I thought I had a good idea what
disasters we might face in 2013, and then I saw the most recent US Commodity
Futures Trading Commission’s Bank Participation Report for gold and
silver. On the basis of recent BPRs these markets are heading for a crisis,
which is generally unexpected. I shall break the reader in gently by looking
at gold first.
The first chart below shows US
banks’ net short exposure to gold up to December 4. Between February
and August the US banks managed to reduce their net shorts from 104,717 to
57,689 contracts against a background of a declining gold price. This is logical, to be expected and sensible
position management. However, when the gold price turned up after the August
BPR, net shorts rapidly rose to new highs, and over the last month
unexpectedly increased again while the gold price actually declined. This is
a sign that the US banks, of which only five made returns for December, are
having difficulty keeping a lid on the market that emotionally at best is
neutral, but most probably somewhat oversold. This differs from an
over-bought market with potential profit-takers to shake out, as was the case
when gold traded at $1,900 per ounce and the same banks were able to bring the
gold price back under control.
The next chart is of Non-US
banks’ net shorts, which tells a very different story. From October
2011 these banks increased their short positions, with a sudden jump between
August and October, before sharply reducing their net positions to 44,707 contracts
this month. It appears that some of the shorts have ended up on the US
banks’ books, pushing their shorts to uncomfortable levels as shown in
the first chart.
The jump in these net shorts
between August and October was comprised of sharp rises in both longs and
shorts involving swap dealers and the other commercials. Longs more than
tripled from 9,199 to 34,881 and shorts rose even more from 49,772 to 113,445
on a rising gold price. The likely explanation is that buyers materialised through some of these non-US banks, who
hedged by buying futures contracts. A dealer or dealers at one or more other
non-US banks saw the price go against their shorts and tried to kill it by
massive intervention. Subsequently, when the US banks sold the market down
from the October rally these non-US banks took the opportunity to reduce
their shorts to more normal levels.
This information is particularly
revealing, given that the Commitment of Traders Report shows a substantial
reduction in the Commercials’ net position by 34,551 contracts for the
week to the same date as the BPR, giving an impression of a market being
brought back under control. The BPR suggests otherwise.
While there is a large stock of
gold that can theoretically become available at higher prices, the same
cannot be said for silver. We shall look at the position of the US banks
first. The first silver chart shows that even though silver is trading well
below its 2011 highs, US banks’ net shorts are substantially higher
than might be expected. The long figure is down to only 625 contracts, while
the shorts are 40,198, so these less-than-four-banks that reported last week
have a net short exposure of nearly 200,000,000 ounces, or twice the
estimated annual supply of silver available to investors after industrial
demand is allowed for.
The final chart shows the non-US
banks’ net shorts. Unlike their exposure to gold, these banks are in
the same deep trouble as the US banks, having made the mistake of turning a
broadly level book as recently as the August BPR into a record net short
position on the August-October price rise. This is a vicious bear squeeze on
them, which added to the US banks’ position amounts to a total short of
290,000,000 ounces. This figure compares with net shorts of only 120,000,000
ounces when the price was successfully taken down from its all-time highs
early last year.
The silver does not exist to
cover these short positions, and it will take very little further buying to
set off a crisis in this important market. In the case of gold, there have
always been central banks with physical bullion available to ease market
shortages, but so far as we are aware the strategic silver stockpiles of
previous decades are exhausted. There is therefore no price at which these
shorts can be closed.
Bank positions in both silver
and gold seem to have been adversely affected by “events unknown”
from the August BPR onwards. All attempts by the banking community to regain
control of these important markets appear to have failed.
Since the date of the latest BPR
(December 4), there have been three serious attempts to reduce these short
positions and each time the same $32.60 level has held firm. This suggests
that a buyer or buyers larger than the banks are prepared to take them on by
buying the dips. This price action supports anecdotal evidence that physical
bullion in important markets such as London is in short supply.
On this evidence, and assuming
the trend continues, there will shortly come a time where NYMEX will be
forced to declare force majeure in this market, which they can do under their
rule book. The consequences of this extreme action could well be destabilising not only for the price and demand for
silver but also disruptive for gold.
Therefore, we must add the
breakdown of precious metals markets to the list of systemic dangers we face
in the New Year.