In Ted Butler's Archive

This memo was distributed to IRI brokers Thursday morning, July 7. See Weekly Commentary following this bulletin.

July 6, 2005

To: All Brokers

From: Ted Butler

In a conversation with Jim Cook today, he suggested that what I was thinking was so important that I should put my thoughts in writing. I think we have flushed out the tech fund longs in silver, with constructive dealer short covering. The same goes for gold, although it’s possible for gold to work a bit lower. What Jim was most interested in were some comments I made on the dollar versus the other currencies, which I don’t normally write about.

First off, I’m not a currency maven and don’t pretend to be one. A man’s got to know his limitations (Dirty Harry, I believe, said that). But I do see what could be a rare and powerful alignment of planets and stars and I’d like to get it off my chest.

There is a question in my mind as to whether currencies influence the metals, or vice-versa, but there usually is a connection that suggests a weak dollar coincides with strong metals. This relationship is soon to reassert itself in a big way. It all has to do with the tech funds and momentum players.

Around March 10th this year, the dollar made a significant low and gold and silver recorded a high for the year. So far, so good. At that time, the tech funds were massively short the dollar (their biggest market) and massively long gold and silver. Since that time, the dollar has risen 10% (a very big move) and the metals, coincidentally, are down almost about the same percentage.

Because of the dollar rally over the past four months, the tech funds closed out all their shorts and have gotten massively long the dollar (short the currencies) and have now abandoned their long positions in the metals. Therefore, market structure suggests major dollar weakness and metals strength straight ahead – simply because the tech funds and momentum players are on the wrong side once again.

If the dollar starts to tank and the metals soar, all sorts of nonsensical reasons will be given, centering around the demise of the dollar and the end of the world. The real reason will be that the brain dead tech funds were snookered once again – no more, no less. The important thing is that silver should do extremely well, dead ahead. The COTs will see to that.

The Flush Out

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.)

Sometimes, it’s downright eerie how reliable the Commitment of Traders Report (COT) can be in forecasting significant moves in the gold and silver market. We’ve just experienced one of those times. The buildup in tech fund long positions and dealer short positions in gold and silver created a clear and present high-risk situation, which resulted in a sharp price break.

Make no mistake; this recent swoon in price was caused by the tech funds dumping as the dealers engineered the price through the critical moving averages. This is not a complaint, just an explanation for what just occurred. In fact, if this recent sell-off caught you off guard, that could only be because you did not consider the COTs. I am not encouraging anyone to approach the markets on a short-term basis. But if you do decide on such an approach, and you disregard the message of the COTs, you will greatly handicap yourself.

Therefore, it is not surprising to me to read more written about the COTs and greater acceptance of this market structure approach as an analytical metric. What is surprising (and amusing) is how anyone can attempt to explain the recent round trip in gold and silver prices without reference to the COTs. Of constant surprise is how the silver miners can ignore the price being set by speculators on the COMEX.

So, what is the current message of the COTs? First, let’s look at where we’ve been. In gold, the tech funds plowed onto long side, with a reckless abandon over a four-week period, to the tune of 110,000 net contracts. Now we are in the midst of the unwinding, which commenced on Friday, July 1. It will take aggressive and high volume selling to clean out the tech funds’ gold buying orgy, such as we’re currently witnessing.

In silver, the flush out appears complete, or largely so. I base this on daily price and volume statistics. By my calculations, much of the 30,000 total net contracts bought by the funds and sold short by the dealers on the previous rally, have been reversed on the price decline in the past week. As such, the recent high risk in the silver market is no longer present, in my opinion. It’s safe to go back into the water.

This is important in silver, because the fundamentals are so powerful and the price is so far below real value, that you need a good reason not to be over-invested at all times.. The only good reason I have ever found not to be over-invested in silver is when the COTs are indicating that the funds are very long and the dealers very short. This was the case until this recent price decline remedied that circumstance. Therefore, I see no compelling reason not to be over-invested in silver. Especially below $7.

Once again, we are set up with a win-win situation in silver. We know there will be a rally once the tech fund selling is exhausted. What we don’t know is how the dealers will behave on that coming rally. Will they sell, as they always have, or will they stand aside, allowing the price to truly explode? It is a resolution best awaited from a fully-committed posture

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