In Ted Butler's Archive

Gold COT Deterioration

(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.)

Most factors that appear to influence gold (and silver) prices seem to be favorably aligned, particularly physical investment demand. However, there has been notable deterioration in one previously important pricing force – the market structure of the COMEX gold futures market, as defined by the Commitment of Traders Report (COT). I am not making any short term price predictions, I am just analyzing the data.

Over the past one and two months, there has been significant speculative buying and dealer selling in COMEX gold futures. Since the COT of November 11, speculators have bought and dealers have sold 80,000 gold contracts net (8 million ounces), on a $180 rise in the price of gold. And 55,000 contracts (5.5 million ounces) of that total have come since the COT of December 9. By way of comparison, the world’s publicly traded ETF’s, perhaps the leading long-term investment force in gold, added 8 million ounces over the past 12 months. While ETF buying represents physical buying and COMEX gold futures represents paper trading, the speculative buying of such quantities of paper contracts has been the primary driver of the gold price rise over the past two months.

History has shown that when the speculators are done buying, the commercials will engineer prices lower and induce the speculators to liquidate at some point. This is the heart of the manipulation. The key question is when will the speculators be harvested? (Or alternatively, will the dealers be overrun for the first time?) I don’t know when that point will come (or if it will come). I’m not trying to be evasive. There have been times when levels equal to current gold COT readings have resulted in big sell-offs, such the recent top in Sept/Oct 2008, in which gold fell more than $200 an ounce. There have been other times when the opposite has occurred, such as September of 2007, when in spite of COT readings worse than now, gold embarked on a six month, $300 additional rally before eventually surrendering all the gains.

Skeptics might counter that such varied outcomes invalidate the premise behind the COTs. They may have a point insofar as making precise future price predictions. I think the real value of the COTs lies in the explanation for why prices move dramatically and for proving manipulation. Here, the behavior of dealers is instructive. Once they establish a big short position, they never buy back their shorts. Their group action is so orchestrated and collusive that it cannot be attributed to free market behavior. While prices rise they continue to hold, no matter how high prices. They wait it out until they can manipulate prices lower. Then they buy back at the lower prices and profit. They can only do this because they completely control and dominate the market.

The COT structure in silver has not deteriorated near as much as gold. Then again, silver’s price action has not been as robust as gold’s. That’s one of the perverse anomalies about the COTs, namely, the better the price action, the worse the deterioration. Normally, given the relative size of each market, COMEX gold is roughly three times larger than the silver market in terms of contracts of open interest and the net commercial COT changes. In the past one and two months, silver’s COT net commercial changes have been running at one-tenth of gold’s changes, and not a more normal one-third. Whereas the commercials added 80,000 gold contracts net short over the past two months, they “only” added 8,000 silver contracts net short. In simple terms, this means that there are fewer speculative long contracts to liquidate in silver than there are in gold.

In addition, as indicated in the just-released Bank Participation Report for January, two or three U.S. banks have increased their gold net short position to levels matching the extremes of the August report, some 80,000 contracts (8 million ounces), or 10% of world annual mine production. It’s not like you have to look far to find the manipulators in gold or silver.

Enough Is Enough

* * * * * * * *

There was an excellent interview of Eric Sprott, of Canada’s Sprott Asset Management just published.

Mr. Sprott is a heavyweight in the world of mining and resource investments. The interview primarily concerns gold, and I would urge you to read it. Here’s a section dealing with silver.

TGR: You mentioned earlier that you are also investing in silver. Can you speak briefly on your viewpoints of silver? We hear that it’s a much more volatile industrial metal and, therefore, it’s more risky.

ES: We almost own as much dollars of silver as we own in gold. I personally did not convert silver bars into coins. Our supply of silver coins is somewhat limited and, of course, the supply of silver coins in the world is very limited; the premiums that we charge are much higher than those charged on gold coins. So, in that sense, a gold coin is a better value vís a vís the premium.

And, yes, silver has the quality of being considered an industrial metal, but I think what’s most interesting about silver is that there’s not a lot of above-ground silver in the world. It wouldn’t take many buyers for there to be no silver around. We’re talking a very small amount of money.

That’s one of the unique aspects of silver. If it really catches a bid here, it can move pretty fast and I happen to be in the Ted Butler camp that—when you look at the goings on and the commodity exchange, it just looks so perverted with the size of short positions that are going on—I think the quoted values, ultimately, will not prove to be relevant.

I’m pleased to be mentioned by Mr. Sprott. He has more experience and market knowledge gained over 40 years, than the cumulative total of the 500 employees of the Commodity Futures Trading Commission. His opinion is that the short position looks perverted. Their opinion is unknown, only that it will be investigated.

Of course, no investigation is necessary. The only thing that’s necessary is for them to explain why one or two U.S. banks holding a short position equal to 25% of the annual world mine production of silver is not manipulation. The disclosure of that position was followed by a 50% decline in price over the following month, one of the greatest declines ever. It is clear that the CFTC is stalling, not investigating. It is infuriating that qualified market participants can see the silver manipulation clearly, yet those responsible for enforcing the law pretend otherwise. Enough is enough. Several readers have reminded me that the only way to force a response from the CFTC is through your elected representatives. Those readers also suggested I give some tips as to what you should write to your senator or congressman.

Keep it simple. Make your letter as short as possible and be clear as what it is you are asking of your representative. He or she will not be familiar with this issue. Don’t get into any conspiracy theories about the Federal Reserve or central banks. You are asking for an explanation to the simple questions you have already asked the CFTC about one or two U.S. banks holding a short position of 25% of world production, something that has never occurred in any other commodity. How could this not be manipulative? I would tell your representative that instead of answering simple questions, the CFTC has embarked on a wasteful and unnecessary taxpayer-funded investigation. Just ask that the above questions be answered. Feel free to reference anything I’ve written.

One thing I assure you of is that this is an important issue. You will not be wasting your representative’s time on a marginal matter. You will not be dismissed out of hand. You should get a response. You will be doing yourself and the market and our country a service by taking the time and expending the effort to get involved.

Finally, it’s no secret w e are in for tough economic times. I have been reading non-stop financial advice and information on personal security. Here’s my advice. Be more generous. Metal investors will fare better than others. That should continue in the future. In addition to increasing your charitable contributions, a special effort should be made to help, in any way possible, the working class that makes up the backbone of our country. No one waiting tables or driving a cab is getting rich. Many are raising families. Now is the time to step up and go out of your way for extra tips for the waters and waitresses, service workers and all independently-employed workmen and women who we often take for granted. Any extra remuneration will not be hoarded away. It won’t hurt you and it will help them.

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