By: Theodore Butler
-- Posted 14 April, 2009
A number of different factors have converged, creating what could be a lift-off point for the price of silver (and gold). This confluence of readily verifiable factors shows the silver market to be in a low risk and high reward situation. The factors involve both the paper and physical silver markets. The only question, as always, is if the manipulators, led by JPMorgan and protected by the CFTC, can thwart the set up once prices rally.
The structure in the paper markets, as defined by the CFTC’s latest Commitment of Traders (COT) and Bank Participation Reports, as well as the year-end OTC Derivatives Report by The Office of the Comptroller of the Currency, are extremely bullish on any objective historical basis. This means that the commercials, as a whole, have a greatly reduced total net short silver position after the recent engineered sharp sell-off. Normally, when the commercials have forcibly liquidated as many leveraged longs as possible, prices stop declining and begin to rally. This is the rhythm of the market.
The latest COT and Bank Participation Reports, for positions as of April 7, show the smallest total commercial net short positions in gold and silver since Feb 17-24, when gold was $1000 and silver $14.50. Since those highs, on the $150 gold price decline and a $2.50 silver drop, the commercials have reduced overall gold shorts by over 40,000 gold contracts and 9,000 silver contracts, or the equivalent of 4 million gold ounces and 45 million silver ounces. This is subjective, but those reductions, particularly in silver, look complete. Not at all subjective is the observation that the only reason for the price declines over the past six weeks was to effect the liquidation of the maximum number of leveraged longs on the COMEX. This is the rhythm of the manipulation.
Despite the big reductions in net commercial short positions, the ongoing manipulation in silver (and gold), based upon a freakish short concentration, is still evident. If anything, the short concentration has grown more extreme. In COMEX gold futures, the four largest shorts hold more than 98% of the entire commercial net short position. In other words, without the 4 large shorts, there would be little or no commercial short position in gold futures at all. Bank Participation Report data show that three or less U.S. banks are the big shorts, while foreign banks are net long.
In silver, the concentration is more extreme, making the manipulation more extreme. The four largest traders in COMEX silver futures hold a net short position almost 50% greater than the entire total commercial net short position. How is this possible? It is possible because, as a group, the rest of the commercials apart from the big 4 are net long. In other words, if it weren’t for the big 4, there would be a big commercial net long position in COMEX silver futures.
Further, the Bank Participation Report data show that one or two U.S. banks (JPMorgan) make up 96% of the entire commercial net short position in COMEX silver futures. Not the 4 largest traders, as in gold, but the one or two largest traders. And we know it is a U.S. bank or banks. That should have your head spinning. The big U.S. banks have masterminded the financial disaster impacting us all, and should be barred from trading of any sort. Yet one or two of them hold the entire commercial net short position in COMEX silver futures.
The next time the CFTC tries to tell you that concentration isn’t the only issue proving manipulation, you should laugh in their face. One U.S bank, JPMorgan, holds perhaps the entire commercial net short position in COMEX silver and that’s not proof of manipulation? What is? To claim they are legitimately hedged is a joke. All the world’s silver hedging must go through one U.S. bank? Get serious.
Let me be clear here - you can have a nice set up and still be in a manipulated market. Long-time readers will recall many such occasions over the years. The fact that the short position has become so concentrated is actually part of the nice set up, to my way of thinking. That’s because the big short commercial traders are being increasingly challenged by other commercials, who I refer to as the raptors. These raptors are long in both silver and gold and will buy more when and if prices decline. They provide real competition to the big shorts. The big shorts can’t shake them out to the downside, like typically leveraged speculative longs. Bottom-line, the structure of the paper markets is encouraging, and any further sell-off will improve the structure.
Away from the favorable structure of the paper markets, there seem to be developments in the physical market worth mentioning. The most obvious, of course, has been the flows of metal into ETF-type investment vehicles. Since just the beginning of the year, gold and silver metal inflows has been historic, with three month+ totals reading like full year amounts.
In gold, some 14 million ounces, worth close to $13 billion, have been absorbed by the world’s various public metal investment vehicles in the first quarter. This compares to 10 million ounces absorbed in all of 2008, in turn one of the best years for this type of gold investment. Yes, there has been a notable decline in Indian gold demand and a sharp increase in scrap gold recycling, but the demand in gold investment vehicles has been nothing short of outstanding.
In silver, close to 75 million ounces have been absorbed by various silver investment vehicles, in just the first three months of 2009, compared to 100 million oz for all of 2008. Please remember that prior to 2006, there was no silver ETF demand. While Indian demand is lower and there has been some increase in scrap recovery, it is not as pronounced as in gold. In silver, the story had been a fall off in industrial consumption that enabled the big investment demand to be met. But that appears to be over, as production now seems balanced with industrial demand. There are signs emerging that future silver investment flows will be tighter and will require higher prices to effect those flows.
One sign has been the decline in COMEX warehouse stocks. Unlike the big increases seen in base metal inventories last year, COMEX silver inventories never grew at all. And after a recent 10 million ounce withdrawal, these inventories are at a two-year low of 116 million oz. What made this recent withdrawal noteworthy is that it appeared to be made by a single entity. Most likely, it was not a movement by an industrial consumer, given its size, rendering it as some type of investment flow.
Since this movement coincided with a 4 million ounce deposit in the big silver ETF, SLV, I can’t help but speculate that the COMEX withdrawal was shipped to London. Perhaps more confirmation, in the way of additional SLV deposits, will be revealed in the near future. The connection of the COMEX withdrawal to the deposit in the SLV, which I lean towards, would be important if accurate. That’s because nothing would reflect tightness in the wholesale silver market like someone having to satisfy metal requirements in the SLV by withdrawing the metal from the COMEX.
The recent deposit of close to 4 million ounces in the SLV (to a total of over 270 million ounces) was noteworthy on another level. The deposit also coincided with a decline in the reported short interest of close to 3 million shares in SLV, from 6.8 million shares to 3.9 million. There are only two ways to close out a short position in SLV, namely, by buying the shorted shares back or by depositing the metal against shorted shares. My guess is that the metal deposit was intended to close out those short positions. This also may be related to the recent announcement that Barclays was selling its I-Shares operation, of which SLV is a part.
Long-time readers should know how I feel about the short sale of shares of SLV, as well as the two other hard-metal gold ETFs, GLD and IAU. (I don’t think any short sales of any stock should be allowed, but that’s another topic). To me, the short sale of hard-metal ETF shares is fraud, pure and simple. That’s because the innocent and unaware buyer of any share sold short does not have the metal backing promised in the prospectus. How could he when the short seller of these shares does not deposit metal at the outset of the transaction. I went over this in great detail almost a year ago in "A Hidden Silver Default?" http://www.investmentrarities.com/06-16-08.html I remember Barclays dancing around the issue in a manner that would have won Dancing With The Stars.
My point here is that neither Barclays nor the new buyer of I-Shares, CVC Partners, are fools. They know the shorting of SLV is a fraudulent practice and can cause headaches at some point. What better time to address the issue than upon a change in ownership. If this is what the shipment of metal and close-out of shorted shares is about, then it’s especially bullish. Not only would it confirm silver is tight, it would also suggest the fraudulent short-selling of SLV shares may be ending.
The current set up, in both the paper market structure and the physical world, should be the start of something good, price-wise. Whether it runs into increased manipulative short selling on a rally remains to be seen. I know many feel this pattern won’t be broken, but a true physical shortage will trump any and all paper games. When this baby goes, it will be a sight to behold.
-- Posted 14 April, 2009
Showing posts with label cot. Show all posts
Showing posts with label cot. Show all posts
15 April 2009
29 July 2008
Coincidence or Confirmation?
(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)
Big news recently is the world record loss in crude oil trading, taken by SemGroup, of Tulsa, Oklahoma, a large but mostly unknown oil pipeline, storage and trading company founded in 2000. To my knowledge, the reported $3.2 billion loss is the second largest commodity debacle ever, only behind the $6 billion loss recorded by Amaranth Advisers two years ago in natural gas.
What is remarkable is how little has been written about SemGroup’s loss. I realize that we have become numb to reports of multi-billion dollar losses, thanks to the mortgage and credit disaster. But it is still amazing to me that more attention has not been placed upon this oil trading loss, because it explains so much about the recent volatility in the price of oil. If there’s one concern ahead of the mortgage and credit crisis, it has to be the price of crude.
Given the recent fervor by elected officials to pin the blame for the unprecedented price moves in crude on speculators, I’m surprised that more observers are not making the connection between SemGroup’s actions and the big price move in crude oil. I thought the CFTC would be all over this major market event, but they instead announced, with great fanfare, charges concerning truly insignificant oil market violations. These events occurred more than a year ago and the dollar amount was a million dollars. The SemGroup’s loss was 3200 times more significant, yet neither the CFTC nor the NYMEX, where $2.4 billion of the loss reportedly occurred (the rest was OTC) have said a word about the 2nd largest commodity loss in history.
So, how do you lose $3.2 billion dollars in crude oil trading and how did that affect the price? The answer is with an obscene number of contracts on the wrong side of a rising market on the short side. That’s smack-dab where SemGroup was positioned, with more (and perhaps much more) than 100,000 short futures and options contracts.
The exact number of contracts that SemGroup actually held short has not been revealed. However, by dividing the total loss listed in bankruptcy filings and published reports, by a reasonable loss per barrel, it’s not hard to deduce the total number of short contracts held. To appreciate what a 100,000 contract position represents, it is the equivalent to 100 million barrels of oil, or more than every barrel produced and consumed in the entire world for a day.
In terms of dollar amounts, it appears that SemGroup held short positions on more than $15 billion worth of crude oil and perhaps much more. In practical terms, it would take a position of that size going against you in order to generate a loss of $3 billion. You should be asking yourself, how did the NYMEX and the CFTC allow SemGroup, or anyone, to amass such a large position that it, obviously, couldn’t stand behind? What do these regulators do all day?
I’m certain that when the details emerge, we will read of a story that has recurred in previous market debacles, namely, an initial market miscalculation compounded by repeated attempts to get whole by doubling up. As those increased bets don’t pan out, and margin calls can’t be met, the game is over in an instant and the loss is recorded.
In this case, it’s easy to see, based upon the timeline, how SemGroup’s trading debacle influenced oil prices, first up, then down. As the end came near for SemGroup’s large, increasing short position, that position was forcibly bought back (probably by SemGroup’s lead broker, said to be Barclays). This accounted, by my calculations, for the last $15 to $20 increase in the price of oil, up to the $147 price high. When the forced buyback of the short position was concluded, a buying void was suddenly created and prices then fell $20+ to date. So, not only did SemGroup manage to lose over $3 billion and go bankrupt in the process, it also dramatically influenced the price of oil and fuel for the rest of the world.
As the SemGroup story comes out, I’m certain my version will prove fairly accurate. In fact, I already wrote about it, or nearly so, in an article on June 10, titled "The Real Speculators"
http://www.investmentrarities.com/06-10-08.html In that article, I opined that speculators were influencing the price of crude oil alright, but it wasn’t the speculators everyone thought were the culprits, like hedge and index funds on the long side. Instead, the real speculators were short traders, mainly in the commercial category, who were stuck in losing positions and the buying back of those losing short positions was driving prices higher. I pointed out that these speculators on the short side were masquerading as commercials or legitimate hedgers.
I’ll leave it up to you to decide if this previous article of mine was just a remarkable coincidence, or a confirmation of my point. To that, add last week’s announcement by the CFTC that it had reclassified a very large trader in crude oil from the commercial category to the non-commercial category, because it determined that the trader wasn’t legitimately hedging. It would appear that trader may have been SemGroup. Regardless, the CFTC’s reclassification came after the harm was done and appears to be nothing more than public relations damage control from an ineffective regulator. As usual.
Let me be clear here. I am not suggesting that the price of crude oil doubled in less than a year solely because of SemGroup or any other short speculators, pretending to be legitimate hedgers, bought back those losing short positions, driving prices higher. Obviously, oil is the biggest commodity market by far, and it takes real fundamentals to move the price by that magnitude.
But, if there was a speculative premium to the price of oil, I contend that premium was created more by the speculative shorts buying back those short positions, rather than the speculative longs buying and adding to their longs. After all, the public data clearly indicates that open interest in crude oil futures has been declining over the past six moths, indicating that contracts have been liquidated on balance. That means that the longs have been selling and the shorts have been buying. It doesn’t take a rocket scientist to figure out that the buying pressure has been coming from the shorts, and even our elected officials should be able to figure this out.
I have taken your time in explaining what has occurred in oil, not because it may have confirmed what I had written in a previous article, but because I think it is important to fully understand what has transpired. Additionally, I believe it has special relevance for silver investors. There is a remarkable similarity to what has just occurred in oil to what will occur in silver.
The first observation is that both commodities are traded on the same exchange, the NYMEX/COMEX. This is no small coincidence, as I believe there is a common culture of management and regulatory attitude that has created in silver the same set up that permitted what just occurred in crude oil. This is particularly significant for silver investors, because it represents a force that will propel the price of silver far higher than most could ever imagine.
To those who may question how paper trading in oil or silver, no matter how extreme, might influence the worldwide pricing in each commodity, it is important to recognize the significance of being the world’s largest futures exchange, as the NYMEX is in oil and COMEX is in silver. Most real world transactions are priced off the prices set on whatever is the most dominant futures exchange. So forces that drive prices on the leading futures exchanges also drive world prices on physical transactions.
The common denominator in oil and silver is the large, and largely illegitimate commercial short position. I’m not saying that all commercial shorts are really speculators in drag, but some are. Certainly, in oil, SemGroup was not a legitimate hedger, as it is not possible to lose more than $3 billion on a legitimate hedge. And this took place under full view and supervision of the NYMEX and the CFTC.
Likewise, the public evidence indicates a commercial short position in COMEX silver that is so large that it defies common sense and economic justification. In fact, the commercial short position in silver is relatively and proportionately many times more extreme than the short oil position held by SemGroup. Whereas their failed oil short position represented just over one day’s world oil production and approximately 10% of total crude oil futures open interest, the big commercial shorts in silver make SemGroup look like a pipsqueak.
But make no mistake, the short position held by SemGroup was large enough and ill-conceived enough to make it vulnerable and capable of artificially distorting the world’s largest market. In fact, what occurred was as close as you could get to a contract default without having to declare such. All that separated this event from being a formal default was the clearing firm’s willingness to eat the loss. My point is that the silver short position is dramatically larger and more ill-conceived and, therefore, makes it more vulnerable and likely to artificially impact the price of silver upwards and/or threaten default.
The most recent Commitment of Traders Report (COT), for positions held as of 7/25, shows a new record for the 4 largest shorts in silver futures, with the 8 largest traders close to a record. (For the record, I think the CFTC may have made a mathematical error in this report in overstating the size of the 4 largest traders, but it does not materially alter the conclusion, so I am treating the numbers as reported). The new COT indicates the big 4 are net short more than 175 days of world mine production, and the 8 largest traders short 217 days. This, compared to a little over one day’s worth of oil production held short by SemGroup. As I have written previously, no commodity comes close, or has ever come close to having such a large concentrated short position on this metric.
In terms of the percentage of the total COMEX silver futures market, the 8 largest traders hold 81% of the entire short side, once all spreads are netted out. This is an outrageous level of concentration, not seen in any other market (except gold, which is also 81%).
There is another very important difference between the silver market short position, compared to the SemGroup’s failed oil short position, aside from the obvious and glaring mismatch in terms of size and concentration. That difference is that while there was little public warning of SemGroup’s ill-fated short oil fiasco, that is certainly not the case in silver. In fact, aside from my recent article pointing to the commercial oil shorts as being the real speculators, I am aware of no finger-pointing at these traders in oil.
Compare that to silver, where on more than one occasion over the years, several hundred concerned investors and citizens have petitioned the CFTC to deal with the outsized and non-economic COMEX commercial silver short position. Each time, the CFTC has denied, in detail, that this unprecedented short position is manipulative and represents a danger to the market. Each time, the vast majority of petitioners were unconvinced with the CFTC’s denials. The SemGroup episode is unlikely to persuade objective market observers that the silver short position is not manipulative and dangerous.
It is hard to imagine, after the unnecessary oil market volatility caused by SemGroup’s failed short position, that the CFTC could still maintain the no problem in silver story with a straight face. After all, the CFTC and the NYMEX clearly failed in their prime oversight role in allowing SemGroup to amass such a large, non-economic and dangerous short position. According to their own data, the silver short position is many times larger, more concentrated and, therefore, more dangerous than SemGroup’s oil short position ever was.
Regardless of whether the CFTC or the NYMEX/COMEX are finally forced to uphold the law and live up to their responsibilities, the message to silver investors should be clear. If SemGroup’s failed short position could have the price influence it had on the world’s largest commodity, oil, then what is the likely price impact of the failure of a very much larger short position on one of the market’s smallest commodities, silver?
My point is that because silver is such a small market and because the short position is so large and concentrated, the impact on price is certain to be much more dramatic than what we just witnessed in crude oil. One trader, buying back a short position equal to one day’s world production in the largest commodity market caused the price of oil to rise and fall by $20 a barrel and more.
What would be the effect on a small market, like silver, if several traders bought back, or tried to buy back many days of world production, perhaps a hundred days or more, in a very short and compressed time frame, such as was just experienced by SemGroup in oil? My back-of-the-envelope calculation would be silver would move up by double to triple the amount just seen in oil, on a dollar per barrel/dollar per ounce basis. In other words, if oil was moved by $10 to $20 per barrel by SemGroup’s buying, silver, in comparable circumstances, would move by $25 to $50+ per ounce.
Even this rough calculation understates what is likely to occur in silver price-wise, as it leaves out the most important difference between oil and silver, namely, the very nature of each. First, oil is a primary consumption commodity. By that I mean it is the prime cost component in most of it’s major uses, such as a transportation or heating fuel. This means that, although oil is a truly essential commodity, a price rise in oil is felt immediately by everyone, encouraging conservation and a fall off in demand, as we’ve seen in the US.
Silver, on the other hand, is not the prime cost component in the vast majority of it’s industrial applications, because so little of it is used per average application. This makes silver demand more insensitive to rising prices. The term used to describe this phenomenon is price inelasticity. Even in jewelry, because of the current low price, labor and fabrication outweigh the metal in calculating the total cost. Therefore, unlike oil, sharply rising prices shouldn’t bring about an immediate fall in silver demand.
But the most important difference in the nature of oil and silver is that higher prices for each bring entirely different reactions from investors and speculators. Higher oil prices have led to a reduction in investor demand for long positions in the commodity itself. This is borne out in the public data that shows long positions have been reduced on the price rise (Remember, it is the shorts who were doing the buying to the upside).
In silver, higher prices excite and encourage investor demand, as is seen in the strong growth in silver holdings in the ETF’s, and other public data sources, such as the US Mint’s record sales of Silver Eagles. That’s because silver is a primary investment asset, in addition to being a vital industrial commodity. Oil is the most vital industrial commodity of all, but, as a commodity, it is not also a primary investment asset.
It is this difference in the nature of these two commodities, that makes the prospects for sharply higher silver prices so exciting. When oil goes up, everyone tries to use less. When silver goes up, not only is there no great push to use less, but investors want to buy more. Recognizing and taking advantage of this difference will make many wealthy in the future.
Big news recently is the world record loss in crude oil trading, taken by SemGroup, of Tulsa, Oklahoma, a large but mostly unknown oil pipeline, storage and trading company founded in 2000. To my knowledge, the reported $3.2 billion loss is the second largest commodity debacle ever, only behind the $6 billion loss recorded by Amaranth Advisers two years ago in natural gas.
What is remarkable is how little has been written about SemGroup’s loss. I realize that we have become numb to reports of multi-billion dollar losses, thanks to the mortgage and credit disaster. But it is still amazing to me that more attention has not been placed upon this oil trading loss, because it explains so much about the recent volatility in the price of oil. If there’s one concern ahead of the mortgage and credit crisis, it has to be the price of crude.
Given the recent fervor by elected officials to pin the blame for the unprecedented price moves in crude on speculators, I’m surprised that more observers are not making the connection between SemGroup’s actions and the big price move in crude oil. I thought the CFTC would be all over this major market event, but they instead announced, with great fanfare, charges concerning truly insignificant oil market violations. These events occurred more than a year ago and the dollar amount was a million dollars. The SemGroup’s loss was 3200 times more significant, yet neither the CFTC nor the NYMEX, where $2.4 billion of the loss reportedly occurred (the rest was OTC) have said a word about the 2nd largest commodity loss in history.
So, how do you lose $3.2 billion dollars in crude oil trading and how did that affect the price? The answer is with an obscene number of contracts on the wrong side of a rising market on the short side. That’s smack-dab where SemGroup was positioned, with more (and perhaps much more) than 100,000 short futures and options contracts.
The exact number of contracts that SemGroup actually held short has not been revealed. However, by dividing the total loss listed in bankruptcy filings and published reports, by a reasonable loss per barrel, it’s not hard to deduce the total number of short contracts held. To appreciate what a 100,000 contract position represents, it is the equivalent to 100 million barrels of oil, or more than every barrel produced and consumed in the entire world for a day.
In terms of dollar amounts, it appears that SemGroup held short positions on more than $15 billion worth of crude oil and perhaps much more. In practical terms, it would take a position of that size going against you in order to generate a loss of $3 billion. You should be asking yourself, how did the NYMEX and the CFTC allow SemGroup, or anyone, to amass such a large position that it, obviously, couldn’t stand behind? What do these regulators do all day?
I’m certain that when the details emerge, we will read of a story that has recurred in previous market debacles, namely, an initial market miscalculation compounded by repeated attempts to get whole by doubling up. As those increased bets don’t pan out, and margin calls can’t be met, the game is over in an instant and the loss is recorded.
In this case, it’s easy to see, based upon the timeline, how SemGroup’s trading debacle influenced oil prices, first up, then down. As the end came near for SemGroup’s large, increasing short position, that position was forcibly bought back (probably by SemGroup’s lead broker, said to be Barclays). This accounted, by my calculations, for the last $15 to $20 increase in the price of oil, up to the $147 price high. When the forced buyback of the short position was concluded, a buying void was suddenly created and prices then fell $20+ to date. So, not only did SemGroup manage to lose over $3 billion and go bankrupt in the process, it also dramatically influenced the price of oil and fuel for the rest of the world.
As the SemGroup story comes out, I’m certain my version will prove fairly accurate. In fact, I already wrote about it, or nearly so, in an article on June 10, titled "The Real Speculators"
http://www.investmentrarities.com/06-10-08.html In that article, I opined that speculators were influencing the price of crude oil alright, but it wasn’t the speculators everyone thought were the culprits, like hedge and index funds on the long side. Instead, the real speculators were short traders, mainly in the commercial category, who were stuck in losing positions and the buying back of those losing short positions was driving prices higher. I pointed out that these speculators on the short side were masquerading as commercials or legitimate hedgers.
I’ll leave it up to you to decide if this previous article of mine was just a remarkable coincidence, or a confirmation of my point. To that, add last week’s announcement by the CFTC that it had reclassified a very large trader in crude oil from the commercial category to the non-commercial category, because it determined that the trader wasn’t legitimately hedging. It would appear that trader may have been SemGroup. Regardless, the CFTC’s reclassification came after the harm was done and appears to be nothing more than public relations damage control from an ineffective regulator. As usual.
Let me be clear here. I am not suggesting that the price of crude oil doubled in less than a year solely because of SemGroup or any other short speculators, pretending to be legitimate hedgers, bought back those losing short positions, driving prices higher. Obviously, oil is the biggest commodity market by far, and it takes real fundamentals to move the price by that magnitude.
But, if there was a speculative premium to the price of oil, I contend that premium was created more by the speculative shorts buying back those short positions, rather than the speculative longs buying and adding to their longs. After all, the public data clearly indicates that open interest in crude oil futures has been declining over the past six moths, indicating that contracts have been liquidated on balance. That means that the longs have been selling and the shorts have been buying. It doesn’t take a rocket scientist to figure out that the buying pressure has been coming from the shorts, and even our elected officials should be able to figure this out.
I have taken your time in explaining what has occurred in oil, not because it may have confirmed what I had written in a previous article, but because I think it is important to fully understand what has transpired. Additionally, I believe it has special relevance for silver investors. There is a remarkable similarity to what has just occurred in oil to what will occur in silver.
The first observation is that both commodities are traded on the same exchange, the NYMEX/COMEX. This is no small coincidence, as I believe there is a common culture of management and regulatory attitude that has created in silver the same set up that permitted what just occurred in crude oil. This is particularly significant for silver investors, because it represents a force that will propel the price of silver far higher than most could ever imagine.
To those who may question how paper trading in oil or silver, no matter how extreme, might influence the worldwide pricing in each commodity, it is important to recognize the significance of being the world’s largest futures exchange, as the NYMEX is in oil and COMEX is in silver. Most real world transactions are priced off the prices set on whatever is the most dominant futures exchange. So forces that drive prices on the leading futures exchanges also drive world prices on physical transactions.
The common denominator in oil and silver is the large, and largely illegitimate commercial short position. I’m not saying that all commercial shorts are really speculators in drag, but some are. Certainly, in oil, SemGroup was not a legitimate hedger, as it is not possible to lose more than $3 billion on a legitimate hedge. And this took place under full view and supervision of the NYMEX and the CFTC.
Likewise, the public evidence indicates a commercial short position in COMEX silver that is so large that it defies common sense and economic justification. In fact, the commercial short position in silver is relatively and proportionately many times more extreme than the short oil position held by SemGroup. Whereas their failed oil short position represented just over one day’s world oil production and approximately 10% of total crude oil futures open interest, the big commercial shorts in silver make SemGroup look like a pipsqueak.
But make no mistake, the short position held by SemGroup was large enough and ill-conceived enough to make it vulnerable and capable of artificially distorting the world’s largest market. In fact, what occurred was as close as you could get to a contract default without having to declare such. All that separated this event from being a formal default was the clearing firm’s willingness to eat the loss. My point is that the silver short position is dramatically larger and more ill-conceived and, therefore, makes it more vulnerable and likely to artificially impact the price of silver upwards and/or threaten default.
The most recent Commitment of Traders Report (COT), for positions held as of 7/25, shows a new record for the 4 largest shorts in silver futures, with the 8 largest traders close to a record. (For the record, I think the CFTC may have made a mathematical error in this report in overstating the size of the 4 largest traders, but it does not materially alter the conclusion, so I am treating the numbers as reported). The new COT indicates the big 4 are net short more than 175 days of world mine production, and the 8 largest traders short 217 days. This, compared to a little over one day’s worth of oil production held short by SemGroup. As I have written previously, no commodity comes close, or has ever come close to having such a large concentrated short position on this metric.
In terms of the percentage of the total COMEX silver futures market, the 8 largest traders hold 81% of the entire short side, once all spreads are netted out. This is an outrageous level of concentration, not seen in any other market (except gold, which is also 81%).
There is another very important difference between the silver market short position, compared to the SemGroup’s failed oil short position, aside from the obvious and glaring mismatch in terms of size and concentration. That difference is that while there was little public warning of SemGroup’s ill-fated short oil fiasco, that is certainly not the case in silver. In fact, aside from my recent article pointing to the commercial oil shorts as being the real speculators, I am aware of no finger-pointing at these traders in oil.
Compare that to silver, where on more than one occasion over the years, several hundred concerned investors and citizens have petitioned the CFTC to deal with the outsized and non-economic COMEX commercial silver short position. Each time, the CFTC has denied, in detail, that this unprecedented short position is manipulative and represents a danger to the market. Each time, the vast majority of petitioners were unconvinced with the CFTC’s denials. The SemGroup episode is unlikely to persuade objective market observers that the silver short position is not manipulative and dangerous.
It is hard to imagine, after the unnecessary oil market volatility caused by SemGroup’s failed short position, that the CFTC could still maintain the no problem in silver story with a straight face. After all, the CFTC and the NYMEX clearly failed in their prime oversight role in allowing SemGroup to amass such a large, non-economic and dangerous short position. According to their own data, the silver short position is many times larger, more concentrated and, therefore, more dangerous than SemGroup’s oil short position ever was.
Regardless of whether the CFTC or the NYMEX/COMEX are finally forced to uphold the law and live up to their responsibilities, the message to silver investors should be clear. If SemGroup’s failed short position could have the price influence it had on the world’s largest commodity, oil, then what is the likely price impact of the failure of a very much larger short position on one of the market’s smallest commodities, silver?
My point is that because silver is such a small market and because the short position is so large and concentrated, the impact on price is certain to be much more dramatic than what we just witnessed in crude oil. One trader, buying back a short position equal to one day’s world production in the largest commodity market caused the price of oil to rise and fall by $20 a barrel and more.
What would be the effect on a small market, like silver, if several traders bought back, or tried to buy back many days of world production, perhaps a hundred days or more, in a very short and compressed time frame, such as was just experienced by SemGroup in oil? My back-of-the-envelope calculation would be silver would move up by double to triple the amount just seen in oil, on a dollar per barrel/dollar per ounce basis. In other words, if oil was moved by $10 to $20 per barrel by SemGroup’s buying, silver, in comparable circumstances, would move by $25 to $50+ per ounce.
Even this rough calculation understates what is likely to occur in silver price-wise, as it leaves out the most important difference between oil and silver, namely, the very nature of each. First, oil is a primary consumption commodity. By that I mean it is the prime cost component in most of it’s major uses, such as a transportation or heating fuel. This means that, although oil is a truly essential commodity, a price rise in oil is felt immediately by everyone, encouraging conservation and a fall off in demand, as we’ve seen in the US.
Silver, on the other hand, is not the prime cost component in the vast majority of it’s industrial applications, because so little of it is used per average application. This makes silver demand more insensitive to rising prices. The term used to describe this phenomenon is price inelasticity. Even in jewelry, because of the current low price, labor and fabrication outweigh the metal in calculating the total cost. Therefore, unlike oil, sharply rising prices shouldn’t bring about an immediate fall in silver demand.
But the most important difference in the nature of oil and silver is that higher prices for each bring entirely different reactions from investors and speculators. Higher oil prices have led to a reduction in investor demand for long positions in the commodity itself. This is borne out in the public data that shows long positions have been reduced on the price rise (Remember, it is the shorts who were doing the buying to the upside).
In silver, higher prices excite and encourage investor demand, as is seen in the strong growth in silver holdings in the ETF’s, and other public data sources, such as the US Mint’s record sales of Silver Eagles. That’s because silver is a primary investment asset, in addition to being a vital industrial commodity. Oil is the most vital industrial commodity of all, but, as a commodity, it is not also a primary investment asset.
It is this difference in the nature of these two commodities, that makes the prospects for sharply higher silver prices so exciting. When oil goes up, everyone tries to use less. When silver goes up, not only is there no great push to use less, but investors want to buy more. Recognizing and taking advantage of this difference will make many wealthy in the future.
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