In Ted Butler's Archive

Keeping It Simple

(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.)

I hadn’t planned to write this week, but market developments were dramatic enough to warrant some commentary. Since my recent articles concerned potential high risk/reward and volatility, due to an extreme mismatch in the futures market structure in gold and silver, the subsequent sell-off and volatility were not unexpected. Granted, the $50 gold and $2 silver thumping was extreme, but so too was the tech fund long/dealer short position on the COMEX, as documented in the Commitment of Traders Report (COT). Obviously, we truly were at a critical juncture.

The most recent COT, for positions held as of 2/27 (just before the sell-off began in earnest), confirmed, and even exceeded, expected extreme tech fund long/dealer short position readings in gold and silver futures. In fact, there was a notable record set in silver. The concentrated net short position of the 4 largest traders reached an historic level of more than 263 million ounces, up over 36 million ounces for the week. Please think about that for a moment. The 4 largest commercial traders just happened to have the largest net short position in the history of COMEX trading, and we dropped $2 per ounce in days. Do you think that was coincidental?

In gold, the total net commercial short position rose to a combined (COMEX and CBOT) 206,000 contracts (20.6 million ounces), a short position greater than at any other time, save for one previous week (Oct 11, 2005). From the price low in January until the most recent COT, the combined net tech fund long/dealer short position in gold grew by almost 115,000 contracts (11.5 million ounces), with a 22,000 contract net increase in the past week alone. Gold subsequently fell almost $50 in days. Again, I ask you, do you think that fall was coincidental to the dealers having a near record short position? Further, do you think it was just coincidental that gold and silver had such extreme short positions and both fell so much in such a short period of time?

Let’s keep this simple. Gold rose $80 and silver rose $2.50 an ounce from early January to last week, because 11.5 million ounces of paper gold and 120 million ounces of paper silver were bought by tech funds and sold by the dealers during the price rise. So far, gold has fallen $50 and silver $2, because those paper positions are being liquidated. No other reason comes close to explaining the price movements. Not currency, not inflation, not ETF or retail physical buying or selling, not world tensions, not charts, not anything. Given the stark reality of the verifiable data of the COTs, it is hard to understand how any observer of gold or silver does not see this. Let me be clear – while the COTs may not always predict the future with pinpoint accuracy (although they can at times), they always explain a big move afterward. This adds tremendous understanding for future analysis.

What now? Undoubtedly, there has been significant liquidation of tech fund long and dealer short positions on the decline. That’s what the decline is all about. Has there been enough liquidation to pound the table and pronounce the market fully liquidated and at a very low risk level? No. Can we rally from here? Sure. Can we still sell-off sharply? Sure. Will the dealers succeed, as always? Maybe not, but history suggests they will. Will there be continued volatility? Count on it.

To their credit, I have noticed many more analysts and commentators and investors embracing the logic of the COTs as never before. As a long-time observer of the COTs, I welcome them and wish to address them now. You now know why gold and silver went up in the past two months and why they went down so much in days. It could not be clearer. There were no dramatic changes in gold or silver supply/demand fundamentals during this time – no sudden production or consumption shocks, no grassroots movement by investors to buy or sell real gold or silver in great quantities, no obvious world event that impacted either metal. You now know the price moves were caused by paper trading on the COMEX and CBOT.

I ask you to take this knowledge and do something constructive with it. I ask you consider that this dictating of the price of gold and silver by paper and electronic trading on the COMEX and CBOT by a small number of large traders is in direct violation of US commodity law. This law holds that price should be set away from the futures markets and be determined in the real world of supply and demand. Futures trading should discover, or uncover, what the true price should be, and not be the sole determinant of price at any time. If you now know from the COTs that the price of gold and silver have been set by the futures market, you also now know that this is illegal activity.

I ask you to do something about it. Something that can’t hurt and just might help. I ask you to communicate with your readers and with the regulators on what you know to be true, namely, that the price of gold and silver has been set on the COMEX and CBOT and that this is contrary to commodity law. I’ve been doing it for more than 20 years and feel fortunate that I have done so. You will not be embarrassed for doing so.

Some might say it’s a wasted effort and that I’m just whining about the recent drops. That’s nonsense. Complaining about a manipulation, when a manipulation clearly exists, is not whining, especially when you prepare yourself accordingly. Go back and count the analysts who cautioned of high risk before the sell-off. Anyone who has approached these markets from the premise that they are manipulated and that it has been more fruitful to monitor the manipulation by use of the COTs has come out better than any other approach. But the ability to analyze a crooked market doesn’t make the market any less crooked. You don’t have to tolerate manipulated markets quietly.

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