In Ted Butler's Archive

A Nice Set Up

(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.)

A number of different factors have converged, creating what could be a lift-off point for the price of silver (and gold). This confluence of readily verifiable factors shows the silver market to be in a low risk and high reward situation. The factors involve both the paper and physical silver markets. The only question, as always, is if the manipulators, led by JPMorgan and protected by the CFTC, can thwart the set up once prices rally.

The structure in the paper markets, as defined by the CFTC’s latest Commitment of Traders (COT) and Bank Participation Reports, as well as the year-end OTC Derivatives Report by The Office of the Comptroller of the Currency, are extremely bullish on any objective historical basis. This means that the commercials, as a whole, have a greatly reduced total net short silver position after the recent engineered sharp sell-off. Normally, when the commercials have forcibly liquidated as many leveraged longs as possible, prices stop declining and begin to rally. This is the rhythm of the market.

The latest COT and Bank Participation Reports, for positions as of April 7, show the smallest total commercial net short positions in gold and silver since Feb 17-24, when gold was $1000 and silver $14.50. Since those highs, on the $150 gold price decline and a $2.50 silver drop, the commercials have reduced overall gold shorts by over 40,000 gold contracts and 9,000 silver contracts, or the equivalent of 4 million gold ounces and 45 million silver ounces. This is subjective, but those reductions, particularly in silver, look complete. Not at all subjective is the observation that the only reason for the price declines over the past six weeks was to effect the liquidation of the maximum number of leveraged longs on the COMEX. This is the rhythm of the manipulation.

Despite the big reductions in net commercial short positions, the ongoing manipulation in silver (and gold), based upon a freakish short concentration, is still evident. If anything, the short concentration has grown more extreme. In COMEX gold futures, the four largest shorts hold more than 98% of the entire commercial net short position. In other words, without the 4 large shorts, there would be little or no commercial short position in gold futures at all. Bank Participation Report data show that three or less U.S. banks are the big shorts, while foreign banks are net long.

In silver, the concentration is more extreme, making the manipulation more extreme. The four largest traders in COMEX silver futures hold a net short position almost 50% greater than the entire total commercial net short position. How is this possible? It is possible because, as a group, the rest of the commercials apart from the big 4 are net long. In other words, if it weren’t for the big 4, there would be a big commercial net long position in COMEX silver futures.

Further, the Bank Participation Report data show that one or two U.S. banks (JPMorgan) make up 96% of the entire commercial net short position in COMEX silver futures. Not the 4 largest traders, as in gold, but the one or two largest traders. And we know it is a U.S. bank or banks. That should have your head spinning. The big U.S. banks have masterminded the financial disaster impacting us all, and should be barred from trading of any sort. Yet one or two of them hold the entire commercial net short position in COMEX silver futures.

The next time the CFTC tries to tell you that concentration isn’t the only issue proving manipulation, you should laugh in their face. One U.S bank, JPMorgan, holds perhaps the entire commercial net short position in COMEX silver and that’s not proof of manipulation? What is? To claim they are legitimately hedged is a joke. All the world’s silver hedging must go through one U.S. bank? Get serious.

Let me be clear here – you can have a nice set up and still be in a manipulated market. Long-time readers will recall many such occasions over the years. The fact that the short position has become so concentrated is actually part of the nice set up, to my way of thinking. That’s because the big short commercial traders are being increasingly challenged by other commercials, who I refer to as the raptors. These raptors are long in both silver and gold and will buy more when and if prices decline. They provide real competition to the big shorts. The big shorts can’t shake them out to the downside, like typically leveraged speculative longs. Bottom-line, the structure of the paper markets is encouraging, and any further sell-off will improve the structure.

Away from the favorable structure of the paper markets, there seem to be developments in the physical market worth mentioning. The most obvious, of course, has been the flows of metal into ETF-type investment vehicles. Since just the beginning of the year, gold and silver metal inflows has been historic, with three month+ totals reading like full year amounts.

In gold, some 14 million ounces, worth close to $13 billion, have been absorbed by the world’s various public metal investment vehicles in the first quarter. This compares to 10 million ounces absorbed in all of 2008, in turn one of the best years for this type of gold investment. Yes, there has been a notable decline in Indian gold demand and a sharp increase in scrap gold recycling, but the demand in gold investment vehicles has been nothing short of outstanding.

In silver, close to 75 million ounces have been absorbed by various silver investment vehicles, in just the first three months of 2009, compared to 100 million oz for all of 2008. Please remember that prior to 2006, there was no silver ETF demand. While Indian demand is lower and there has been some increase in scrap recovery, it is not as pronounced as in gold. In silver, the story had been a fall off in industrial consumption that enabled the big investment demand to be met. But that appears to be over, as production now seems balanced with industrial demand. There are signs emerging that future silver investment flows will be tighter and will require higher prices to effect those flows.

One sign has been the decline in COMEX warehouse stocks. Unlike the big increases seen in base metal inventories last year, COMEX silver inventories never grew at all. And after a recent 10 million ounce withdrawal, these inventories are at a two-year low of 116 million oz. What made this recent withdrawal noteworthy is that it appeared to be made by a single entity. Most likely, it was not a movement by an industrial consumer, given its size, rendering it as some type of investment flow.

Since this movement coincided with a 4 million ounce deposit in the big silver ETF, SLV, I can’t help but speculate that the COMEX withdrawal was shipped to London. Perhaps more confirmation, in the way of additional SLV deposits, will be revealed in the near future. The connection of the COMEX withdrawal to the deposit in the SLV, which I lean towards, would be important if accurate. That’s because nothing would reflect tightness in the wholesale silver market like someone having to satisfy metal requirements in the SLV by withdrawing the metal from the COMEX.

The recent deposit of close to 4 million ounces in the SLV (to a total of over 270 million ounces) was noteworthy on another level. The deposit also coincided with a decline in the reported short interest of close to 3 million shares in SLV, from 6.8 million shares to 3.9 million. There are only two ways to close out a short position in SLV, namely, by buying the shorted shares back or by depositing the metal against shorted shares. My guess is that the metal deposit was intended to close out those short positions. This also may be related to the recent announcement that Barclays was selling its I-Shares operation, of which SLV is a part.

Long-time readers should know how I feel about the short sale of shares of SLV, as well as the two other hard-metal gold ETFs, GLD and IAU. (I don’t think any short sales of any stock should be allowed, but that’s another topic). To me, the short sale of hard-metal ETF shares is fraud, pure and simple. That’s because the innocent and unaware buyer of any share sold short does not have the metal backing promised in the prospectus. How could he when the short seller of these shares does not deposit metal at the outset of the transaction. I went over this in great detail almost a year ago in “A Hidden Silver Default?”  I remember Barclays dancing around the issue in a manner that would have won Dancing With The Stars.

My point here is that neither Barclays nor the new buyer of I-Shares, CVC Partners, are fools. They know the shorting of SLV is a fraudulent practice and can cause headaches at some point. What better time to address the issue than upon a change in ownership. If this is what the shipment of metal and close-out of shorted shares is about, then it’s especially bullish. Not only would it confirm silver is tight, it would also suggest the fraudulent short-selling of SLV shares may be ending.

The current set up, in both the paper market structure and the physical world, should be the start of something good, price-wise. Whether it runs into increased manipulative short selling on a rally remains to be seen. I know many feel this pattern won’t be broken, but a true physical shortage will trump any and all paper games. When this baby goes, it will be a sight to behold.

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