Who’s In Charge?
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.)
First, a quick word on the structure in various markets, as defined by the Commitment of Traders Report (COT), and then a follow up on something I wrote about last week. The move down in gold and up in the dollar, as a result of the French vote, augments the existing structure and the reversal, when it comes, should be powerful.
In silver, the impressive rally, while expected, was on fairly heavy volume and penetrated all the moving averages, suggesting a significant amount of tech fund buying. Almost perversely, this does increase the odds of a tech fund sell-off back down through those same moving averages. There may be a quick, sharp sell-off, although this should matter little to long-term silver investors. Of course, when the moment of truth arrives in silver, the COTs will lose their significance and we will just explode in price
Last week, I wrote the following about copper – “Once again, there is no legitimate economic reason for a short not to deliver as soon as they possibly can, save they don’t have the material. About the best thing one can say about the May COMEX silver delivery is that it is nowhere near as extreme as the May COMEX copper delivery, where there are over 2000 contracts open with the same two trading days remaining. Interestingly, this number of contracts in copper is more than all the total copper in COMEX warehouses, something I have never seen before. This is a very extreme and unusual circumstance. I don’t know what conclusion to reach other than copper is, obviously, very tight and that the management of the COMEX doesn’t seem quite on top of the situation in allowing such a development.”
In subsequent trading over the next two days, the May copper contract exploded in price, both on an absolute and relative basis to other months. On the last trading day, the 26th, the May contract closed at life-of-contract and, I believe, an historic high price for copper of $1.6140 per pound. This price was more than 16 cents higher than the active July contract, up 5 cents on a spread basis on the last day alone, also unprecedented and an historic spread differential. In addition, the price of the May copper contract jumped more than 15 cents per pound in the last five trading days, of more than 10% of the copper price, a huge world market. There was no cash market explanation for the move. A reasonable person would consider this price action to be unusual.
Unusual, perhaps, but completely expected. It was no accident that the big price move in the May copper contract coincided with the cessation of trading in that contract. That’s why I mentioned copper in last week’s report. You see, the last trading and delivery days of the contract is when the rubber meets the road. When you have to put up or shut up.
My concern was that there was such a mismatch between open positions in the May copper contract vs. what was in position in the COMEX warehouses that could possible be delivered, that it was a potentially dangerous situation. As such, I questioned whether COMEX management (and CFTC regulators) were on top of the situation. Afterwards, that question is still unresolved.
Now, some would say that my concerns were unfounded as everything worked out fine and there was no default. I disagree with that and would like to explain why. I think there are some real lessons to be learned here.
First, if there are big price moves in the last few trading days of any commodity contract, when delivery is due, that strongly suggests that the price of the commodity was incorrectly priced prior to those last few trading days. In commodity circles, this phenomenon is known as price convergence. At the very end of a commodity contract, the price of the futures contract should converge, or come to meet the price of the underlying cash market from which the contract was derived. This is normal and happens in every single commodity futures contract traded.
What’s not normal is a sharp change in the price during this convergence. As the very term implies, there should be a smooth gradual convergence of the futures and cash market prices. If there is a sharp change, as there was in copper, that tells you something is wrong. And since the sharp price change in copper was the May contract moving sharply higher at the very end of the contract, we can conclude two basic things. One, the May contract price was artificially depressed compared to the underlying cash market, and two, the culprits of that artificial pricing were the shorts in the May copper contract. Only when the shorts’ feet were held to the fire of trading termination, did they relent and allow the price to be marked to free market levels. They had no choice.
This is not how the markets are supposed to work. The sad thing about this copper episode was that this manipulation was entirely foreseeable and preventable. Years ago, I offered repeatedly the only fair solution – make sure the shorts have warehouse receipts on first delivery day. Don’t wait until the last minute. That the COMEX is headed by a former Chairman of the CFTC and this lesson still hasn’t been learned is truly shameful.
The bigger lesson here is for silver investors. Here you are given clear proof, once again, that the very best investment is in real silver, not paper contracts. Just like in copper (and platinum and palladium earlier), when the crunch comes, fully paid actual silver or warehouse receipts will be the safest form and command the highest price. You can’t depend upon exchange officials or government regulators to protect you. You must take care of yourself. If you wait until the last minute to secure real silver, you may have a problem. Once you get your real silver, no problem.