In Ted Butler's Archive

COT Update

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 most recent Commitment of Traders Report (COT) reflected continued deterioration, or a build up in dealer net short positions in silver and gold, as should be expected in strong price rallies. While it is true that we are no longer at the recent low-risk entry points in silver and gold, we are nowhere near the extreme high-risk points of the past, when the dealers held historically large and dangerous net short positions.

It is important to put the analysis of the COTs into proper perspective. First, they should be used to help determine where we stand on a short to intermediate term basis (weeks to months). The COTs are not much good either for daily or very long term analysis, and should never be substituted for long term supply/demand investment considerations. The COTs change all the time; long-term fundamentals don’t. Most importantly, the COTs are factual and objective readings on the holdings of the various categories of traders, while the analysis of that data is necessarily subjective (including mine).

With that caveat, here’s where I think we currently stand. In gold, from the top of the market in December, the dealers covered 130,000 net short contracts on the $50 decline into the lows at $410 a few weeks ago. On the subsequent $25 rally, they have re-shorted up to 50,000 contracts (extrapolating from the Tuesday cut-off). We’re still much closer to the bottom, COT-wise, than we are to the top, but we could experience increased price volatility. It’s easier to make a call when we are at COT extremes and those extremes have been very reliable indicators all along. I’d still expect new price highs in gold and an extreme COT top formation ahead.

In silver, the dealers covered 44,000 net short COMEX futures contracts (220 million ounces) on the big price decline from the December price highs, to the early February COT readings. Since then, on the subsequent one-dollar plus price rally, the dealer net short position has grown by around 13,000 contracts, also still much closer to the bottom than the top.

Bottom-line, there is much more room to the upside than the downside in silver, but there is also more of a chance of downside temporary shake-outs and sell-offs than existed at the former extreme low dealer net short readings. Could we experience a sell-off that would violate the moving averages and get the tech funds to sell aggressively enough to bring us back to extremely favorable COT levels? Yes. Could we march ahead to significant new highs from here? Yes. Increased price volatility is a fact of life.

I have detected, at least in silver, dealer attempts to engineer a sell-off over the past week, but that doesn’t mean they will be successful. More importantly, since we are closer to the bottom in the COTs, even if the dealers are successful in rigging a sell-off, my sense is that such a sell-off is likely be to short and sharp, and not a long drawn out affair. Therefore, the most prudent course would seem to be to hold all positions (speculations included) and ride out any sell-off.

It is important to remember that the past reliability of price movements of gold and silver dictated by extreme readings in the COT, is another proof of manipulation in these markets. There is nothing random, free market, legal or economically legitimate about the price-setting tango between the tech funds and the dealers. In fact, it is as far removed from what is mandated by commodity law as is possible. How the producers of real silver tolerate this activity is beyond me.

Just this past week, I had the occasion to review the quarterly earnings reports of two high-profile silver miners, Pan American Silver (PAAS) and Hecla Mining (HL). For the fourth quarter, the price of silver averaged $7.25/oz. and gold averaged $440/oz., much higher than we’ve seen in recent years. These are basically prices only dreamed about a few years ago. Additionally, the price of co-products, like copper, zinc and lead, were also very high relative to recent years. Unless I’m reading these earnings reports all wrong, when you strip away all the one-time events, these companies are still not able to earn a real operating profit at these prices. There are a few points I would like to make.

One, it would appear the cost of producing an ounce of silver for these companies is more than $7.25/oz., and not the silly low cash costs always trumpeted. Two, shareholders don’t benefit anywhere near as much as management when a company produces at a real loss. Three, these companies, along with Coeur d’Alene and Apex Silver, still haven’t lifted a finger to combat the obvious and ongoing manipulation in silver, and that has hurt shareholders.

Finally, I have received a large number of e-mails regarding my article, “Where’s Your Silver?” Unfortunately, I have been unable to personally respond to all of them. Many asked what I thought about specific storage programs and pool accounts. There is no way I could or would comment on such specific accounts. I tried to be clear in the article – if you don’t have serial numbers and weights on any 1000 oz bars you have paid for, assume there is not real silver backing your account. It is up to you to determine if you are comfortable with the future financial health of the firm holding such unbacked accounts.

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