JULY 25 2007 5:00PM - The dollar index closed below the "magic" 80 level late yesterday yet silver and gold continued to remain weak in after-hours electronic trade, which set up today's steep drop in the PMs as the dollar finally caught a break. I'm not terribly upset by this turn of events because it falls into the general shape and timeframe of a retracement. The $12.50 level in silver continues to be the key.
Today, I would like to provide a brief update on the silver ETF situation. As of yesterday, the Barclays iShares ETF (SLV) has reached a new record of 141.7 million ounces, although this latest addition was somewhat tenuous since it has caused the NAV to go further into negative territory. What this tells me is that silver demand is there but it remains modest.
Moving on, I am happy to report that the ETF Securities ETFS Physical Silver product (yes, the one with the phonetically controversial trading symbol, the utterance of which got at least one TV actor in the U.S. fired from a nice role) now holds approx. 2.3 million ounces of silver after three months of trading. Although not a big number at this point, it does look to grow in the future and so I have decided to start reporting it in my "Silver Alerts" section. This ETF remains the only one that publishes a bar list of its silver holdings. Notice, however, that for now we don't actually know when the 2.3 million ounce level was reached since no reporting date is given for the bar list (I have contacted the ETF about this, and would suggest others do the same).
Meanwhile, the only other physical silver ETF to be launched so far (as if 3 weren't enough), the Swiss ZKB Silver ETF, still has not provided an official accounting of its holdings. Without this, my best estimate based on trading volume and market data is that it holds perhaps just a little more than 1 million ounces of silver at this point (despite earlier reports that it already held around 2.5 million ounces just two weeks after commencement of trading). I will be providing an update on this ETF in the near future and I hope to be pleasantly surprised by the size of its silver position if and when it is reported.
That's it for ETFs, now I'd like to move on to Ted Butler's latest commentary in which he makes the point that a large concentrated short position is an undeniable sign of market manipulation, whether a position is backed by physical metal or naked. I couldn't disagree more. Why? Remembering that a COMEX short position is essentially a sale, try to answer these question:
Is it manipulation for someone or some group that owns (or has claim to) X million ounces of silver to SELL that silver?
Specifically, was Warren Buffett manipulating the silver market when he sold his 130 million ounces?
More generally, can it ever be called manipulation when someone or some group that owns a large quantity of something decides to liquidate its position?
Clearly not! Therefore, it is critical to establish whether or not the commercial shorts in COMEX silver are naked. If they are not, the short positions are merely sales. And I maintain they are most probably not naked, though I will admit that at least a portion of the commercial claims on silver are backed by nothing more than paper (see my recent work on the U.S. Mint's practice of selling excess inventory via the COMEX using derivative contracts). Bottom line, until someone can conclusively demonstrate (good luck!) that commercial shorts do not have access to the silver they have sold short, there is simply no basis to assume that they are naked.
What about the accusation that the concentration of shorts (sellers), even if not naked, is tantamount to a price suppression scheme? Mind you, not just manipulation of the market for the sake of trading profits but a concerted effort to keep prices artificially bottled up for long time periods. My response, pat as it may be, is that long-term price suppression of tangible goods has never, ever succeeded in the history of mankind. The reason? Prices simply cannot be kept at artificially low levels through excessive selling of an item in limited supply. Even if sales temporarily overwhelm inherent demand, the imbalance will eventually prompt additional demand as well as new uses that were once irrational. Any seller attempting to suppress prices would face mounting losses while buyers would benefit proportionately.
In contrast, attempts at price suppression of intangible goods, where supply is not strictly limited, have some historical precedent (national currencies, dumping of products in order to drive competitors out of business, etc.) though the results are often ill-fated. Still, the practice is assumed by many to be more prevalent than it actually is. For example, the supposedly widespread problem of naked shorting of stocks is actually a relatively rare phenomenon. Why? Primarily because there are few people stupid enough to try it. And even if there were more of them, it would take a special kind of company to be enough of a basket case to succumb to a price suppression scheme (e.g., naked shorting). Enron might certainly fit that bill, although its demise was hastened by reckless management not shorting. The situation is simply not all that common.
It is quite ironic, then, that silver bugs might think somebody would be willing to try suppressing the price of silver since such a stance would essentially amount to a tacit admission that silver is susceptible to manipulation as a result of some fundamental weakness. Yet, the very argument used to reassure fellow worry warts is that silver is strong enough to eventually overcome the manipulation. So, which is it? If silver is fundamentally a good speculation from the long side, it is highly unlikely that anybody would ever try suppressing its price. To argue otherwise is to try keeping your cake and eat it too.
What about the alleged manipulators, who are they exactly? Mr. Butler's latest theory on this appears to be a sharp detour from his past thinking: the manipulation is now apparently the work of rogue elements in the metal divisions of a few major financial institutions, and the previously guilty heads of these firms are now just blissfully ignorant simpletons who are unaware of it all. While this model fits better with historical examples of rogue trading in commodities and derivatives (Sumitomo and Barings Bank spring to mind), I find this revamped theory just as difficult to believe as the original. For one, the advanced trade reporting systems and controls used at the major banks that are likely among the largest commercial traders on the COMEX make it very unlikely that large unauthorized or undocumented transactions can be hidden for a sustained period of time (if even a day). Second, the monitoring and periodic inquiries by regulators at the COMEX and CFTC are designed to circumvent rogue traders by maintaining contact with a trading firm's compliance and internal audit departments. That is why in America, when traders blow up a company, they do so with the full backing of management! What I'm saying is that Mr. Butler's original theory actually made more sense.
Continuing with the theme of common sense explanations, let me offer a few more reasons why the popular theory that a large concentrated short position exists "only" in silver as a result of manipulation is pure bunk. First, let's consider the idea of diamond futures, recently proposed as a means to create price transparency in a market dominated by insular trading. De Beers dominates the diamond industry through its wholesale operations that account for 40-50% of the trade by volume, so it will be interesting to see what level of commercial trading concentrations would appear in diamond futures over time. My guess is that if De Beers did not constitute the major commercial position in diamond futures, the diamond futures market would simply fail to create price transparency. Simply put, a market cannot determine prices without the participation of the major players.
But here is the really interesting part as it pertains to silver. Would De Beers maintain a long or short position in diamond futures? The obvious answer is that De Beers is already long in physical diamonds and would therefore need to use futures as a sales mechanism, that is, De Beers would have to maintain a net short position in diamond futures. This is not only natural, but if it were otherwise, De Beers would rightfully be guilty of price manipulation. After all, who would think it proper for a single entity that already controls 50% of a market to consolidate its dominance to an even greater degree? In this instance, a long position in diamond futures would consolidate De Beers' dominance while a short position would de-consolidate it.
Think about it for a second and then apply this fictional example to the real world of silver. Doesn't it make sense that commercial traders in silver might be short by a large margin only if they maintained a dominant claim over physical silver on the long side? Why else would, or could, they be short?
Bottom line, why is the commercial position in silver concentrated on the short side? I would offer that this is simply the case because the small size of the silver market makes it susceptible to scarcity and attempts to corner it. The Hunt Brothers come to mind. As a result, the commercials are long in off-market forms of silver where there is no regulation, including derivatives and physical metal. They use the COMEX primarily for shorting (selling) their long positions. They have no other choice in a market like silver since market regulators would otherwise be all over them like white on rice (pardon the cliche but you'll shortly realize its comedic intent).
Still don't believe me? Okay, I'll try one last time to convince you. If I'm right about silver, other small, susceptible markets should have similar concentration ratios and distributions of commercial position. Can you think of any comparables? Let's see . . . oh, here's one: rough rice. Yep, the 4 largest commercials traders in rough rice are net short a massive 251% of the net commercial short position as of the latest reporting period. Compared to the 109% concentration ratio for silver touted by Mr. Butler, rough rice must therefore be manipulated at least twice as much!
No fair, you protest, rough rice is a small market like silver, but it is not a metal! Okay, let's try palladium. Aha, you exclaim, the concentration figure is only 50% for palladium! Well, before you get too smug, you might try noticing that this concentration ratio is "so low" only because the commercials in palladium are short a staggering 90% of open interest on a gross basis. That compares to a mere 64% for silver. What this means is that traders other than commercials are short about 36% of the contracts in silver but only 10% in palladium! Imagine that, the short side of every 9 out of 10 contracts in palladium is held by a commercial trader! Following this logic to its natural conclusion, palladium clearly must be manipulated to a much greater extent than silver.
Finally, what about the most precious of the precious metals, platinum? Prices in this tiny market are also apparently suppressed by the commercial interests since the concentration ratio, as with palladium, seems low at 56% until we find once again that commercials absolutely dominate this market. And just how thorough is the alleged manipulation by commercials in platinum? They hold a massive short position representing 86% of all platinum futures contracts, that's how.
Of course, there are similar concentration ratios in much more liquid markets from time to time and so these must also be manipulated by the commercials. A couple you might want to check out right now are the Canadian Dollar and the British Pound. No more or less remarkable than silver, they all seem to have at least one thing in common: they are in strong bull markets despite the alleged price manipulation that is so reasonably beyond doubt based on the commercial dominance and concentration on the short side. With enemies like this, I ask, who needs friends?
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