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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 latest Commitments of Traders Report (COT) confirmed that the technical funds completely abandoned the long side in silver, removing the major downside risk to the market. Also, these funds ran strongly from the long side in gold, especially when you extrapolate for trading action since the report’s cutoff date, 10/7. While it is possible to see further long liquidation in gold, tech fund long liquidation is over in silver. All that remains to be seen is if the tech funds can be tricked onto the short side in silver.
Once again, the COTs explained the recent sell-offs in gold and silver. On the surface, all appeared normal, the tech funds ran and the dealers covered their shorts to the downside. The dealers maintained their record of never having capitulated and having to cover their shorts on the upside. But there was something about this recent COT episode that was notable to me, namely, that I came away with the feeling that the dealers just barely pulled this one off. It was not a resounding victory for the dealers, nor a crushing defeat for the funds. If you track closely the run up in silver and gold prices over the past couple of months and then the sell-off, and study the prices that each side established and liquidated their positions, it looked like a wash. Especially in silver, I have the feeling that the dealers were glad to cover a big chunk of what was an historic net short position. The price was secondary. Getting off the short side, as much as possible, was their primary goal.
Ironically (and perhaps heretically to those who’ve read my past writings on the subject), I get the sense that the COTs will not work in the future as they have in the past, especially in silver. I say this for a number of reasons. For one, as I have always maintained, the coming silver shortage will, at some point, trump the COTs. It feels to me, like that physical shortage is very close. Two, the COTs have become a mainstream analytical tool. While trying to decipher who is long and short will always be a worthwhile endeavor, I think any tool loses effectiveness the more popularly it is embraced. (Mind you, I’m certainly not abandoning the study of the COTs. I’m just speaking out loud on some growing reservations of mine, even though they have worked fine to date.) Lastly, the COTs will lose their effectiveness if certain market segments don’t behave within historical patterns. For instance, if, as I suspect, the small trader category in silver increasingly represents participants who are attracted to the low price for fundamental and value considerations, this segment becomes the strong hand and will not liquidate at even lower prices. This would represent a decided break with past historical patterns and render this aspect of the COTs worthless.
Perhaps because of my growing unease with long-learned analysis of the COTs, and my sense that things will play out differently than they have in the past, I find myself asking the question – is this the mother of all buying opportunities in silver? Not from a fundamental perspective, of course, as the answer is a resounding yes. The deficit, the nonexistent inventories, the law of supply and demand, the extreme low risk, the extraordinary high profit potential, etc., are the reasons behind that resounding answer. That’s a given. I’m talking about timing and near term price expectations. This is something I prefer not to do, because I never want my sense of near term pricing to ever cause anyone to become unbalanced and, if I am wrong, lose a long term, sure thing position in silver. While I can be wrong short term on silver, the long term is guaranteed by the fundamentals and the deficit. And the manipulation.
Ever since the price of silver burst upward at the end of July, I was consistently wary that it was the real move, simply because the tech funds had gotten so long on that move quickly and the dealers the reciprocal short. That is no more. The tech funds are off the long side completely, and all that remains on the long side are the hard core non-technical large speculators and the previously mentioned small pit bull longs. As I mentioned at the outset, the only remaining question is will the tech funds be tricked onto the short side? I don’t know. If I did know, I could easily tell you the bottom in silver. So let me tell you what I do know and what I suspect.
If the tech funds don’t go short, then this is now the mother of all buying opportunities (“MOABO”) in silver. If they do go short, when they are done shorting, then will be the MOABO. The good news, no the great news, is that they are not long. The good news is that if they do go short, it should not take prices much lower than we are now. That’s not because the tech funds are smart (as you know, I think they’re as dumb as dirt), but because their mechanical rules prevent them from initiating new short sales too far below the moving averages, currently around $5.10. It would take a lot of time, probably months, for the dealers to engineer the tech funds to the short side of silver, based upon historical patterns. I don’t think the dealers have the luxury of time.
To be clear, what I am saying is either we are at the MOABO right here and now, or we will be, pretty soon, right around these price levels, or just a bit lower. I don’t see a lot to be gained, price-wise, by waiting. I am no longer wary, as I have been for the past two months. The market structure is better positioned for this being a bottom than at any point in the past few months. Of course, if I’m wrong, I’ll apologize. Just don’t over-leverage yourself to the point where a near term setback will cause you to jettison a long term silver position.
I think a key factor in the timing issue will be the disposition of the December silver call options. There are roughly 45,000 open calls due to expire on November 24, less than six weeks from now. That’s the equivalent of 225 million ounces of silver, a huge amount. You may recall that I wrote about these options at the beginning of the year. There will be a concerted effort by the shorts to prevent these options from expiring in the money. If they succeed, we will have to wait until the expiration to explode. If they fail, all hell could break loose to the upside.
Of course, I am assuming that on the next silver rally, the dealers will not allow the tech funds to get long (or cover their shorts, if the tech funds are tricked into going short), by the dealers themselves selling short big on that rally. This is the essence of the MOABO – the dealers don’t short and prices vault upward. This hasn’t happened yet, and this is why we haven’t moved higher in silver. The dealers always sell. Or, at least, they always have sold. One day, for sure, they won’t.
I think that day is close. For one thing, their game is becoming more obvious to more people. Almost 1300 people took the time to add their names to the petition to Attorney General Spitzer. For a strong, continuing manipulation, that’s not good. A manipulation doesn’t thrive when many ordinary folks are aware of it. (By the way, when I get around to writing my book about silver, those names will be recorded therein). Another thing suggesting we are close to the end of this silver scam, is the lack of any type of rebuttal by anyone, but especially the CFTC and the COMEX to my very constructive suggestion of eliminating the possibility of a silver delivery default by making sure that the longs and shorts in the current delivery month are able to perform by first notice day.
Since this is such a simple and constructive proposal, I think some people may be taken back by its very simplicity, and I have been asked to better explain my solution. So let me explain what I’m talking about. For silver (and other commodity) futures contracts, the delivery period begins at the very beginning of the contract month, as that month comes due, and lasts until the very end of that month. First delivery day is at the start of the month, last delivery day at the end of the month. The short contract holder has the option of deciding when to deliver, from first delivery day until the very last day, if he so chooses. I’m not proposing to change that. What I am proposing is that the exchange certify that by first notice day, those holding short contracts in the current delivery month actually have the goods to deliver. If not, then that short must close out his position, or roll it into a more deferred month. To be fair, I am also proposing that any long position holder have the full cash value of the contracts he holds deposited by first delivery day, so he too is certified to take delivery, or the long must close out his position or roll over. This would eliminate completely, the chance of a delivery default. This would be a very good thing.
As it stands now, current rules allow the longs and shorts to “bluff” each other in the current delivery month, with neither being required to prove they can perform their delivery requirements. This is insane and irresponsible. If we get to last delivery day, and either party, but particularly the shorts, can’t deliver, we have a default. That’s the worst thing that can happen. It is what I am trying to prevent. You would think the NYMEX/COMEX would be very receptive to my solution, considering their track record. Three years ago, the price of platinum soared 60%, in two days, from $500/oz to $800, because the shorts in the April 2000 contract couldn’t deliver on a measly 40 contracts, on the two last delivery days. The shorts’ bluff was called. Were my solution in effect, this could never have happened.
As if this relatively recent delivery month debacle isn’t enough of a reason for the NYMEX/COMEX to step up to the plate and do the right thing and adopt my delivery month solution, there is also the blackest of black marks marring the NYMEX’s history. I’m talking about the 1975 Maine Potato disaster on the NYMEX, where a once vibrant market was shut down forever because of a delivery default against the May contract. Yeah, the shorts couldn’t deliver. As unbelievable as it sounds, even with this market infamy tainting the history of the NYMEX, exchange officials are trying to look the other way to a fair and surefire solution to prevent a recurrence. You would think they would have adopted my solution on their own, long ago.
Whether the NYMEX and the CFTC do the right thing, or not, is something that they will have to live with. Certainly, they will never be able to say they didn’t have the opportunity of making COMEX silver default proof. For the time being, silver investors should concern themselves if we are facing one last opportunity for the investment ride of a lifetime.