Blood From A Stone
(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.)
The more deeply you study something, the more you should come to know about that subject. When the subject is complex, like the silver or gold market, you also learn that some things are beyond knowing, such as advance knowledge of an unexpected event or the precise timing of a price move. Therefore, in my opinion, it seems reasonable to concentrate on what is knowable and don’t obsess with that which is unknowable, like precise timing or surprise events. That doesn’t mean I don’t try to catch market tops or bottoms, just that I don’t delude myself into making that my prime focus.
My prime focus is to analyze on a fundamental supply/demand basis for the long term, supplemented by studying the market structure, as defined by the Commitment of Traders Report (COT), for shorter-term price movements. The long term is simple – silver has never looked better as a long-term investment based upon real supply and demand. Increasingly, the $13 price level in silver is looking like the $5 level used to look.
And while the COTs are not a precision timing tool, they come closer to identifying major price tops and bottoms than any other public data source that I am aware of. One thing the COTs usually do is explain what happens, if not always when. I think I know what has been transpiring in the recent sell-off in gold and silver and why it has occurred.
The current sell-off in silver and gold is a result of tech fund and other speculative selling (both long liquidation and new short selling) and dealer buying (T. rex short covering and raptor long accumulation). In addition, the sharp decline in silver today can also be traced to a large number of put options that suddenly went into the money on today’s option expiration. Bullish silver investors who sold these puts undoubtedly found themselves in sudden loss situation and had to take the only corrective action they could take to protect themselves, namely, sell silver futures. This was not accidental, but a designed strategy by the dealers. The dealers, large and small, can buy on the way down because they are disciplined and collusive, and are keenly aware of how the markets work. The tech funds and leveraged speculators are not. The current sell-off will end when the last tech fund and speculator sells.
My sense is that we must be close to that point, especially with today’s option expiration. In fact, it feels like the dealers are almost wringing blood from a stone, trying to uncover and engineer the very last sell contract from the non-commercials and non-reporting traders on the COMEX. These dealers seem to be using every trick in the book, including using the overnight markets to their advantage. This engineering has taken on the aura of the last big clean out before the real move up.
It is always important to know, in a broad perspective, the general nature of what you are studying. The recent sell-offs in gold and silver have nothing to do with real fundamentals like supply and demand, and everything to do with dealers’ activities on the COMEX. The most appropriate term to describe this activity is manipulation, because the paper trade is dictating the world price of gold and silver. This is against the law, but that matters little if the regulators won’t enforce the law. The good news is that the market structure only improves on these sell-offs, while the bad news is that it necessarily involves interim pain.
Of course, knowing why and what the sell-off is about can’t tell you precisely how much may be left, so you must govern yourself accordingly. Are the metals a great buy here? Absolutely. Should you buy them on such an extremely leveraged basis that you could lose your position on lower prices? Absolutely not.
One last point. Today’s sell-off was particularly offensive in that there were no outside influences to explain it. It was all COMEX and option expiration related. This is like a mugging in broad daylight with the police just watching. Forgetting the police (the regulators), perhaps even worse is that anyone who follows the market should be aware of what happened. To remain quiet and say nothing and pretend no crime has taken place is morally offensive. If you are a letter writer or advisor, you should speak up. The free market is at risk.
The Senate Report And Hearing On Amaranth
After 9 months, the Senate just released details of and held hearings on its investigation into the collapse of the Amaranth hedge fund. The short version is that Amaranth held a super concentrated position in natural gas that may have manipulated the price. The fund’s position quickly imploded when the NYMEX ordered the fund to reduce its oversized and concentrated position. Once again, the connection between concentration and manipulation has been established. Once again, the regulators, including the CFTC, waited too long to head off the problem, and showed up after the building had burned to the ground. The Senate’s recommendation? Give the CFTC more taxpayer money. Great.
Exactly one year ago, many of you petitioned the CFTC concerning the concentrated net short position held by the 4 largest traders on the COMEX silver market. At the time, that net short position averaged around 34,000 contracts, or 170 million ounces. In terms of days of world mine production, the concentrated short position represented almost 100 days, towering over any commodity traded. The CFTC answered, as usual, no problem.
As of the most recent COT report, as of the close of business on June 19, the big 4 are short almost 255 million ounces, or 50% more than a year ago. In terms of what this represents in days of global mine production, it’s pressing on 150 days. No commodity comes close to this concentration or increase in concentration. That the NYMEX and CFTC can publicly overlook this obscene concentration is shameful and negligent. I can only imagine how much new funding the Senate will want the throw at the CFTC when the silver manipulation blows up.
COMEX Silver Warehouse Movements
The past 7 days have seen some unusual movements in COMEX silver warehouse inventories. There were approximately 8 million ounces withdrawn and 19 million ounces received, for a net addition of 11 million ounces. This did not appear to be the same silver being shuffled around. There may be more large silver stock movements ahead. Interestingly, 90% of the gross 19 million ounces received, or 17 million ounces, came into one warehouse, operated by ScotiaMocatta, in the eligible category. As long-time readers know, I have previously speculated that ScotiaMocatta was one of the Silver (price) Managers. There is certainly no need to speculate that ScotiaMoccata is one of the dominant silver dealers, if not the most dominant. They are proud of that distinction and say so on their website http://www.scotiamocatta.com/interface.htm
There is no way to know, at this time, if ScotiaMocatta is behind this silver movement for its own account or a very large customer, or if it is strictly acting in a warehouse role, but I feel that the large concentrated short is behind this inventory movement. At the very least, it seems logical that just one party is responsible for this silver inventory in movement, and not many independent entities.
Aside from the silver ETF, the COMEX inventories are the most widely watched silver inventories. Although it is easy to establish that COMEX inventories and movement of those inventories have very little bearing on production or consumption fundamentals, or even accurately reflect overall world inventories, because they are so visible, COMEX silver stocks are closely monitored. Like it or not, movements in and out of the COMEX warehouses influence silver observers’ thinking. Therefore, it is natural to join in that contemplation. As always, I think it is important to focus on what is knowable and apply common sense as to what may be behind these recent inventory movements.
I admit that I am only speculating, but I can come up with very little “innocent” reasons for the large and concentrated in movement. I can, however, come up with several not so innocent explanations. For one, if an entity desired to undermine the market into making observers feel there was much available silver for sale, then the easiest way to influence that feeling would be to move in large quantities of inventory. Remember, contrary to what many may think, these movements don’t necessarily reflect change in ownership of the silver, just that it is being moved. So a party could “show” large amounts of silver to psychologically damage the market. It would be illegal, but effective.
Two, the large in movements could be used to negate and offset what positive feelings may have resulted from a very impressive out movement of 8 million ounces during these seven days. I have noticed many times in the recent past where this trick has been employed on the LME base metals market, where inventories increase, prices decline, then the inventories fall again and prices rise. It’s an old dealers’ game.
Three, the in movement could be the result of upcoming delivery demands for the big July COMEX contract. In this case, the in movement would not really be bearish, but as a result for demand for silver, always a bullish factor. It’s just that you don’t know if there’s a bullish connection to the in movement when the metal is first received.
Lastly, I think that there is a chance that the concentrated short position has grown to such obscene levels in COMEX silver that the regulators may be privately coercing the big short(s) to show some metal to somewhat justify the big short position. This would be a welcome development, as it would suggest that the regulators, at least privately, are finally awakening to the glaring problem of the concentrated short position in silver. And it just might suggest the beginning of the end of the manipulation in silver. We can only wait and see.