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On A Silver Platter

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.)

In last week’s comments, “Pounding the Table”, I discussed the improving structure of the COMEX silver market, as indicated by the Commitments of Traders Report (COT), and why, quite apart from the compelling supply/demand argument, this was a great opportunity to buy silver. I define the structure of the market as improving when the mechanical technical funds get more and more short and the commercial dealers get less and less short. When the technical funds get maximum short, the market is at a bottom, offering very low downside risk with an almost certain rally ahead.

Of course, we can only know for sure when the technical funds have their maximum short position on in hindsight, after the market turns up. But we can speculate about the tech funds maximum short position when it reaches historical extremes. We are now at, or very close to, those historical extremes.

I had guessed that the new COT report would show an improvement (a contraction) of 7 to 8 thousand contracts in the commercials dealers net short position to under 25 thousand contracts. Remember, there had already been a contraction in the dealers’ net short position by a very large amount, almost 11 thousand contracts, to around 32.5 thousand contracts. I sensed continued new tech fund shorting and dealers’ short-covering subsequent to the report’s Tuesday cutoff. I’m very happy to write that the new COT report, for positions held as of 3/25/03, showed a much bigger improvement than I had expected, by 100%. The commercial net short position declined by 15.5 thousand contracts to just about 17 thousand contracts, as the tech funds plowed onto the short side. I would use two words to describe this COT – shockingly bullish. And I think there has been a further improvement since the Tuesday cutoff, by a few thousand contracts.

In two months, the commercial dealers, thanks to the technical funds, have succeeded in reducing their net short position from 75,000 futures contracts to around 15,000 contracts, or by 60,000 contracts. That’s equal to 300 million ounces of silver, truly a massive amount. That’s 2 to 3 times more than all the visible silver bullion inventory in the world. That’s more than half of total annual mine production. Because the amount of paper silver changing hands between the dealers and tech funds on the COMEX dwarfs anything in the real world, it should be clear that this is what is dictating the price. Commodity law was created to prevent just such a manipulative abuse.

So what does this all mean? In addition to the ongoing spectacular supply and demand fundamentals, we now have a spectacular technical market structure on the COMEX. The bad guys, the commercial dealers who have been manipulating the silver market for decades, are at historical small short positions. That’s good because it is now advantageous for these commercial dealers to let the price of silver rise. These dealers know, full well, that it is just a matter of time before the tech funds start to buy to cover their shorts. Sure, we could see slight new price lows if the tech funds have a few thousand more contracts to sell short, but the bulk of their selling is complete. The only question remaining is whether the dealers sell short aggressively and manipulatively on the coming silver rally and we end up with a 50 or 60 cent move. Or do the dealers keep their hands in their pockets and look the other way when the tech funds come in to buy?

If the dealers don’t let the tech funds shorts off the hook, then watch out. We get the market event I wrote about 4 months ago. Please read that article again, as the COTs are just about where they were then.
(“Major Market Event Ahead?”

How the tech funds allowed themselves to get into a big net short silver position, at such low prices is absolutely amazing. It’s hard to conceive of a dumber trade. Use their mistake to your advantage by buying real silver now.

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