In Ted Butler's Archive

The Mother Of The Mother

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.)

Like a guillotine, the commercial dealers beheaded the tech fund longs in COMEX gold and silver over the past week and a half. It was the tightly disciplined wolf pack’s finest moments, thereby making it one of the free markets’ worst. Make no mistake, there is a war for money and financial survival in the metals that includes both yours and the manipulators’. They won a key battle, but in winning that battle, they may have lost the war.

In gold, the dealer wolf pack lured the tech funds into the long side of COMEX gold futures to the tune of some 100,000 contracts, and then engineered the funds into dumping those contracts at roughly a $20/oz loss. By trading as one coordinated and non-competitive unit, the wolf pack functioned as the ultimate market maker. (The problem is that commodity law prohibits market making in the COMEX’s open outcry and auction market system.) In COMEX gold futures alone (not including options or off-COMEX transactions), the dealers made, and the tech funds lost, some $200 million. That’s a pretty big payday, even for the cohesive and illegal market-making manipulators.

Anyone who doesn’t see the back and forth between the mindless computer-driven tech funds and the scheming dealer as revealed in the Commitment of Trader reports isn’t paying attention. This all can be seen in the public record. And speaking of the public record, let me be clear that I have no sympathy over tech fund losses (or the dealer wolf pack’s gains). My concern is solely about the conversion of what should be a free market into a private bucket shop, where massive paper trading swamps any and all real world developments.

Unlike gold, where the obvious intent was to take as much money from the tech funds in as short a time frame as possible (and influence silver), the wolf pack’s goal in smashing the silver price was not short term profits. Since the beginning of this year, this is the second time that the dealers have hoodwinked the tech funds in gold, letting them get long big, then yanking the rug out from under them, and reaping hundreds of millions in profits. In silver, there was a different pattern. The tech funds were basically long big in silver (with the dealers short) and that position structure was maintained until the past 2 weeks. In other words, the tech funds were fully positioned on the long side of COMEX silver at $6, in January, and held that position up through $8 on the upside, only now liquidating, on the return trip down to $6. The dealers held the reciprocal short position throughout these past few months, covering just in the past two weeks. What does this tell us?

The wholesale tech fund silver long position liquidation has not been at an actual loss to them, as it has been in gold, twice since January 1. (This week’s COT will tell us more.) True, the $2+ price crash in silver was a horrendous drop in open profits for the funds and other leveraged speculators, but because the funds got in so early, they are basically liquidating on a break-even basis. Don’t get me wrong, the profits the funds gave up in silver were awesome – some $300+ million in COMEX silver futures alone – but they still represent a loss of profits, not actual losses from their original entry points.

Conversely, the dealers didn’t actually book profits in covering their short positions in this huge silver price drop, as they did in gold. But they did recoup hundreds of millions of dollars of open losses on their silver short positions. Certainly, for anyone who has ever held a big losing open position, breaking even can be a huge victory. Add in the big recent profits from gold trading, and the dealer wolf pack seems way ahead. They should be declared the victors in these recent metals battles.

The war the dealers are going to lose, however, is the war to continue their manipulation of the silver market. Why do I say this? Precisely because of the way the dealers behaved the past few months. It was not technical fund and speculator buying that drove silver to the recent highs, contrary to popular opinion. The funds were fully positioned on the long side from the beginning of January. It wasn’t a case of these funds piling onto the long side of silver that pushed prices up. It was something else. Perhaps it was stress in the industrial wholesale market, or maybe one key dealer broke from the pack, or perhaps it was behind the scenes pressure from the regulators. But it definitely wasn’t the normal fund buying on the long side.

The dealers were out big money on their silver short position at the highs. Very big money. So much money, that they had to engineer something special. The main “something special” that the dealers engineered in silver was a dramatic and historic sell-off – more than 25% in less than two weeks. They did this by agreeing among themselves to collectively pull all their bids at times, forcing the liquidating funds and other leveraged speculators to sell into a void. The proof to my statement – on the way up, we didn’t have one 25 cent COMEX gap up opening in the six month $3.50 rally, yet we had four 25 cent, or greater, COMEX gap downs in the week and a half $2+ smash. That’s with no real silver world news. That price pattern is not possible without collusion among the dealers. Period.

The important point is that the dealers were stuck on the short side of silver big time, and they had to do something drastic to get out. Which they did with the dramatic price crash. But that’s exactly why I think they’re about to lose the silver manipulation war. Having been staring into the abyss at the recent highs in silver, the dealers are not likely to put their heads back into the lion’s mouth, and reshort silver in a big way again. I think they aren’t interested in the risk, nor the potential regulatory attention of being that short in silver, ever again.

These dealers aren’t stupid. They know they never had, nor could get, the real silver to back up their massive naked shorts. They know people are wising up to their manipulative silver tricks. They know there are now more than 3200 names on the silver petition to Eliot Spitzer. They know that hundreds of people have written to the CFTC, and neither the CFTC, nor anyone else has been able to provide answers to simple questions about the silver manipulation. Most importantly, the dealers know how tight the silver physical market has become with recent delivery demands.

In order to get to the mother of the mother of all buying opportunities in silver, it was mandatory to have the market crash first in order to flush out as many funds and other leveraged speculators as possible. This forced liquidation, in fact, is precisely what enables the dealers to cover as many of their silver shorts as possible. But that crash and forced liquidation has come and gone and no longer represents a potential bone-jarring sell-off. It does not appear likely that the funds, having liquidated the majority of their long positions, will now go short and it looks like we’re very much back to dimes to the downside, dollars to the upside.

It is not just the suddenly more favorable risk/reward ratio, created by the sharp sell-off, that leads me to suggest that this is the mother of silver buy points. I believe that the dealer wolf pack does not want to endanger their very survival, by going short big in silver on the next turn to the upside. If so, we could be on the threshold of something I have long contemplated (and written about.) That something is a melt-up, caused by a wolf pack selling void, similar to, but much greater in magnitude than the coordinated wolf pack buying void we just witnessed to the downside. The wolf pack’s recent near death experience at the recent highs surely made a big impression on them. I don’t think they want to play this silver manipulation game any longer.

Many have written to me, asking what it is that will prevent the dealer wolf pack from continuing the silver manipulation, by continuing to short on future silver rallies? My answer is two-fold. One, the dealers did not make money on their last short campaign in silver. They escaped with their financial lives. They had to pull out every trick in the book to break even. This was not lost on them, as they had to realize just how deep in the hole they were. This was very much different than any silver shorting campaign by the dealers in almost 20 years. More importantly, the about to emerge silver shortage, courtesy of the structural deficit, will eventually blow the shorting scam out of the water. The only question is when does physical silver trump the paper shorts. The dealers know how tight the industrial physical market has become, better than anyone. That’s part of their business. They know that demands for physical delivery will overpower a paper short position. Since they have been struggling, for more than a year, to progressively meet COMEX delivery demands, and now face extreme difficulty in meeting two particular Canadian delivery demands, the time for a sea change appears close at hand.

But what if I’m wrong and the timing of the certain coming physical crunch is somewhat off into the future, and the dealers do sell short on the next rally? The great thing is that won’t matter. Silver is still vastly undervalued, the risk is still dimes to the downside, and we’ll still get a rally, albeit not the big one. What makes this buy point so attractive is the low risk, as the dealers will only sell, if they sell at all, on higher prices. But if I’m right, and the dealers don’t sell, we will be adding dollars per ounce in the blink of an eye, and the mother of buy points will be a fleeting memory.

I heard from heavily leveraged speculators, who were damaged and shell-shocked by the crash. Let me offer some words of a constructive nature. Leverage has a place only if you have the emotional stamina and risk tolerance for such. Especially at times like now, when so much risk has been removed from the market, by the price drop and tech fund exit, leverage might be in order for those so inclined.

Leverage, necessarily, involves borrowing of some type. You borrow money to get a bigger bang for your investment buck. My suggestion – separate the borrowing function from the buying function of a futures contract, and you will immunize yourself from the manipulative tricks of the dealer wolf-pack. Specifically, buy real silver from your dealer, or take delivery on futures contracts, and borrow from your bank to the extent you wish to leverage. Obviously, you must be able to service the debt comfortably. This way, you will own the silver outright and have a separate debt which you are responsible for, but is not directly related to the silver. Don’t borrow from the same place you buy and hold your silver. Ever.

By buying from your dealer, and separating the borrowing function, here’s what you’ll accomplish. For one, you will have no Dec 31 mark to market tax liability. Two, you will be holding precisely the form of silver that will come to be in greatest demand, real silver. The coming move to backwardation, where cash silver trades for more than futures contracts, will benefit real silver holders the most. Three, you will protect yourself from arbitrary exchange rule changes limiting delivery or increasing margins. Four, you will be less likely to over-margin yourself, as profits will be harder to pull out as prices rise. The big problem with futures is that, when it’s going your way, the gains are intoxicating. You pile up money so fast, and it’s so easy to remove the money or spend it buying more contracts, you inevitably get in too deep, with a much bigger position than originally planned. It is at that point, invariably, when the sharp sell-offs occur, and positions must be jettisoned. But doing it the way I suggest will prevent you from removing profits easily, or buying more. Stay away from pure futures and pyramiding them as silver climbs.

No, I am not encouraging folks to speculate in silver. I am offering this suggestion only for those who are going to speculate in futures or leveraged contracts anyway. If you’re going to do it, at least do it right, or where you improve your chances for success. I was surprised to hear from folks who were speculating and got hurt (lost their leveraged positions), since I never publicly suggested to do so. I don’t want to see people get hurt in the future. My advice for the vast majority of folks is to buy real silver on a cash and carry basis. It is your greatest insurance against volatility and manipulation. And do it soon, before the best buy point in history becomes history.

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