In Ted Butler's Archive

The Senate Report

(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.)

On June 24, the US Senate Permanent Subcommittee on Investigations issued a 247-page report entitled, “Excessive Speculation in the Wheat Market.” The press release can be found here Click Here

The full report here Click Here

This is an important report. It is likely that its recommendations will be implemented. The Subcommittee found that the CFTC failed to uphold commodity law, by allowing large index traders to hold long positions in wheat well above the proscribed speculative position limits of 6,500 contracts. (Index traders represent pools of passive investors, like pension plans that seek to replicate the long term performance of commodities through the purchase of futures contracts. There is little index fund buying of COMEX silver futures). The report indicated that large long positions of index traders caused the price spike in wheat and other markets last year. It recommended that the CFTC scale back their permission to hold positions above the limits, and lower those limits if necessary.

The issue of the index funds is one I have written about often. Click Here
I agree that large futures positions can influence the price of a commodity. If a futures market position grows too large it will affect the underlying cash market. Unfortunately, they only looked at long-side traders, while giving a pass to the short side traders who also hold positions well-above existing position limits. It’s a universal disconnect that only speculators on the long side cause problems. A more balanced finding would have laid some blame on shorts who over-extended themselves and drove prices higher in panic short-covering.

One great thing about this report was that it is right to the point. It lays out the problem and proposes a no-nonsense solution. I don’t ever recall any similar government report this specific. I’d be lying if I said I wasn’t gratified that the report validated most everything I’ve held about silver for the past 25 years. In fact, the report is harshly critical of the CFTC and agrees with me on some recent specific disputes I’ve had with the Commission.

The Senate report contains facts important to any observer wishing to understand the issues of concentration and manipulation. The report was careful not to use those words specifically for a very good reason. Since there are roughly 25 to 30 long index traders operating in the Chicago wheat market at any time, that’s too many to meet the definition of concentration. As I have written often, concentration is required for there to be manipulation. Furthermore, because there is no evidence that the index traders had any intent to influence wheat prices, the word manipulation was avoided. Just as a reminder, the terms concentration and manipulation do apply in silver, because there are so few big short traders and there appears to be clear intent to influence silver prices.

Rather than use the word manipulation, the report consistently refers to “excessive speculation.” Instead of the word concentration, the report describes the dominant position long index traders held as percent of the entire market. So let’s keep this simple and compare wheat and silver in the terms of the Senate report. The only difference is that the excessive speculation and dominance alleged in the report of the wheat market is on the long side, while in the silver market it’s on the short side. According to commodity law, excessive speculation and undue market dominance are not allowed on either the long or short side.

The speculation that the report describes as excessive is the amount held by index traders above what these traders would be allowed to hold had they not been granted exemptions to the existing statutory position limits by the CFTC. (Legitimate position limits in silver is the main issue I have raised with the CFTC and the COMEX, going back 25 years.)

Position Limits

Position limits mean just what the term indicates, namely, a restriction on the number of contracts an individual speculator may hold, long or short. The purpose is simple – prevent a speculator, or a number of speculators from buying or short-selling any commodity in such large quantities that it impacts the price. It’s a time honored and integral part of commodity regulation, going back to 1936. Then what’s the problem? If position limits are sacrosanct, then why is the Senate report harshly criticizing the CFTC over position limits in wheat and why am I criticizing them in silver?

In wheat, the index funds were granted exemptions from existing position limits, on the basis of their operations. The index funds didn’t sneak into the futures markets under the cover of night. They applied for permission, in advance, to hold positions in excess of statutory position limits. Those requests were granted by the CFTC. The Senate report has concluded that was a mistake on the part of the CFTC and is demanding the exemptions be cancelled and that all long traders be restricted by existing position limits, or even lower position limits.

What’s not covered in the report is that there are large short traders, classified as commercials in wheat and all other markets, that hold speculative short positions that are also trading larger quantities than allowed by existing position limits. In fact, this is the dirty little secret of the commodities markets and what enables the big shorts in silver (and gold) to manipulate those markets. Just as the CFTC carelessly granted waivers from position limits for the index funds on the long side of wheat (according to the report), it routinely grants the commercial shorts an exemption from position limits on the short side, even though they are speculating, not hedging. It seems the CFTC is consistently lax when it comes to this commodity law.

Invariably, the key question about position limits comes down to what is the proper level of position limits? The Senate report concludes that in wheat the limit should be no more than (the existing) 6,500 contracts and perhaps 5,000 contracts. How did the report reach this conclusion? Based upon the contents of the report, the authors placed great emphasis on the size of the real wheat crop, both on a domestic and world basis. This is logical, as position limits have to be set relative to something. Since futures are derivatives contracts, they must be gauged relative to the host market from which they are derived. In wheat, paper futures contracts are derived from the physical wheat market, not the other way around. Therefore, position limits in wheat futures should be set relative to the physical wheat market. The Senate report does this.

The 6,500 contract position limit in wheat is equal to 32.5 million bushels (5,000 bushels per contract). The total US annual wheat crop is 2 billion bushels. World annual wheat production is ten times that, at over 20 billion bushels. Therefore, the position limit of 6,500 futures contracts represents 1.6% of the total US wheat crop (32.5 million bushels vs. 2 billion bushels). Relative to the total world wheat crop, the 6,500 position limit represents 0.16% of the total 20 billion bushel crop. This ratio of wheat position limits to actual production is broadly similar in other important commodities, like corn or soybeans. And please remember, the Senate report is leaning towards reducing the position limit to 5.000 bushels in wheat. What about silver?

In silver, there are no hard position limits in force. There used to be, but the CFTC allowed the COMEX to replace hard position limits many years ago. Instead, now there is an “accountability limit” of 6,000 contracts. This limit is regularly exceeded by the big silver shorts, but rarely by the longs. Since there are 5,000 ounces in a COMEX futures contract, the accountability limit is equal to 30 million ounces. Whereas the position limit in wheat was 1.6% of the US crop, the accountability limit in COMEX silver is almost 52 times larger, at more that 83% of total US mine production (estimated at 36 million oz by the USGS). While the position limit in wheat was 0.16% of the world wheat crop, the COMEX accountability limit is 28 times larger, at 4.5% of the world silver mine production (660 million oz. per the US Geological Survey). Just to keep the record straight, the US is the 4th largest producing country in wheat and the 7th largest in silver.

What this demonstrates is that there are no effective position limits in COMEX silver. The limits are set so high as to not have any impact. It’s like setting the speed limit in a school zone at 100 MPH. In silver it’s made worse because the absurdly high limit isn’t observed. More correctly, the limits are observed by the longs, just not by the shorts. CFTC data show that the 4 largest shorts currently hold an average position of almost 12,500 contracts each, while the 4 largest longs hold an average long position of just over 3500 contracts each.

The facts are clear. While the Senate report has concluded there should be no exemptions to position limits in wheat, the position limits in silver (if you can call them that), are 52 and 28 times larger, in terms of real US and world production.

Here’s a graphic representation showing the difference in position limits relative to US and world production of a few commodities.

So why no Senate report on silver? That’s simple. It has to do with the dirty little secret. Only those holding long positions can be guilty of excessive speculation. It’s not possible for the shorts to sell excessively, especially if they happen to be US banks. Put limits on the longs, but look the other way when it comes to the shorts. It’s the new un-American rule of law, as dispensed by the regulators.

In the keeping with the Senate report, let me offer a specific and simple remedy to the problem of silver position limits that are so large as to limit no one. Lower the position limit in silver to 1500 contracts (7.5 million ounces), all months combined. In keeping with commodity law, bona fide hedge exemptions can be granted upon request. But please remember, there are only about 20 or so mining companies in the world with production greater than 7.5 million ounces a year. These are the natural hedgers on the short side. Since very few of them, less than 5 or so, hedge their silver production, there will be very few requests for exemptions from the 1500 contract position limit. This should make it easy for the CFTC to track exemptions.

Market Share

The Senate report emphasized the impact that the index funds had on wheat prices, due to the large percentage of the market they held. The report stated that the index funds held between 35% to 50% of all wheat contracts on the Chicago exchange. Quoting from the press release,

“The Subcommittee investigation uncovered substantial and persuasive evidence that, by purchasing so many futures contracts, commodity index traders, in the aggregate, pushed up futures prices …”

Since 35% to 50% represents a significant share of any market, the report is correct to point to the price impact of such a dominant position. However, because of the number of index fund traders, between 25 to 30 traders, no one can label the large market share as being concentrated. To be concentrated, such a large market share would have to be held by one or a very few traders

CFTC data has shown this to be the case in silver. Not only do the large short silver traders hold as significant a market share as the long wheat index traders, the position in silver is concentrated beyond debate. The current Commitment of Traders Report (COT) for positions held as of June 23, indicate the 4 largest traders as holding a net short position of 47.2% of all COMEX futures contracts, as well as almost 38% of equivalent world silver production. Over the last year, the CFTC has reported, via its Bank Participation Report, that 1 or 2 US banks have held a net short position of more than 33% of all COMEX futures contracts and 25% of world production.

The CFTC data clearly show that the large silver shorts have as dominant a market share as the long wheat index traders, but the silver shorts are concentrated to boot. That makes it doubly wrong and proves manipulation, a word the Senate report does not utter. By any reasonable and objective standard, there’s more of a problem in silver than there is in wheat. If the significant market share of the index traders pushed up wheat prices, then the significant and concentrated market share of the COMEX shorts pushed down silver prices.

Passive Versus Active

Another significant difference between the long index fund wheat traders and the big short silver traders is that the index funds are primarily passive, while the silver traders are active. The index traders do not actively trade the market. They do adjust positions due to index formula changes, investor money flows and the rolling of contracts as expiration approaches, but they are usually “buy and hold” traders. They are in it for the long term and don’t generally respond to price changes. In wheat, and other markets in which index traders operated, they bought and held their positions before the big explosion in prices last year and held them through the decline. The Senate report is not accusing the index traders of buying and adding to positions as prices rose sharply. Therefore, no one can point to any action by the index traders to actively “goose” prices higher by their trading.

In contrast, the large silver shorts, in addition to holding a dominant and concentrated market share, are among the most active of all traders. In fact, they have come to be regarded as “market makers,” although no such provision exists under commodity law granting them that privilege. The regulated futures markets are supposed to be an open auction-type market, not a specialist or market making operation, like the New York Stock Exchange. Yet when any significant buying or selling emerges in the silver market, it is assumed and expected that the large silver shorts will take the other side of the transaction. This is basically how they assembled their extraordinary short position to begin with.

Because there are more natural buyers of silver at the current depressed price than there are natural sellers, any new buying that emerges requires the big silver shorts to sell additional contracts short. That’s why their market share and concentration has grown over the years. If they didn’t cap and manipulate the silver market, it would be much higher. The big shorts can only buy back contracts when they engineer sell-offs. Unlike the long index fund traders in wheat who are passive, the big silver shorts must remain vigilant and active, at all times, lest the free market take over and determine prices.

Personal Validation

The Senate report validated a number of recent analytical conclusions I have made in silver. One, involves a recent public disagreement between myself and the CFTC. Regular readers know that I have often made the point that, in order to correctly calculate the true net percentage and degree of concentration in any market, one must remove all spread positions in order to drill down to the true number of contracts outstanding in any market. When this calculation is performed in silver, for instance, the true net concentration of the 4 largest short traders jumps from roughly 47% of the market to over 71%. This increase of 50% in the true net percentage of concentration is based on data in the COT of June 23, 2009.

Recently, Commissioner Bart Chilton, in an email to all who wrote to him, took issue with my analysis. He wrote that, “There was no real economic justification for subtracting out the spread positions from the total open interest over than to inflate the reported concentration ratio.” I strongly disagreed and you can find all the details here, including a link to Commissioner Chilton’s entire email. Click Here

The Senate report would appear to settle the matter. On page 121 of the report, it describes how spread traders should be excluded for the very reasons I have explained. In fact, they even include a chart (Figure 29) which shows the degree of market share of the index traders in four commodities net of spreads. Of course, even with spreads removed, the level of market share held by the four largest shorts in COMEX silver is much greater than the market share held by the 25 to 30 index traders in each of the four markets depicted in the Senate report.

In that same section (page 122), the Senate report highlights another analytical point I have made often, namely, comparing the aggregate size of the largest longs relative to the aggregate size of the largest shorts. The Senate report states that it was somewhat unusual and telling that there were times when the aggregate long position of the index traders exceeded that of the commercial shorts, as normally there was a balance between the relative size of the largest longs versus the largest shorts. This “balance” that the Senate report refers to is the same point I have made in the past.

In silver, however, the balance is more lopsided than in any commodity. The situation, however, is completely reversed. The big silver shorts have held an aggregate net short position 4 times larger than what the big longs held. I think the authors of the Senate report would have fainted had the index longs held a position 4 times larger than the big shorts. My point is that the Senate report confirmed my contention that “unbalanced” aggregate positions of the big longs compared to big shorts are cause for concern and must be investigated.


The Senate report is a wake-up call for the CFTC. The report pinpoints where the CFTC has dropped the ball, specifically in allowing a dominant market share to be held by index traders in wheat futures (and other markets), causing disruptive pricing. The report zeros in on the culprit, the granting of exemptions to position limits, and recommends a clear solution, eliminate the exemptions.

The same situation exists in silver on the short side, except to a greater degree, due to the existence of a concentration and the intent to manipulate. The solution in silver is as simple as the Senate’s solution in wheat – have the CFTC enforce existing commodity law and impose legitimate position limits.

The problem is that there is a double standard when it comes to manipulation or excessive speculation. Most have grown to view the long side as the only side that can be manipulated. That’s not true nor is it how the law is structured. However, it is how most people think, especially politicians and regulators. That’s the problem in silver (and gold).

Let’s be realistic. There will never be a Senate report on silver, at least not until after the manipulation is terminated. That’s because there is no political will behind a call for higher silver prices, which an end to the current manipulation would surely cause. But it does not mean you have to tolerate something that is wrong or a violation of the rule of law. It doesn’t mean you have to sit there and accept it. The CFTC knows the silver (and gold) manipulation is in place. The manipulators know what they are doing is illegal. The authors of this Senate report can draw the parallels between wheat and silver. But unless you press them all, they’ll pretend the manipulation does not exist. This is not a matter of changing the law or determining what is right or wrong. It is a matter of changing a perspective that is wrong.

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