In Ted Butler's Archive

It Takes Two To Tango

By Theodore Butler

(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.)

There were some very significant developments in the world of gold and silver, in terms of the market structure on the COMEX, as defined by the Commitment of Traders Report (COT). The most obvious development was the stunning deterioration in gold. While generally expected based upon daily price and volume and open interest changes, the actual numbers when reported, caused observers to do a double take. For instance, while I publicly anticipated a 30,000-contract increase in the dealers’ net short position for the week, the actual 50,000+ increase was a bit of as jolt.

Extrapolating from last week’s cut-off date, it appears another 30,000+ contracts have been added to the dealers’ net short position in gold, putting their total net short position at over 180,000 contracts. This means that around 100,000 net contracts have been added to the tech fund long/dealer short position on the $25-$30 gold rally over the past few weeks. Let me be clear – this is why gold has rallied in the first place. Of course, with the price rally in gold has come the creation of much higher risk of ultimate sale by the tech funds of their new big long position, at some point.

Silver has been in an opposite situation compared to gold. Not only has the price action stunk, precisely because of that poor price performance; there has been no deterioration in the market structure. In fact, based upon reported and extrapolated COT readings, silver’s market structure is great, with a reading suggesting low risk and high profit opportunity.

In fact, we are at an interesting juncture in the relative readings of the COTs in gold and silver. Never before have we witnessed such negative readings in gold, at the same time the silver readings have been so positive. Since it is unprecedented that the current relative structures are at extreme opposite readings, there is no historical pattern developed to offer guidance for how this gold/silver COT mismatch will be resolved. The consensus among the published reports I have seen to date is that when gold weakens, it will exert downward pressure on silver. Maybe, but I’m not so sure. There are a number of ways this could play out. One thing appears certain to me – the relative COT readings in silver and gold now fully support the relative actual physical rarity argument of mine that favors silver over gold.

Speaking of published reports on the COT readings, I am continually amazed at how widespread (and good) the coverage of this aspect of market analysis has become. While there are still holdouts to this brand of analysis, there seems to be a growing tide of believers and public observers who grasp the concept. Intellectually, I can’t say I’m surprised, since the COTs are based upon such logical principles and this is why I have written about them for so long. On the flip side, I also can’t help but feel that when something is finally universally accepted, as the analysis of the COTs seems to be headed, it must lose its effectiveness at some point.

But with the tremendous amount of recent attention being placed upon the COTs as an analytical tool, there is one thing that I observe that has not been generally accepted. No one will come right out and state the obvious, namely, that the COTs prove that the markets are manipulated. And that the brain dead tech funds are as much to blame as the dealers. Don’t get me wrong; I still believe that the dealer community, the silver wolf pack, is as crooked as the day is long. But the tech funds are almost as much to blame, as they are the enablers that allow the dealers to continue the manipulation.

I think that those who write about the COTs, and especially those who promote free markets and the end to manipulation in gold and silver, are missing an important point when they don’t label the tech funds as an integral component in the manipulation when prices are rising, as well as falling. I can understand that when the tech funds come rushing in to buy, as they’ve just done in gold, causing prices to rise, that the rising price feels good and bulls are reluctant to complain about anything that causes prices to climb. But that is wrong, in my opinion. You just can’t complain about manipulation when the price is falling, if the manipulation process is in place when prices rise and fall. The manipulation either exists or doesn’t exist, regardless of short-term price fluctuations.

The key point is that the price only moves in gold and silver (and other markets) when the tech funds and dealers go at it. The reason the COTs have been so effective as an analytical tool is precisely because they measure what causes prices to move. It’s not a case that tech fund/dealers trading is coincidental to price moves. It’s much more than that. Tech fund/dealer trading is why prices move. It’s causal. Because it is not the trading of real producers and consumers that is setting prices, but rather the paper trading of the tech funds and dealers on the COMEX that is setting prices, the price setting is illegal. Period.

I don’t claim to know the motivation of the brain dead tech funds, but my sense has always been that they are stubborn and mechanical to a fault. Others suggest darker motivations for how they can persist in a game that has offered them so few rewards. But motivations are secondary to their actual effect on the market. When they buy, we go up, when they sell, we go down. This is against the main intent of commodity law, which holds that speculators must not set the price. Those who analyze and write about the COTs should step back and consider what it is they are actually analyzing. If they are writing because they have come to believe in the validity of the COTs, they should reflect on what is it that creates that validity.

So, how will we resolve the current dichotomy in the COTs with the negative gold structure and the positive silver structure? Since this is an unprecedented situation and no one can point to history, we are forced to guess or speculate. But we do know certain facts. We know that gold has an extremely large tech fund net long position and reciprocal dealer net short position. That gold tech fund long/dealer short position can grow much larger amid higher prices (as I suspect) or the move up can terminate not far from current levels. We can state that we are no longer at the ultra-low risk levels we were at $25 lower and 100,000 net contracts ago.

In silver, we know that we are at an extremely low dealer net short position relative to the past year or two. We know that there is a zero tech fund long position and a very large tech fund short position, so there is no tech fund long liquidation possible, only the possibility of them adding to their short positions. The only fuel for selling to the downside must come from the large non-tech funds in the non-commercials category, the commercials that have recently entered on the long side in unusually large numbers, or the small traders. None of these three groups of traders have shown much inclination of liquidating long positions on sell-offs.

While the price action of silver relative to gold has been awful recently, this price action has been created by the actions of the tech funds and dealers, which, in turn, has created the unusual COT structure. You can’t get to a bad structure without good (higher) prices, and you can’t get to a good market structure without bad price action. That’s just the way it is.

I’d like to speculate a bit here, but please remember it’s just that, speculation. I’ve held a core belief, for two decades, that before we get my long-expected explosive up move in silver, the dealer wolf pack will cause one final sell-off, in which they clean out as many longs as they possibly can. Once the decks are cleared, off we’ll go, immediately. That’s one of the main reasons I started following the COTs so closely 20 years ago. That’s why I have always publicly recommended only a fully paid for physical position in real silver. You can’t get shaken out on that basis.

Lately, I’m seeing things that tell me we’ve just seen that final shakeout, or soon will. I get the feeling that the normal dealer shorting wolf pack has become very reluctant, even afraid, to sell their normal big quantities of silver short. After all, they certainly weren’t afraid to sell short an additional 100,000 contracts of gold recently. But they completely avoided selling decent quantities of silver short when they could have done so easily. Instead, they maneuvered the price of silver lower, before building up their normal big short position. That’s precisely why we have this extreme dichotomy between the gold and silver COT structure.

Of course, I could be dead wrong in my speculation and I will tell you in advance what will make me wrong. If we see big dealer short selling on the next significant rally, then I was obviously wrong about them being afraid to sell. If that occurs, it doesn’t mean that it’s all over for silver, just that my speculative feelings of the big one being close at hand were misguided. No harm, no foul. We’ll have to assess the risk, if that happens.

But if the dealers smell that the jig is up, and that is why they were reluctant to sell when they could have done so easily, then that’s another matter completely. If the dealers don’t sell when the tech funds, or any other entity come in to buy, the lid gets blown off the silver market. That will happen one day. It’s just a question if it’s one day soon.

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