1 September 2008

Firestorm Erupts Over U.S. Banks' Gold, Silver Shorting

Got Gold Report – Firestorm Erupts Over U.S. Banks' Gold, Silver Shorting

By Gene Arensberg
01 Sep 2008 at 03:13 AM GMT-04:00

A very few and very large banks seemed to have positioned very well ahead of the plunge in prices for gold and silver, but in the process they may have bought more than they bargained for – possible class-action lawsuits.
HOUSTON (ResourceInvestor.com) -- An internet firestorm erupted over an August 5 report issued by the Commodities Futures Trading Commission (CFTC) which report revealed an unprecedented exponential one-month spike higher in short positions in gold and silver futures reported by two U.S. banks in silver and three U.S. banks in gold. Investors and bullion dealers may band together to seek legal recourse against the thus far unnamed banks.

In that CFTC report it surfaced that those few banks took the huge net short positions in gold and silver futures just ahead of the largest and harshest fall in prices for gold and silver since the Great Gold Bull began in 2001 – 2002. The Got Gold Report covered it from the silver point of view earlier this week.

Sucker Punched

Speculation in the metals community since the issue was first raised by silver analyst Ted Butler on August 22 has centered around whether the few banks acted principally to profit by their own downward trading pressure after taking the extremely large short positions, or if those very large net short positions could have been legitimate positions put on as offsetting hedges to other over-the-counter trading positions, swaps and derivatives held by the very large banks.

Subsequent work done by independent analysts point to specific banks as the most likely actors responsible for the immense short positions. As examples, (and there are more), Rob Kirby of Kirby Analytics in Toronto opined that the action is likely the work of the U.S. Federal Reserve in concert with J. P. Morgan Chase in an August 25 piece on FinancialSense.com. Tom Szabo of Silveraxis.com researched FDIC Quarterly Banking Profiles and Call Reports and concluded the most likely “usual suspects” were J.P. Morgan Chase and HSBC. Investors keenly interested in this subject will want to read Rob and Tom’s comments carefully.

Since we’ve already looked specifically at silver in the previous Got Gold Report, this report looks closer at the gold positioning. The three unnamed U.S. banks went from holding long positions for 538,100 ounces of gold in July to holding short positions for 8,222,800 ounces one month and four days later. That’s a huge change in positioning for just three trading entities. (From $448 million dollars worth long to $6.8 billion dollars worth short if we value gold at $830.) Just below is what it looks like on a graph.

Note: The graph only includes the net short positions of the three to five U.S. banks for the 24-month period shown. The CFTC report also shows participation by non-U.S. banks, but this analysis focuses strictly on the U.S. bank positioning. For the last seven months of data there were only 3 U.S. banks included in this CFTC report.

At the very least it is obvious that these three banks evidently saw in advance that gold and silver were about to plunge off a cliff in price and positioned in advance of it perfectly. At worst these few banks sucker punched gold and silver investors by taking such overwhelmingly large short positions as to literally crush those metals markets with the weight of their own trading.

CFTC Says “No Manipulation” in May

In response to persistent public concerns about market manipulation, in May of this year, the CFTC Division of Market Oversight issued its Report on Large Short Trader Activity in the Silver Futures Market. The 16-page executive summary of that report can be found here. The report concludes that the silver market is not manipulated and cites as evidence that, according to the commission: “There is no observable relationship between short-futures-trader concentration levels and silver prices.”

Perhaps if there was no observable relationship between short-futures-trader concentration prior to that report there is now as of the August 5, 2008 CFTC Bank Participation in Futures Markets report.

Again, according to the CFTC, between July 1 and August 5, 2005 three U.S. banks went from being 5,381 contracts net long COMEX gold futures to being 82,228 contracts net short. During the exact same period the total collective commercial net short positioning reported in the CFTC Commitments of Traders Reports (COT) went from 227,027 contracts on July 1 to 198,917 contracts net short on August 5. So, if we are to believe the COT reports, these three U.S. banks were layering on 82,228 net short positions in gold futures at the very same time that the commercial net short positioning was going DOWN 28,110 contracts.

From July 1 to August 5, 2008 these unnamed three U.S. banks went from being net long gold futures to overwhelmingly net short and over 41.34% of all the commercial net short positions. What did they know and when did they know it? (And, did they also put out special “market short calls” to their most valued customers at the time?)

For instant comparison, below is a snapshot of the gold market for the past three months.

We can probably assume that the bulk of the three banks' net short positions were put on in the early part of July as gold neared $950.

Regardless of whether or not the very large bank short positions are letter-of-law legal (and we’ll leave it up to others to determine that) they are almost certainly spirit-of-law aberrant. The sheer size and concentration of so large a unidirectional positioning from so few entities certainly raises legitimate questions and concerns about the metals futures markets and their roles in legitimate price discovery in the U.S. commodities markets. Especially since the action on the paper-contract-dominated spot cash market prices for gold and silver caused shortages for physical metal in the physical markets the futures markets are supposed to “answer to.”

Questions and Possible Legal Action

A few questions for those looking at this in depth: Why did three U.S. banks suddenly switch from being long gold to so overwhelmingly short gold (and silver) in one month? Where do these bank’s short positions show up in the regular commitments of traders reports? (Hint: They apparently don’t.) If these U.S. bank’s net short positions are not contained in the commercial category, then where are they? Which banks have the ability to sell that many contracts short on the COMEX without running afoul of the position limits and anti-manipulation checks put in place by the CFTC and enforced by the SEC?

At least one group of investors in California is incensed enough about the bank’s positioning and their apparent manhandling of market prices to look into the possibility of a class action lawsuit. A representative of the group contacted this reporter (and others) and plans to enlist the support of a Los Angeles based law firm there. If they go forward and keep this report informed, we’ll report the details here in future reports.

Something’s Gone A Kilter?

Interestingly, remember that on July 1, 2008 the commercial net short positioning for all large commercial traders on the COMEX for gold (LCNS) amounted to 227,027 contracts. It was quite high relatively speaking. By August 5, 2008 the LCNS had actually declined to 198,917 contracts. So, as these three U.S. banks were layering on 87,609 new short contracts in gold futures (to come up to 82,228 contracts net short themselves) the collective commercial net short positions of all commercial traders were falling, not rising.

Apparently these three U.S. banks were going very much against the tide in gold futures at the time in other words. Below is a graph which shows all the collective commercial net short positioning for gold on the COMEX.

Gold closed on July 1 at $939.68. During the month that followed gold began its precipitous decline and by August 5 it was down to $874.35, a drop of $65.33 or 7%. Normally as gold declines we tend to see a reduction in commercial net short positioning on the COMEX. As the price of gold gets cheaper, there is usually less motivation for commercials to take the short side of gold contracts. But in this case, as gold was plunging the LCNS was merely easing lower. (It has fallen sharply since August 12, though.)

Is it a coincidence that these two or three U.S. banks took such huge short positions in gold and silver not very long after Federal Reserve Chairman Ben S. Bernanke spoke publicly about the weak dollar? (A very rare event, but it occurred in the same week in June that Treasury Secretary Paulson and President Bush both came out and jawboned the dollar higher.)

Did J. P. Morgan Chase, the same bank that the Federal Reserve turned to in the “rescue” of Bear Stearns, act on behalf of the Fed to knock the legs out from under the gold and silver markets while simultaneously supporting the U.S. dollar? If so, is that a legitimate function of a U.S. bank to perform on behalf of its central bank?

One school of thought holds that propping up a fiat currency in order to maintain public confidence is indeed a legitimate function of the Department of Treasury from time to time. Indeed, Mr. Bernanke’s predecessor in office is widely credited for having said so in the past.

The jury is still out as to exactly who did what and how much, largely because the evidence is still murky and difficult to obtain and analyze, but nevertheless a body of evidence is building which supports those who think that’s what just happened. What is not yet crystal clear is whether or not it’s over. For now.

On the Sunny Side

The good news for gold investors is that the LCNS has since retreated back to lower levels now that gold has sold off so harshly. As of this past Tuesday (8/26) COMEX commercial’s positioning had fallen to 121,919 contracts net short. That’s not all that much higher than the LCNS August low point in 2007 of 91,994 contracts net short which occurred on August 21 of 2007. (Technically, the LCNS nadir for 2007 occurred on January 9 at 81,674, but that was with gold then at $613.00.)

In fact, since the LCNS peaked on July 15 at a whopping 246,577 contracts net short (a near record) it has fallen 124,658 to just 121,919 contracts net short as of Tuesday, August 26. That’s the lowest LCNS since August 28, 2007 (98,864) and a drop in commercial net short positions of 50.56%.

Perhaps even more importantly, the LCNS as compared to the total open interest on the COMEX (LCNS:TO) has “improved” considerably over the past few weeks. On July 15 the collective commercial net short positioning represented a very high 50.95% of all open contracts on the COMEX. As of this past Tuesday (8/26) it had plunged to just 32.02%.

Although above last year’s nadir, the LCNS:TO is certainly in much more “bullish” territory than it was just a month ago.

Physical Metal Scarce

As silver and gold investors lick their wounds from the recent harsh plunges in the prices of precious metals, one focus is tuned to the extraordinarily large price drops which seemed to ignore a growing scarcity of physical supplies.

By almost all accounts available on the web as of this week, the paper futures contract dominated spot price has disconnected from the popular physical silver and gold bullion markets. To most investors it seems odd indeed that the spot price has moved so far down that bullion dealers are forced to charge double digit percentage premiums for some silver bullion products and up to 5% premiums for gold bullion items. That’s if customers can actually find a dealer that has any products in stock to sell.

Bullion dealers also report a very dramatic drop in scrap purchases over the past several weeks. “I’m only buying about $50,000 a week in scrap now,” says one Houston dealer. “Last month I was buying more than $150,000 of scrap per week and more,” he added.

Gold ETF Investors Holding

Investors have largely held onto their gold ETF holdings as well. In fact, over the past week gold holdings at SPDR Gold Shares [GLD] remained flat at 651.37 tonnes of gold bars held by its custodian in London.

Apparently larger holders of gold ETFs are content to ride out this price storm or add to their long-term holdings, because gold holdings for gold ETFs have not been reduced all that much compared to the drop in metal prices.

The authorized market participants for GLD have to add shares to the trading float and increase the amount of gold held when buying pressure is significantly stronger than selling pressure. The reverse occurs when there is more selling pressure than buying pressure.

Bottom Line

While it is clear that a very few banks seem to have positioned very well in advance of this most recent example of a hot-money exodus in gold and silver, it is also pretty clear that ETF holders and most investors apparently decided it was a good buying opportunity. Both gold and silver are certainly more attractive than they were just one month ago price wise.

That doesn’t mean they can’t test even lower prices, they certainly can, especially if the few futures-playing giant banks stomp their leviathan boots on the neck of the paper-contract-dominated spot market again. We have to believe they won’t though. Not anytime soon anyway. Not unless they intend on feeding a different kind of bear. The grizzlies known as heavy-hitting class action lawyers. … Got gold?

Got Gold Report Charts:
Silver Graphs. Please see the 1-year silver graph and the 2-year weekly version for this report’s technical and expanded market commentary on the graphs themselves.
Gold Charts. Please see the 1-year daily chart for gold and the 2-year weekly version for context as well as this report’s technical and market commentary on the charts themselves.
Gold Indexes. Please see the 9-month daily HUI chart and the 3-year weekly HUI chart for context and this report’s commentary on the graphs themselves.
HUI:Gold Ratio. Please see the one-year daily HUI/Gold ratio chart and the 2-year weekly HUI/Gold version for context and this report’s commentary on the graphs themselves.
U.S. Dollar. Please see the 1-year daily USD chart and the 2-year weekly USD version for this report’s technical and market commentary on the charts themselves.

We apologize if some of this reporting seems a bit technical, but the fund managers and seasoned traders that read this report really do prefer it that way.

That’s it for this special offering of the Got Gold Report. Until next time, as always, MIND YOUR STOPS.

The above contains opinion and commentary of the author. Each person should study the issues carefully and, as always, make their own informed decisions. Disclosure: The author currently holds a long position in iShares Silver Trust, SPDR Gold Shares and holds various long positions in mining and exploration companies.

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