The Commitments of Traders Report
By Theodore Butler
This article about silver is going to be different from other articles I’ve written. As you know, I feel the most important aspects to the silver market are the continuing physical deficit, leasing and the paper short position. These factors account for the persistent low price amid production/consumption shortfalls and disappearing inventories. These factors will account for the certain price explosion to come. But, in the quest for knowledge about silver, there are other factors that effect the price, but are separate and distinct from the bedrock supply/demand fundamentals. I’d like to devote this article to a report that analyzes the most important near-term influence on the price of silver – trading on the New York Commodity Exchange, Inc. (COMEX). The report that offers this analysis is the Commitments of Traders Report (COT), published by the US Commodity Futures
Trading Commission (CFTC).
First off, let me explain, before I get to the report itself, just why I claim that COMEX trading is the dominant day-to-day influence on the price of silver. This is important, because I feel that if I can’t convince you that the price of silver is set on the COMEX, alone, what difference would it make to explain what the COT is all about? I won’t beat around the bush about how dominant COMEX trading is to the daily price of silver – it’s everything. Nothing else matters. I’m talking day-to-day here, not long term. Long term, it’s the deficit and leasing, but for next week, or next month it’s the COMEX.
I know the London Bullion Merchants’ Association (LBMA) claims to do more volume than the COMEX in silver (and gold), but I feel the LBMA’s numbers are bogus, because they refuse to have their volumes certified and audited. The simplest proof I can offer that the COMEX is it for silver is to point out that the price of silver only moves when the COMEX is open or about to open. This is true 99% of the time. The only time that the price of silver changes meaningfully is during COMEX regular hours, or in the hour or two before COMEX regular hours. My proof is simple – the dominant market sets the price. Period. It is not possible for a market with lower trading volume to dictate prices to a market with larger volume on a consistent basis.
Since all significant price changes are made on the COMEX, 99% of the time, a government report that outlines the composition, or structure, of that market, should be something a serious silver analyst digs into. The significance of the Commitments of Traders (COT) to an analyst is that it tells you who has bought and sold. This report answers the question asked by every participant – who is buying and selling? Think about the importance of that. Haven’t you asked yourself – who is selling silver at these prices? To a large extent the COT answers your question.
The Commitments of Traders Report is published weekly, for every commodity futures market in the US, by the CFTC, the government regulator of these markets. They are designed to bring full disclosure to the markets, always a laudable goal. There’s a COT for just about everything – bonds, stock indices, currencies, gold, grain, meat, all commodities. There are countless services that analyze the COTs, attesting to its importance in the professional trading community. The COTs are a tool for traders and analysts. They tell an important market story – who’s holding what?
I’m a real big fan of the COTs. I have been analyzing them for over 20 years, and would be lost without them. Over the years, it has improved. When I first started analyzing the COTs, they only came out monthly. Then, every two weeks. Now, they come out every week. I can’t tell you how much better it is to have a fresh report every week. The COTs are released every Friday afternoon, reflecting futures positions held as of the close of business the preceding Tuesday. By studying changes in volume and open interest in the COT for the three days delay, the COT is, effectively, always current.
When I say the COT tells you who is long and short in each market, the “who” is not by the actual names of each participant, but by category. The COT is divided into three categories – large commercials, large non-commercials, and small traders, and how many contracts each group holds long and short. That’s basically six sets of numbers, which can be further condensed into three net positions, although proper analysis considers both the gross and net in each category.
The commercials are those firms that deal in a commodity in the daily course of their business. In silver, the commercials are the dealers and banks; Chase, Goldman Sachs, AIG, the Morgans. The non-commercials include individuals, hedge funds, etc. The players in these two categories are considered “large”. If a participant holds more than 150 contracts they are considered large. The small trader category includes everyone with under 150 contracts, regardless of type of trader. This is the category in which we would put the public. The Commitments of Traders Report is separate and unique for each commodity. Every COT has its own personality, determined by the participants, and nuances and characteristics unique to that futures contract. The report is free and available at the CFTC’s web site – http://www.cftc.gov.
What’s really great about the silver COT, is that it helps put COMEX trading in proper perspective. It allows you to grasp what has happened to the structure of silver trading through the years. In fact, because we are only talking about a small set of numbers, which change over time, the data can be converted into graphic charts. The very best COT charts can be found at the web site of an Australian friend of mine. The address for these silver COT charts is http://www.sharelynx.net/Markets/Charts/COTAG.htm. In my opinion, the main site is the most information-rich resource for gold, silver and the markets, on the Internet.
I have made the observation, many times, that silver has the largest paper short position of any commodity ever traded. I claim that this is a big factor in the low price of silver. This paper short position in COMEX silver amount to more than 600 million ounces in the combined futures and call option open interest on that exchange. I contend that there has never been a combined short position in any commodity that is greater than either total world annual mine production, or total known world inventories. Only COMEX silver has such an obscenely large short position. The silver COT analyzes that large open interest and short position.
I’ve given all this background on the COT to give you another reason to buy silver. I want to show you why the silver COT is signaling that silver should be bought here. However, I want to make clear that the COT can, and does, signal potential drops in the price of silver. When the COT indicates lower prices in silver no way suggests that long term silver positions be sold. In any event, that’s a moot point, as the silver COT is screaming “buy” now.
In brief, silver trading on the COMEX has changed over the past ten years. The price influence of the “little guy” has been replaced by the big hedge funds. Hedge funds and dealers completely control the day-to-day price of silver. I think this could be illegal and manipulative, but that’s a separate issue. The type of hedge funds that have come to dominate silver pricing, are the funds that trade on momentum, or moving averages. These funds don’t look at anything but the price. If the price moves below a set of moving averages, they sell out and go short. If prices move above those moving averages, they buy, either to cover shorts or to go long. These funds deal in tens of thousands of contracts, and exert more influence, day-to-day, than do the real producers and consumers in silver. Isn’t that crazy? This is why I say it could be illegal.
In any event, these technical hedge funds are massively short in COMEX silver, according to the most current COT, dated August 10, for positions as of August 7, 2001 to the tune of some 34,000 contracts, or 170 million ounces of silver. That’s more than the production of Mexico and Peru, combined.
This is why silver has gone down in price recently – the funds were going short. (The fact that these funds own no physical silver strengthens my manipulation complaint). But, now that the funds are massively short, holding just about the largest short position in the 20+ year history of the COT, their next big play will be to cover those shorts. That is bullish, because these tech funds will buy back their short positions on higher prices, and will, in fact, be a cause of coming higher silver prices. Score one major bullish point.
When I say the technical funds hold close to a record large silver short position, I’m speaking of the large, non-commercial gross short position. On the long side in that same category, we see large long holdings by traders unrelated to the technical shorts, positions held with no regard to the technical price action of silver. These non-commercial longs have not liquidated their positions on the slide in silver prices to multi-year lows. They appear to be strong holders, as they have held their longs for years. They probably see what I see coming in silver. To be fair, this large long position, like any large position, could always be liquidated, putting pressure on prices. On the other hand, if not liquidated, could help squeeze the shorts, a bullish factor. Let’s score it neutral.
In the commercial category, the dealers are currently holding their smallest gross and net short position in history, or just about. (Go to the charts I referenced, and see for yourself.) This is the category most closely associated as being the “insiders”. I think these dealers would love to get long silver real big, but for that to happen, there would have to be some group who would have to go big net short to enable the dealers to get long. What I’m saying, is that the commercials look to be about as little net short as they’re likely to get. I base this on their current small short position, just about the smallest on record. This means that the dealers are less adversely exposed to an upside run in silver, than they have ever been in history. You always want to be on the same side as the insiders in any market. Score a very major bullish point.
In the small trader category, the little guy is less long, on a gross and net basis, than just about any point in history. Now, some would say that isn’t bullish because it shows the public’s lack of interest in silver, compared to years past. Well, while it’s true that the public is holding the smallest silver position in COMEX silver, than it has in history, to me, it’s bullish because there can be no large long liquidation of COMEX silver possible because there’s no large, long position, held by the little guys. In fact, I would go one step further, and argue that if the public were to move big on silver, it could only be to the buy side, as has occurred in the past, adding bullish fuel to the mix. I have to score this major bullish.
In summary, this is my interpretation on the current silver COT – the technical funds are short to the maximum, and their next big move is to buy (to cover shorts). The big non-commercial longs are holding tight, no matter what the price. The commercials (dealers) are positioned the best they have been, ever, for a move to the upside. The little guy is washed out on the long side, and if this category does anything big, it will be to buy. This category has never, and will never, in my opinion, go net short silver, certainly not at these prices. Would you?
Now it’s possible, or even probable, that the current extremely bullish silver COT position may not evolve into the real blastoff in price. Whether this historical bullish extreme in the silver COT turns into the big price runnup I predict depends on the behavior of the dealers. When the technical funds cover their shorts and the dealers are
accommodative in selling to them, we will witness a rally of maybe 20 to 50 cents. Then the move would be over, as the funds would no longer be short, and their buying will have been dissipated. This is exactly what has happened in the past, over and over. We’ll get a quick, small rally in silver, and that’s it. We go back to the silver doldrums, and wait for the COT to hit another bullish extreme.
But one of these days, and maybe now, the dealers are going to behave differently than they have in the past. When the technical funds come in to buy silver, the dealers may refuse to sell aggressively into that buying. The dealers will know, before anyone else, when the physical market is tapped out, and when they know that, they will not sell aggressively. That means that a void, or vacuum, will develop instantly on the sell side. It means we will hit an “air-pocket” in COMEX trading, and melt up. I mean, explode upward.
I can’t tell you when we will hit that air-pocket. I can tell you we will hit it some day. I can tell you that the air-pocket will occur at a time when the silver COT is configured just like it is now. This is why I always caution about the risk of being out of the silver market, and how you can be shut out and unable to secure a position. I can tell you that as long as the silver COT is configured as it is presently, there is not much downside price risk, as the selling is basically complete. What the silver COT says right now, is that the downside is limited, and the upside could be explosive. Based upon the COT, this is not the time to think of selling, but of buying. If there’s a better time to buy silver, than when the COT looks like it does currently, I’m not aware of it.
I want to be clear that the primary reason for buying and holding physical silver is the deficit. With a long term structural deficit between current supply and demand, you could never have a more valid reason to buy any commodity. The fact that silver is also a precious metal, recognized throughout all time, is a rare bonus. The current low price makes it all the more interesting. But in addition to that, I have given you a new reason – my bullish interpretation of the silver COT which indicates a low-risk, high-potential buying point. Looking at every factor it is hard to imagine a better time to buy silver.
