then we face a torrent of problems. In America today, the most serious threats are not taken seriously. Wishful thinking has replaced sound economic analysis. The hopers and the dreamers are directing the music on Wall Street and the mass of investors are dancing to their tune. Unfortunately, the game is over and whoever gets the news last also gets their head handed to them.

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