In Ted Butler's Archive

Seven Equals Five

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’m trying to avoid the short-term analysis of price movements. However, the recent swoon in the price of silver by some 40 cents, and the change in the market structure on the COMEX requires comment. While I’ll be the first to admit that I did not fully expect this blip to the downside, the one-week sell-off in silver has dramatically improved the market structure. I’m convinced that the tech funds were selling (and selling short) and the dealers were buying heavily. This is the stuff of major bottoms.

You won’t see this improvement in the most recent silver Commitment of Traders Report (COT), as the sell-off commenced immediately after the Tuesday cut-off date. But daily volume, open interest and price patterns suggest to me a major (10,000 net contract) improvement in the market structure since that report. We’re now in dimes to the downside, dollars to the upside mode.

In gold, the tech funds did finally enter the long side, according to the latest COT, but I am still unsure of their true position, as I still see evidence of a new large trader(s) in the non-commercial category. While this still means there are a number of possible outcomes, I am left with the feeling that this new trading force is stepping ahead of the dealers on both the buy and sell side, trying to capture some of the brain dead tech funds’ capital. This may explain the sharp, but relatively small moves in gold recently, as we thrash, above and below, the tech funds’ moving average signals.

Another recent development has been the unusual delivery pattern emerging in the May silver contract. On first notice day, only seven deliveries were tendered, the smallest in COMEX history, in my recollection. As I have previously written, simple economics dictates that the first delivery date in all commodities is usually the heaviest delivery day, as the deliverers gain nothing by waiting and lose the use of funds by not delivering at the earliest opportunity. One can’t help but assume that real silver availability was lacking to account for such a small number of first day’s deliveries.

The second day showed a sharp increase to 1519 deliveries, followed by 312 today. The larger second-day deliveries indicate to me that someone bought silver in the roll-over migration just before first delivery day, similar (but on a smaller scale) to the great “snookering” we saw in last July’s delivery episode. There are still over 3000 contracts open in the May contract, so we’ll have to watch developments closely. One day, we are going to have a delivery problem, mandated by the structural deficit.

As recent events have made clear, it is normal to pay close attention to COMEX delivery periods. This unusual May delivery pattern comes on the heels of the move in the March contract to a three-cent premium at the end of the delivery period. Right now, May is tighter than was the prior March contract. We have more unresolved open interest and the spreads are tighter in May than they were in the March contract at an equivalent time. That doesn’t mean May will get progressively tighter from here, as the March did, but it bears watching. Combined with the dramatically improved COT position in silver, it’s hard to imagine a more bullish backdrop.

Let me throw in one more bullish factor for the real silver investor. As the recent round of mining company earnings reports have indicated, it costs a lot more to produce an ounce of both gold and silver. Due to energy, equipment and other cost pressures, the breakeven price for silver at a primary mine appears to be $7 or higher. That’s an increase in the cost of production of some 40% in two years.

What this tells me is that silver at $7, is equivalent to silver at $5, two years ago. Just as prices below $5 proved to be excellent buy points in the past, I think the same can be said about silver prices below $7. An astute analyst said, long ago, that buying any precious metal below its cost of production is foolproof. I think that’s where we are in silver.

As long-time readers know, I have tried to get the silver mining companies to address the manipulated price of silver, with limited success. I have consistently mentioned four companies in particular, Pan American, Hecla, Coeur d’Alene, because they are primary silver producers, and Apex, because it is sitting on such a large cash position. Additionally, the management of these companies purports to be leaders in the silver industry.

It still amazes me that these companies have done nothing to fight for their shareholders and bring attention to the silver price-fixing games on the COMEX. They should see clearly the price setting that takes place between the dealers and tech funds. Instead, these companies continue to pretend the price of silver is set freely and fairly. Here’s a bit of advice for them intended to help suffering shareholders – forget gimmicks like minting your own silver items for the retail public, and speak up about the wholesale manipulation on the COMEX.

Start typing and press Enter to search