The Missing Ingredient
By Theodore Butler
(The following essay was written by silver analyst Theodore Butler. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)
The market structure in the COMEX metals (gold, copper and silver) remains intact and exceedingly bullish. The latest Commitments of Traders Report (COT) confirms the commercial dealers have fled the short side in all three in unusual amounts. The big concentrated commercial traders have their smallest net short positions in recent times. While no one can predict the exact day of liftoff to the upside, the COTs have been a remarkably accurate indicator of major price directions in these markets. Now they are indicating a low probability of a big downside and a high probability of a major move to the upside.
In order to get a sense of where we now stand in the COTs, it might be instructive to compare current readings to where we stood at different points in the recent past. The rule of thumb is the smaller the dealer net short position, the better structured the market is to move higher. The larger the dealer net short position, the more chance there is of a sell off. The trick to interpreting the COTs, in my opinion, is to guess when the dealers are at the maximum point of buying (covering shorts) or selling short and are about to reverse and go the other way.
Because the principal counterparties to the dealers are the brain dead tech funds, the dealers enjoy the advantage of buying on the way down and selling on the way up, precisely because the tech funds do just the opposite. The dealers will take the opposite side, in any quantity, of whatever the tech funds wish to buy or sell, so poor is the tech funds’ trading record in the COMEX metals and their programmed behavior. In fact, interpreting the COTs is also a guess as when the tech funds are done buying or selling, and when the dealers will start harvesting the tech funds positions. As you may know, for the past six weeks or so, I have been under the impression that the dealers have effectively bought back as many gold, silver and copper shorts as they will be able to buy back.
As of the latest COTs, the net short position of the dealers are the smallest they’ve been in a while. You have to go back to when silver was under $5 to find a similarly small dealer net short position. Likewise in gold, the dealer net short position currently is as small as it was when gold was under $340 an ounce. Most importantly, in each, the concentrated net short position by the big dealers is even smaller now, on an equivalent basis.
One thing to remember is that once the metals’ COTs are configured a certain way, bullish or bearish, it has always been just a matter of time before the dealers prevail and clean the tech funds’ clock. As I’ve said before, the next time that the tech funds beat the dealers, will be the first time. However, this does not mean that a bullishly structured COT, like we have now, can’t possibly get more bullish. All it would take to get more bullish would be lower prices, accompanied by further tech fund selling and dealer buying. That can always happen.
But the important point is that lower prices and more tech fund selling from here does not alter the bullish structure, it only strengthens it. I hope everyone is clear on that point. When I come out and pound the table for a market bottom (like I have for the past 6 weeks), that does not mean we can’t go lower temporarily. It just means we are at a price level where, once again, it is dimes to the downside and dollars to the upside, in my opinion. Further, the current market structure suggests to me that we could be days away from an explosion to the upside in gold and silver, as the key moving averages are about to be penetrated. I base this on my expectation that the dealers will not aggressively short the next true silver rally.
You might want to compare this COT market structure approach to other more conventional approaches to the market, such as charting and technical analysis. In case you haven’t noticed, I don’t recall ever writing about such approaches for analyzing the markets. This is not because I don’t consider these forms of market analyses to be legitimate, as I look at them constantly. It’s because all these analyses are predicated upon price and price movement. These forms of analyses assume that all you have to do is study the price, and nothing else.
I have trouble with that assumption for a number of reasons. For one, I truly believe that the price of silver is manipulated, and therefore, studying the price movements alone would likely be frustrating. Also, were one to invest in silver solely based upon “good” technical price movement, one would seem obliged to sell on “bad” price movement. That seems counterintuitive to me. I prefer to invest on a value basis, where the underlying real worth of an item is misrepresented by the price. In that case, if the price moves lower still, the item is more valuable on an investment basis (all things being equal), and should not be sold because of the new lower price.
Lastly, while I do admit to the self-fulfilling aspect to charting and price analysis and its use as a timing tool, it must be remembered that if the majority adhered to this approach, there is no way massive numbers of investors could all practically enter and exit markets as small as silver simultaneously. And, given my anticipation that the real move in silver is destined to be explosive to the max anyway, that dilemma is magnified. Certainly, there is no way I could ever adopt a public stance of a timing-only approach to silver, for all the reasons mentioned. Real silver, on a long term buy and hold, is the sure thing.
It’s not just the COTs that are structured magnificently in silver. All the other important factors, centered around the supply/demand fundamentals and the deficit and general awareness of these facts, seem to be kicking in. In fact, there is only one missing ingredient in the whole silver equation – the price. Please think about that for a moment. The only thing preventing the investment world from recognizing the great value and importance of silver is the final confirmation of price.
If the price of silver were many times greater than it is currently, there would be universal acceptance of the real silver story. There would be no doubts concerning hidden inventories. No one would be asking, “if the fundamentals are so good, why is the price so low?” If silver was well into the double digits in price, it would be common knowledge as to just how critical is this material. If the price was right, silver would be mainstream. Certainly, I wouldn’t be writing the kind of articles I write.
But it is that one missing ingredient, the price, that creates not only the doubts, but the opportunity. If silver investors weren’t in the distinct minority, there would be no outrageously depressed price. The reason the manipulators have succeeded as long as they have, is because the low price has lulled the investing world to sleep. Let’s face it – the first and foremost consideration in any investment is the price. The average investor is not interested in doing his own thinking and homework. When he looks at silver for the first time, like the first time he looks at any new potential investment, the main thing considered initially is the price. Perversely, in investments, low and stagnant prices are an immediate turnoff. Very few will dig deeper to see if the low prices are legitimate or not. That’s just the way it is.
It is this lack of price validation in the silver equation that keeps the majority away, to the benefit of the minority. But it will not stay that way forever. Sooner, rather than later, we will get the price move up that excites the majority and confirms to them that silver is a good investment. But that can’t occur with silver as good of a value as it is now. It must come well off the bottom. It will remain dollars to the upside then, but not dimes to the downside. The trick to investing in any undervalued asset is to position yourself while it is still undervalued, before it is validated by price. You have to be early. When the current missing ingredient in silver is no longer missing, the low-risk opportunity will be.