So Far, So Good
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.)
I delayed this article for a day, in order to review the statistics concerning the first delivery day on the COMEX July silver contract and to see if the CFTC would correct the material error they made in the latest Commitments of Traders Report (COT) for COMEX gold, silver and copper. As it turns out, the CFTC did respond quickly to my notification to them of the error, and that is to their credit. On the other hand, it is telling that they made the error in the first place and I doubt they would have caught it if I did not inform them. It is also notable that so few analysts and commentators even caught the error, which involved many thousands of contracts.
Simply put, the CFTC’s error involved the misclassification of a large trader into the small traders’ category in silver, gold and copper. This was a glaring mistake. I don’t know if market positions were taken as a result, but I certainly read plenty of commentary by analysts that missed the error completely. I think the main lesson to be learned here is that the CFTC is not infallible when it comes to commodity matters. No one is. This is something to keep in mind in light of the CFTC’s 9 page denial of a silver manipulation. The bottom line is that, the CFTC’s mistake aside, the COT market structure remains bullish and intact in gold, silver and copper.
The other reason for my delay of this letter was to analyze the statistics for the first delivery day of the COMEX July silver contract today, June 30. Basically, I was looking for two numbers – one, the remaining number of open contracts in the July contract month, and two, how many contracts were issued on the first day, which is traditionally the heaviest delivery day of all commodities. I wanted to see if there was any chance of a mismatch, or potential for a delivery short squeeze.
I believe a short squeeze is inevitable because we have a structural deficit and it must come to the COMEX sooner or later, given the COMEX’s prominence as the world’s largest silver exchange and largest silver depository. And while this coming short squeeze, or inability of short sellers to deliver called-for physical quantities, can come at any time, it is reasonable to assume it would likely occur during one of the COMEX’s five major delivery months, of which July is one. Of course, no one can know the timing of even the most inevitable events. So we look for clues.
The main clue would be a large number of open contracts on the first delivery day, coupled with a small number of first day’s deliveries, leaving a large number of unresolved contracts. Even if this occurred, it would be no guarantee of a delivery squeeze, but it should make you sit up and pay attention. A week ago, or so, it didn’t look like anything unusual was developing. The July open interest was not particularly large by historical standards, even though total warehouse stocks were the lowest in more than six months, and 4 million ounces less than the last major delivery month, May.
During the past week, however, the open interest in the July contract didn’t decline as much as it historically does, and that’s what has caused me to wait for the first day’s statistics. The first day’s deliveries were 1387 contracts (almost 7 million ounces). Of that amount, Deutsche Bank delivered almost 80%, with two other Silver Managers, HSBC and Bank of Nova Scotia, accounting for 80% of the taking of the total issued. Former Kingpin Silver Manger, AIG, was conspicuous in its absence, once again. (There is no question, in my mind, that AIG senior management took my advice and has abandoned the silver market.)
This is a very small amount of silver for the first day’s notices. Not the lowest in history, but among the lowest in first day’s deliveries. It suggests tightness, not abundance of silver for delivery. When combined with the remaining open interest in the July contract going into the first notice day, it gets even more interesting. The number of contracts still open on the first day was 10,462. This is a very large number, just as first day deliveries were very small. What this means is that there is a very large amount of July contracts that will be still open, after the first days deliveries are netted out, along with last minute liquidation. My guess is that roughly 8,000 contracts will remain at the end of the first delivery day, or the equivalent of 40 million ounces. If I’m correct in my guess, that will represent the largest remaining open interest after first delivery day on the COMEX in many years. I am a bit surprised that there has been very little talk of this potential delivery mismatch.
These two numbers, taken together, should make market observers sit up and take notice. It doesn’t mean, of course, that there will be a delivery problem during the July delivery month, but it doesn’t rule it out either. The larger the remaining open interest in the delivery month, the greater the chance of a delivery problem. As I’ve written before, there has been a progressive tightening in the COMEX silver delivery process for over a year and a half. That certainly appears to be continuing. While no one can say for certain when a delivery problem will occur, I can state something else with certainty, namely, that every COMEX delivery month process weakens the shorts and strengthens the real silver investor. At the end of every delivery month, the shorts have less silver at their disposal and are weaker and real silver investors are in better shape. That’s the beauty of the structural deficit for silver investors. Time is on their side.
And it’s not just the COMEX that offers strong clues as to delivery tightness for wholesale quantities of silver. I’ve heard recently from very reliable sources that one of the big Canadian institutions waiting on a silver delivery has still not been completely received, after several months. Furthermore, I hear that some of the silver that has been delivered has come from Russia. That’s a long way to go for a commodity that many say is very abundant. Certainly, the price doesn’t suggest such physical tightness. As you know, I say that’s because the price is manipulated.
It has now been two months since I wrote that the silver market was at a uniquely low-risk buy point. I still feel that way. Not much has happened price-wise, since then. That’s great, in my opinion. In any investment, not losing is the most important factor. My view was motivated by the low risk nature of the market structure. After plummeting more than $2.50 from the top, we’ve stopped going down in the past two months. We haven’t gone up yet, but we will. Not because I say so, but because of the law of supply and demand.
We now appear to have the best of all worlds. Favorable COT market structure, powerful fundamentals, and clear signs of multi-market delivery tightness. If there could be a significant improvement in this total package, I’m not aware of what it could be. This market is still structured for a big upside and small downside. The only validation still missing is the price. What’s not missing is the great opportunity that still exists in silver.