In Ted Butler's Archive

Silver Default Looming?

(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.)

In last week’s article, “Proving the Silver Manipulation Again,” I highlighted the growing and extremely large concentrated position of the largest short traders (compared to the largest long traders) on the COMEX silver market. I based all my analysis on source data contained in the Commitment of Traders Report (COT) as of May 30, 2006. My intent was to show how the evidence constituted reasonable grounds for an immediate investigation into possible manipulation. I directed this information to the new chairmen of the Commodity Futures Trading Commission (CFTC) and the NYMEX/COMEX, as did many of you, with the expectation that they would explain and/or rectify the situation.

The just released COT, for positions held as of June 6, 2006, shocked and dismayed me. Not only did it confirm my contention that the largest short traders on the COMEX continued (and actually increased) their dominance over long traders by excessive concentration, the new COT contained data that was so disturbing that it raised the possibility of a looming default in COMEX silver. At a minimum, the new data fully explains the recent sharp sell-offs in silver and strengthens my allegations of a downward price manipulation.

What makes the new data so disturbing is that it may indicate that a couple or even just one of the very largest short traders may have become isolated from the rest of the dealer short community and has turned into a rogue trader seeking to intentionally drive prices down to reduce economic loss or to acquire silver on the cheap in other markets. While the dealer community, as a whole, aggressively bought back and covered short positions on the price decline in silver (as expected), the very largest trader(s) actually increased short positions on the decline. This is unprecedented.

And for those confused as to why silver prices have been so weak, the COT report should provide an answer. The largest trader(s) have been selling whenever the market is most illiquid (on the electronic Access market on off-hours and regular session openings and closings) to cause the biggest price declines. It is predatory pricing at its most extreme, designed to cause liquidation from leveraged long position holders. Unfortunately, it has had the intended effect, as leveraged longs have been flushed from the market. Needless to say, this violates commodity law.

Most importantly, the new short selling by the largest trader, on severe price declines, provides prima facie evidence of manipulation. Previously, short selling by the commercials only occurred on price rallies. As such, such selling could fit into the category of market making (a separate issue which may violate commodity law). But with new shorting on severe price declines, all pretense of “normal” selling goes out the window. The selling by the largest trader is clearly designed to cause further price declines. More compelling evidence of manipulation is hard to find.

Let’s look at the data. The current COT shows that the reporting commercials reduced their total net short position by 5300 contracts, principally by an increase in their gross long position. Even the traders identified as the largest 5 through 8 traders reduced their net short position by roughly 2000 contracts. But the traders identified as the largest 4 or less traders actually increased their net short position by 1200 contracts. As a result, the 4 or less largest traders hold a more concentrated position, relative to long traders, other commercials in total and the 5 through 8 traders, than at any time in history.

The change in the actual numbers of contracts in any one-week is not so important as is the behavior and intent of the largest traders that those changes may reveal. It is clear from the ongoing data that the dealers as a whole are running from the short side of silver, while the very largest trader(s) is selling more. I repeat, this has never happened before and should be a significant signal to the CFTC that something is very wrong.

Starting with the COT report of February 28th, the concentration ratios showed that for every net short contract held by the 5th through 8th largest trader, 1.96 net short contracts were held by the 1st through 4th largest traders. Since that time, this relationship has changed. With the last report we now see that for every Net short contract held by the 5th through 8th largest traders, there are now a staggering 4.45 contracts held by the 1st through 4th largest traders. The following graph illustrates this increasing concentration of short interest on the part of a very small number of traders:


In other words, the 4 or less largest traders have more than doubled their concentrated short position relative to the next 4 largest traders during this time period. (Special thanks to Carl Loeb for the graphics and other important contributions for this article).

As previously noted, the fact that a concentrated position exists does not in and of itself mean that a price manipulation is occurring. However, it is also true that without position concentration, manipulation is impossible. This is presumably why the CFTC publishes the concentration ratios for the 8 largest traders – so that when concentrations begin to occur, they can serve as a “red flag” for regulators to make sure an illegal manipulation is not occurring.

Note that the graph shows that the majority of the increase in the concentration of the large trader(s) net short position occurred from May 9th on – precisely during a period of significant and relentless price declines when all other commercial traders were significantly reducing their short position and adding to their long position. A concentrated position either long or short can be an indication of intended manipulation. Such a concentration which drives the price in the direction of the concentrated position is a smoking gun that cannot in conscience be ignored by the exchange or the CFTC

The most recent COT reports provide stark confirmation that an unprecedented concentration of positions has occurred, is growing larger, and as a result, alarm bells and flashing red lights should be going off at the CFTC.

The 4 or less largest traders are now net short the equivalent of 187,625,000 ounces, or 37,525 futures contracts, an incredible 86% of the total net commercial short position. This is the highest percentage in history. Mathematically, this means that the 4 or less short traders also hold the offsetting and reciprocal 86% of the total net long position in the combined non-commercial plus the non-reportable categories. Please think about that. What it means is that 4 or less large traders are net short what many thousands of public participants hold net long. Literally, 4 traders short against the world. Or, perhaps more accurately, one main short against the world, with the other 3 traders in this reporting category holding much more modest net short positions more in line to those traders in the 5 through 8 largest trader group.

What does this unprecedented and verifiable concentrated short position, manipulative as I allege that it is, have to do with possible looming silver default? Here you must rely on your common sense. You must think of how this concentrated short position will be resolved.

As I have written previously, every short position is an open transaction that must someday be completed, or closed out. The completion can be by a delivery, in this case by actual silver, or by a repurchase, or buyback of the shorted contracts. This applies to the 187 million ounces held short by the 4 or less largest traders. If, in fact, these traders do hold 187 million ounces of real silver that they intend to deliver, then there is no default looming. But that still doesn’t mean they are not guilty of manipulation and predatory pricing, as the ownership of a large quantity of a commodity does not allow one to dominate and manipulate a market, according to commodity law.

If these traders do not own the actual silver, however, in addition to price manipulation, the specter of disorderly pricing and/or default becomes more likely. These large traders are clearly influencing prices to the downside and it stands to reason they will influence prices to the upside if and when they reverse course. First, manipulation to the downside, then disorderly pricing to the upside. That’s pretty ugly from a regulatory perspective. But there’s even an uglier outcome – an actual default on the COMEX silver contract by repudiating those contracts through bankruptcy.

Of the 187 million ounces held short by the four or less traders, I am now convinced, from studying the data, that anywhere from 100 to 125 million is held by just one trader. It is looking more likely that this could be a rogue trader, selling more in order to buy time, although he’s probably already in too deep. The other dealers are realizing this and they are moving to buy back their short positions and going long, leaving new selling solely to the big short. Recent history is replete with examples of this type of behavior. For instance, rogue traders from the Peoples Republic of China have emerged in both oil and copper in the past couple of years. Why not silver? While I certainly wouldn’t be surprised if it turns out to be a rogue trader from the PROC behind the concentrated silver short selling, the who is not important. What is most important to the market is that rogue traders eventually default, and the default causes chaos

I know I can’t blame the officials from the CFTC and the COMEX if they do not want to hear from me. What institution wants to hear from a critic, especially an outsider? But I know I may be doing them a favor, by alerting them to a very serious potential problem. Given the current concentration of a short position well in excess of all COMEX inventories (certainly not all of which is available for delivery), the risk of a default in COMEX silver by the largest and most concentrated trader looms large. Innocent bystanders, from clearing member firms to ordinary seat holders and traders, and employees of all types would suffer in a silver default. Default is the worst possible thing that could happen to any exchange or market. A default would make the thought of the NYMEX going public a sick joke, even sicker than Refco’s public offering turned out to be.

The last thing I wish to witness is a default in COMEX silver. In the spirit of averting such a terrible occurrence, I’ll even offer a constructive solution for preventing such an outcome. Exchange and regulatory officials should insist, just for the most concentrated short traders, that for every contract not certified to be backed by readily deliverable silver, the full contract value be maintained as surety the position can be settled without disrupting the common good and damaging the ordinary investors the CFTC was created to protect.

Just so no one misinterprets my words, this default potential is the most bullish development possible for the price of silver and those holding real silver positions. It introduces a bullish factor beyond description, as and when this concentrated short position is resolved. Please allow me to leave it at that, as I don’t want to detract from my message to the regulators by speaking of the investment merits of silver.

I know that the issues I raise are serious and the regulators will respond, as they always do. However, the last time I petitioned them, with your help, we had to wait five months and wade through 9 pages of convoluted and misleading denials. The current situation in silver is an emergency. It is a crime in progress. The big short is forcing the market sharply and intentionally lower by building on an already heavily concentrated short position as is clearly evident from the CFTC’s own published data. This serves no sound general economic purpose, and may only serve to delay a terrible day of reckoning, which when it comes, may be a very ugly event for the exchange, its trustees and the CFTC.

The regulators from the CFTC and the NYMEX/COMEX must immediately intercede to halt the manipulative behavior of the concentrated short trader(s) and take measures to protect the market from default. Or explain, in a timely manner, why their published data is not indicating a manipulative and dangerous concentration not seen since the days of the Hunt Brothers.

I have sent this article to the new chairmen of the CFTC and the NYMEX/COMEX, with a cover letter asking that they look into and respond to this issue. Generally speaking, there is a better chance of a timely response if many people contact them. If you do decide to contact them, please feel free to send my article.

The Honorable Reuben Jeffery III


Commodity Futures Trading Commission

Three Lafayette Centre
1155 21st Street, NW
Washington DC 20581


Richard Schaeffer



World Financial Center
One North End Avenue
New York, NY 10282-1101

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