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
