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The price fireworks
over the July 4 holiday, particularly in silver, were met with an outpouring
of commentary and renewed interest. Not only have precious metals prices
soared to levels not seen in a couple of years, it’s hard for me to recall a
time with more input from different voices. It’s also hard to believe that it
was only six months ago that gold and silver were locked in nearly the opposite
situation. So the obvious questions are what happened and, more importantly,
what is likely to occur from here?
I continue to
believe that the main price driver for gold and silver was the historic
positioning changes in COMEX futures over the past six months. Year to date,
the now $300+ rally in gold and $6+ rally in silver, were driven by more than
30 million oz of paper gold and 325 million oz of paper silver on the COMEX,
bought principally by managed money technical funds and sold by commercials
(mostly banks).
In addition, the
price rally in gold, in particular, set off significant buying in ETFs and
other investment vehicles in which massive amounts of physical gold were
purchased and deposited. In six months, nearly 20 million oz of physical gold
were deposited into ETFs and COMEX warehouses (11 million oz in GLD alone),
further cementing the gold rally. In dollar terms, that comes to $25 billion.
The physical flows into silver have been much smaller in dollar terms as less
than $1 billion worth of silver (40 million oz) has been deposited in silver
ETFs, although there are recent signs that may be changing.
The purchase of so
much physical gold has apparently thwarted the usual outcome of an extremely
bearish COT market structure causing a big price selloff, or at least so far.
Physical metal demand is understandable because it is near impossible to
construct a fundamental bear case for gold or silver. I don’t think many
would disagree over what occurred these past six months, namely, historic COMEX
positioning, coupled with massive physical buying in gold ETFs. Now what?
In contemplating
what occurs next, it comes down to will the commercial traders succeed in
turning price lower and triggering off technical fund selling on the COMEX
and, at the same time, cool off ETF demand for physical metal? Up until very
recently, history favored the commercials succeeding for the simple reason
that they had never lost. Stated differently, the commercials as a whole and
particularly the largest commercial traders had never been forced to buy back
short contracts in COMEX gold and silver on rising prices.
I’ve tried to
characterize the circumstance in black and white terms in that either the
commercials would prevail as usual and drive prices lower or would fail for
the very first time. The chance for failure was predicated on the unusually
large financial risk the commercials had found themselves in as a result of
historically large and concentrated short positions in COMEX gold and silver.
Further, the possibility of commercial failure was augmented by a potential
double cross by JPMorgan, which has accumulated half a billion ounces of
physical silver and perhaps a large physical gold position as well.
To be fair, either
outcome, a price selloff or surge, must be considered possible, but recent
developments have raised the odds of a commercial failure in which prices
surge, especially for silver. I’m still of the mind that we will go straight
up or jiggle down one more time before then moving straight up, but it’s more
important to focus on the facts and figures and the reasoning behind the
increased odds of something that has never happened before. It has to do with
the money game on the COMEX.
Through yesterday
(July 5), the commercials had never been this deep ($2.1 billion) in the hole
before in combined gold and silver losses; so in the truest sense of the
word, these losses are unprecedented. Since futures trading is a zero sum
game, meaning that what the shorts lose, the longs gain (and vice versa), the
open profits for the managed money technical funds longs have also never been
larger. These large open losses to the commercial shorts makes them
both more vulnerable to further losses and more desperate to turn prices
down.
Make no mistake -
whether the commercials succeed or not is what will determine which way gold
and silver prices move in the immediate future. Even if the commercials
prevail yet again, and that is far from certain, the tide seems to be turning
on the whole COMEX game that has existed for decades. I believe there are a
number of factors pointing to changes in the usual business of setting gold
and silver prices.
For one thing, it’s
hard to characterize the current extreme set up in COMEX market structure as
being deliberately constructed by the commercials in its current form. After
all, who would knowingly dig themselves into the deep hole the commercials
find themselves in? What’s most unprecedented about current circumstances is
that never in the past have gold and silver prices rallied strongly after
historic commercial short positions had been established. Yet, for the very
first time, prices have so rallied.
It’s not possible
the commercials intended to be billions of dollars in the hole and the most
plausible explanation for why they are so deep in the red is simple
miscalculation. And if the commercials have miscalculated to this point, that
would seem to increase the odds of continued miscalculation, leading to a
total failure which I would define as aggressive short covering on escalating
prices. I don’t think anyone could conclude that the commercials have the
technical funds exactly where the commercials want them to be. At this point,
given the positions and overall price levels, the best the commercials could
hope for would be to rig prices low enough to recoup their sizable open
losses and get out of this jam without being decimated. It’s almost
impossible to imagine that the commercials deliberately put themselves in a
$2 billion hole in order to score billions of dollars of profits in the end.
Along those same
lines, it doesn’t seem plausible that the phenomenal demand for physical gold
in world ETFs was fully anticipated by the commercials. There was no
evidence, for example, at the start of the year that the commercials held
vast amounts of physical gold that they were seeking to unload. To the
contrary, commercial net short positions in COMEX gold (and silver) were at
extreme lows. If the commercials were expecting big physical buying in gold,
they wouldn’t have rushed onto the short side so early and aggressively.
I believe the
massive and, largely, unanticipated demand for physical gold this year not
only adds to the premise of commercial miscalculation, but holds special
potential significance for silver. As I indicated earlier, surging physical
ETF investment demand has largely been confined to gold, but could and may be
developing in silver, based upon price and volume patterns in silver ETFs,
including the largest, SLV.
It’s kind of
remarkable that $25 billion worth of gold has come into world ETFs over the
past six months, while less than a billion dollars’ worth of physical silver
has come into the world’s silver ETFs. Not that gold isn’t the larger market,
but there are other instances where the dollar demand for silver comes close
and sometimes exceeds the dollar demand for gold, like in sales of Eagles
from the US Mint. While gold did outperform silver pricewise earlier in the
year, more recently silver has outpaced gold in the performance department. I
can’t help but think that if silver is doing so well despite the lack of
physical demand compared to gold this year, what the heck will silver do when
physical investment demand kicks in, as is almost certain at some point.
In fact, that’s always
been the prime component for my investment case in silver – the likelihood of
a physical shortage. Now, more than ever, does the potential for a
physical silver shortage exist. And while I have been amazed at the quantity
of physical gold that has flowed into the ETFs this year, to this point the
lack of big deposits in SLV and other silver ETFs leaves intact the
possibility that no big quantities of physical silver are available to the
market near current prices.
Since it has been a
while, let me outline the silver shortage premise. First off, I am referring
to a coming shortage in the form of silver that matters most – 1000 oz bars.
Shortages in supplies of Silver Eagles or smaller bars of silver have gotten
to be somewhat of a regular affair over the past few years, but do not
directly impact the wholesale price of silver. The wholesale price of silver
is determined by 1000 oz bars, because they are the industry and investment
standard.
Apparently
overlooked by many, is the tiny quantity of 1000 oz bars of silver in
existence. The entire world supply of verifiable 1000 oz bars in existence
(including ETF and COMEX inventories) is just under 900 million oz, to
which I would add 500 or 600 million oz in unrecorded 1000 oz bars (of which
I believe JPMorgan holds the majority). Let’s call it 1.5 billion oz, worth
around $30 billion, compared to known gold in all forms of 5.5 billion oz,
worth $7.5 trillion. In dollar terms, there is more than 250 times more gold
than silver in the world. Common sense would suggest if there is going to be
a shortage, it would likely occur in a commodity where inventories are small
to begin with.
But like most
investment assets, including gold, very little of what exists is truly
available for sale at any point in time. That’s because relatively few
sellers exist at any time in any asset or investment, usually amounting to no
more than 5% or 10% of the total of any asset and sometimes much less. In
silver, the 1.5 billion oz in the form of 1000 oz bars, probably has an actual
availability of no more than 100 million oz. In other words, no more than $2
billion worth of silver could be bought at any time (say over a month or so).
I noted earlier that less than $1 billion of silver in 1000 oz bar form had
been bought by ETFs over the past six months.
But we live in an
investment era when many billions of dollars could flow or change direction
at any time, almost instantly. Should the smallest amount of money get
directed towards silver, say 10% of what flowed into gold ETFs over the past
six months or $2 billion, it would likely absorb and exceed the amount of
metal available. In addition to sending prices higher, sudden investment
demand would disrupt the entire silver supply chain and lead to the
“doomsday” effect in silver – an industrial user inventory buying panic.
It would work like
this. Investment demand for 1000 oz bars of silver, either through ETF demand
or COMEX deliveries, triggered by higher prices (silver is up more than any
other commodity or asset this year), triggers further investment buying until
the supply of available 1000 oz bars are temporarily exhausted. But because
90% of silver demand is earmarked to industrial or total fabrication demand,
the investment buying surge will result in growing delays in delivery of 1000
oz bars to users. This will cause those users denied timely delivery to
behave like any industrial consumer when faced with the shortage of any vital
commodity, namely, to not only buy, but buy more than usual, adding to the
physical shortage.
Certainly,
regular readers know I have held this industrial user buying panic premise
from the beginning and while we came close to physical shortage in early
2011, my premise has yet to fully blossom. Not only do I see my premise
playing out, I believe the first stage, investment buying, may have begun or,
at a minimum, is set to begin, based upon recent buying in SLV. The recurring
image in my mind is that the coming silver user buying panic is like the
great white shark lurking just off the beach. It doesn’t matter until you
cross its path, but when, not if, investment buying depletes the available
supply of 1000 oz bars, industrial users will bite the silver market like
never seen.
In
fact, this is the main difference between gold and silver. Gold is not an
industrial commodity. Because silver is an industrial commodity, both world
inventories and current production have been and are reduced by industrial
demand. Very few recognize just how much this has depleted world silver
inventories and available current production. World silver inventories are
down more than 90% from 75 years ago and only 10% (100 million oz) are
available from current production for investment in 1000 oz bars. It will
take much higher prices to balance supply once investment and user demand
kicks in. This is the case for $100 and higher silver. Not the end of the
world as we know it, just the ignition of investment demand and user
inventory buying.
That’s
what makes the current set up so intriguing and dramatic. At precisely the
same time 8 commercials have never been short so much silver on the COMEX
(nearly 500 million oz), higher prices have put those traders more deeply
underwater (in combination with gold) than ever, while those same rising
prices threaten to ignite an investment stampede. It’s as if one were
deliberately chumming the waters off shore to excite the great white shark of
user inventory buying.
Even
more stunning is the quickness in which the commercial losses developed. Only
five weeks ago, the commercials were net-net ahead for the year by around
$1.5 billion, meaning there has been a turnaround in the collective
commercial position in COMEX gold and silver of close to $4 billion.
These
are big numbers in any event, but when you distribute the turnaround and assign
losses by the actual number of commercial traders holding short positions,
the numbers become quite dramatic. COT data indicates only 8 traders hold the
entire commercial net short position in silver (nearly 500 million oz) and 8
traders in COMEX gold hold 86% (28 million oz) of the 33 million oz total
commercial record net short position. The $4 billion turnaround in commercial
financial results over the past 5 weeks comes to many hundreds of millions of
dollars per trader. Not all of the $4 billion collective commercial negative
turnaround needed to be deposited as additional margin, but at least half
did.
I’ve
removed JPMorgan from my calculations of ongoing commercial losses, as I
believe the bank holds so much physical silver and perhaps enough gold to
offset losses on COMEX short positions. Here’s an interesting thought – at
current silver prices, JPMorgan is now close to even on the 500 million oz of
physical silver I claim that it started buying 5 years ago and above $30 an
ounce. Previously, I calculated that JPM had an average price of around $20
an ounce and I think I remember dismissing concerns that the bank may be
underwater by as much as $6 per ounce or $3 billion back when silver traded
at $14. Perhaps the real lesson is that if an average price of $20 is
good enough for JPMorgan, it should be good enough for anyone.
The
circumstances surrounding JPMorgan are very much different from that of the
other commercials. Because JPM holds so much physical metal, it is immune
from damage to the upside. That cannot be said of the other commercials who
appear to be taking it in the teeth. And, of course, it is the difference at
the core of the double cross premise. Should JPMorgan not join in with the
other commercials as short sellers of last resort, it’s hard for me to see
how the commercial short selling scam in COMEX silver and gold doesn’t
unwind.
Considering
the price volatility in silver, I’m surprised that the CME hasn’t raised
margin requirements yet. I think I know why the CME hasn’t raised silver
margins and that’s because as prices are rising (as has been the case in
silver) any increase in margin requirements hurts the shorts and not the
longs. That’s because longs profit as prices rise and silver has risen enough
that longs have enough open profit to meet any additional margin requirements
without having to deposit additional funds. Those same rising prices have
been causing the shorts to come up with additional margin on a daily basis
and any increase in exchange margin requirements would force the shorts to
put up even more. Since the commercial shorts are of more concern to
the CME than the longs, the exchange has dragged its heels in raising
margins.
What
the crooks at the CME prefer to do is to wait for a turn in prices lower and
then raise margins so that the shorts can use developing equity from falling
prices to cover any increase in posted margins and the longs are the ones who
have to come up with more money and not the shorts. It’s an old dirty trick
last employed in the great silver smack down of May 2011. The remarkable
feature is that the CME hasn’t been able to employ this trick yet because
silver prices hadn’t made a turn down through today’s close. But expect these
crooks to do so as soon as they can.
Ted Butler
Sent
to subscribers on July 6, 2016
For subscription information, please go to www.butlerreseach.com
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