Tuesday, January 13, 2009

COMEX commercial positions favor silver: Got Gold Report


Gold seems trapped in its present consolidation

In this first Got Gold Report of 2009 we’ll jump right into the “meat” of what GGR readers want. Gold and silver exchange traded fund updates, changes in the positioning of the largest COMEX futures traders, and an update on the latest developments in premiums for physical gold and silver. 

In the near future, the Got Gold Report plans to provide its more detailed analysis in association with Brien Lundin’s GoldNewsletter.com. Details are to be announced very shortly.

Gold ETFs   

SPDR Gold Shares, [GLD], the largest gold exchange traded fund, reported adding yet another 7.37 to show 787.6 tonnes of gold bars held for its investors by a custodian in London. The popular gold trust reported a new record of 787.88 tonnes held on Tuesday, January 6, just before a small 0.28 tonne maintenance reduction.  

Source for data SPDR Gold Trust 

So that the price of each share of GLD tracks very closely with the price of 1/10 ounce of gold (less accumulated fees), authorized market participants (AMPs) have to add metal and increase the shares in the trading float when buying pressure strongly outstrips selling pressure. The reverse occurs when selling pressure overwhelms buying pressure.

Barclay’s iShares COMEX Gold Trust [IAU] gold holdings added 0.75 to show 67.52 tonnes of gold held for its investors. 

SLV Metal Holdings

Metal holdings for Barclay’s iShares Silver Trust [SLV] jumped strongly over the first full week of the New Year. The U.S. silver ETF reported adding a net 270.49 tonnes to show a new record 7,063.48 tonnes of silver metal held for its investors by custodians in London.  

Source for data Barclay’s iShares Silver Trust 

Gold COT Changes  

The COMEX is a window. It is a view into a much larger, but much less understood global over-the-counter market where the vast majority of gold actually changes hands daily. 

The window is not crystal clear. It is more opaque than it is transparent, but by observing how the largest of the largest traders on the COMEX are positioning we gain insight into what their expectations are. Especially interesting are very significant changes in their positioning or unusually abrupt changes by these well-informed veteran traders, which can signal shifts occurring in their near-term outlook.

In the Tuesday 1/6 Commodities Futures Trading Commission (CFTC) commitments of traders report (COT) for gold metal the COMEX large commercials (LCs) collective combined net short positions (LCNS) INCREASED 6,709 contracts, or 4.7% from 142,773 to 149,482 contracts net short Tuesday to Tuesday as spot (paper contract) gold FELL $9.34 or 1.07% from $873.50 to $864.16.

An increase in the LCNS on a decrease for gold is normally less bullish very short term. 

Gold versus the commercial net short positions as of the Tuesday COT cutoff:

Source for data CFTC for COT, cash market for gold. 

Over the past four COT weekly reporting periods (since December 9), as gold rose $87.27 or 11.2% from $776.89 to $864.16, traders classed by the CFTC as commercial increased their collective net short positioning by a whopping 54,610 contracts or 57.6% from 94,872 to 149,482 COMEX gold contracts net short. (More than a 5:1 ratio percentage wise.) During the same period the total open interest increased 59,390 or 22.8% to 320,391 open contracts.

The chart below compares the COMEX commercial net short position with the total open interest (LCNS:TO).  

Source for data CFTC for COT, cash market for gold 

Clearly, over the past four weekly COT reporting periods, the largest of the largest traders for gold on the COMEX have positioned more for gold weakness (as measured in U.S. dollars) than they have for gold strength. Indeed as of this past week they seemed rather determined in that net short positioning. Each daily high was a little lower for four consecutive days this past week until Friday’s rally attempt back up to the high $860s. However, significant and seemingly equally determined buying pressure showed in the $830s on multiple days.  

It is likely no coincidence that the gold LCNS increased substantially just ahead of the annual rebalancing of several widely followed commodity indexes. Rebalancing that lowered exposure to gold on those indexes. Note please, for evidence, that there was no correspondingly large increase in the silver LCNS:TO as shown below. There was also no change in the percentage weighting for silver in the indexes.    

JP Morgan Chase estimated publicly a direct net sell effect of less than 10,000 February 2009 gold contracts as a consequence of the rebalancing. However, that estimate blithely ignores the run-on effect and other funds which shadow the major commodities indexes.  

Be that as it may, the direct effects of the rebalancing are probably already waning as this is being written, the weekend of January 10-11.

Technically, gold is very close to an implied resistance breakout of a months-long consolidation (see linked charts below) and in the event gold were to trade to and through the $880s (convincingly) the aggressive commercial net short positioning and latent buy stops just above could add bullish fuel for a follow through. Until it does, however, gold seems trapped in its present consolidation with lower implied support probably rising somewhere in the $760s.

Silver COT

As silver rose 52 cents, or 4.75% COT reporting Tuesday to Tuesday (from $10.95 to $11.47 on the cash market), the large commercial COMEX silver traders (LCs) increased their collective net short positioning (LCNS) by a smallish 676 or 2.24% to 30,920 contracts of net short exposure, while the total open interest on the COMEX increased 1,476 contracts to a still very low 86,788 COMEX 5,000-ounce contracts. 

Source for base data CFTC for LCNS, London Silver Fix for silver from LBMAuntil 2-26-08 then cash market 

In a sense the very large increases in commercial net short positioning for gold have not been “confirmed” in the silver LCNS. 

For context, the chart below compares the silver LCNS to the total number of open contracts on the COMEX, division of NYMEX. When compared to all the contracts open, the commercial net short positioning in silver futures comes in this week at 35.63%. That is ever so slightly higher than the previous week but the LCNS:TO for COMEX silver remains in the lower reaches of the graph. That normally tends to favor those who buy on dips more than those who sell on rallies.   

Source for base data CFTC for LCNS, London Silver Fix for silver from LBMAuntil 2-26-08 then cash market 

In contrast to the COMEX gold market, over the past four COT reporting periods (since December 9), as silver increased by a net $1.64, or 16.7% from $9.83 to $11.47, the COMEX commercial traders added 6,169 contracts to their net short positioning, an increase of 24.9%. That is less than a 1.5:1 ratio percentage wise, a fact that should be disconcerting to silver bears short term. 

During the same period the total COMEX silver open interest increased 3,312, or 4% from 83,476 to 86,788 open contracts (not much). So, over the past four reporting periods it seems that the COMEX commercials were not as aggressive in taking the short side for silver as they were for gold. Although they did increase their net short positions by just under twice the increase in the total open interest nominally, both the LCNS and the LCNS:TO are at low levels historically speaking.  

That suggests a shift is occurring that favors silver ETFs and physical silver over the more highly leveraged and much more manipulated futures markets for silver. It also suggests that the very largest traders on the COMEX are much less confident of lower silver prices in the future than they are for gold. 

Indeed, after two months of relatively small metal reductions during the heat of the most recent market panics in October and November, SLV, the largest silver ETF, has once again begun adding to its silver holdings as shown in the graph below. That reflects much more buying pressure for the silver ETF than selling pressure.  

Note: January 2009 is as of January 9. Source for data iShares Silver Trust.   

COMEX Spec Buyer’s Strike for Silver

We can observe that even while investors are flooding into the big silver ETF there continues to be a lack of speculative buying activity in the COMEX silver market. For evidence look no farther than the pathetically low total open interest this past COT week of less than 87,000 contracts. As recently as August of last year, the COMEX open interest for silver was 140,000 contracts. 

At the same time we see dramatically higher demand on the Street for physical silver (evidence: historically high premiums) and strongly increasing demand for silver via the ETFs (evidence: overwhelming buying pressure over selling pressure for SLV), the COMEX, which ironically almost unilaterally sets the prevailing spot price, is bereft of buying interest? Why? 

One reason could very well be that so much of the COMEX commercial net short position is held by just two U.S. banks. As of December 2 the two big U.S. banks held an unconscionable 98% of all the commercial net short positioning on the COMEX for silver – virtually all of it

Perhaps investors and speculators see that so much of the COMEX net short positioning is in just two very powerful hands they now question the legitimacy of that market as a price setting venue. Investors and speculators are moving to other venues such as allocated physical silver in London and silver ETFs here in the U.S. Who wants to take on two giants that can hurl buckets of big rocks and the referees in the fight are either asleep or betting with the giants? 

According to respected industry sources the two big banks are JP Morgan Chase and HSBC, both of which reported very large spikes higher in their gold and silver derivatives books in Q3 08. While it is possible these very large trading entities are using the COMEX to lay off corresponding opposite positions in the larger OTC markets, the fact that the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) allow just two large trading bullies to control nearly all the commercial net short positioning in the small silver market undermines confidence in that market for all traders and investors. We’ll have much more about that in future reports, but for now one tangent.

Time for Change

Whether or not the overly large net short positioning by the two U.S. banks is legitimate “hedging” of other offsetting long positions in other OTC markets, the fact that just two entities can literally control the action in what is supposed to be a price discovery mechanism turns the idea of a free market on its head. When just two actors can move the markets with the weight of their own trading that market is prone to distortion of value through manipulation.

Please don’t send emails about how the rules allow hedgers and market makers exemptions from position limits and why. The players speaking for both the banks and the regulators will use trendy industry jargon, double speak and lots of circular logic to justify just about anything, but let’s cut to the chase. Until there are strict (and equal) position limits for all participants long and short; that is, until the playing field is level, the COMEX will remain suspect as a true price discovery venue because the rules unfairly favor the short side at the expense of everyone else including the industry that market is supposed to find prices for.

As of the end of 2008, the SEC and the CFTC seem content to allow just two big U.S. banks to amass short positions in silver that are so large relative to the entire market that the banks almost certainly are compelled to defend them. How does one defend a large short position? It is by keeping downward pressure on the market; by selling more and more paper silver futures whenever the price attempts to recover; and by hammering advances in order to discourage adversaries.

Yes, even when the shortage of that commodity on the Street is so widespread that people are forced to pay 30% and 40% premiums for it as it was for silver in November and December.  

Instead of trying to gauge supply and demand, investors and speculators are rewarded only if they guess right when the gigantic entities decide to go long. It’s perverse, it’s immoral and it is time for that to change.         

Racked by growing mistrust, scams and gross mismanagement, there is currently a heightened level of scrutiny toward Wall Street and this could be the time when meaningful change can be made to the futures markets. More transparency, better enforcement of existing rules and strictly enforced position limits on both sides of the tape to level the playing field are the issues which investors, speculators and especially the titans of industry ought to champion right now. 

Odds and Ends

The Gold: Silver Ratio (GSR), which reached a 16-year high in October of 88 ounces of silver to one ounce of gold, has gradually “improved” as we suspected it would. The highest the GSR has ever been occurred very briefly in 1991 at near 100:1, but it’s very rare to see the ratio as high as the 80s. As of the Friday close the GSR showed 75.78 ounces of silver to one ounce of gold using cash market closing figures. 

Even at a ratio of 75:1 considerable conversion of gold into silver is almost certainly underway because it is historically unusual to be able to exchange gold for silver at that ratio or higher. It would not be at all surprising to see the GSR return to a level in the 50s in the not-too-distant future. 

However, about the only place one can actually convert gold to silver at the GSR ratio is on the futures markets themselves. Premiums for silver products outside of the heavily distorted futures markets are too high to allow conversion near the spot prices. And speaking of premiums…  

Bullion Premiums Remain Strong 

It doesn’t take an economic Einstein to understand that it was the most bizarre of circumstances in October and November that saw the spot prices of the two most popular precious metals plunging at the very same time the metals were in short supply. It isn’t very often that we see prices falling sharply with bona fide shortages of the commodities doing the falling. It is rare indeed to see prices collapsing for something that investors on the Street can’t even find to buy as physical silver was in late November.   

Price collapses (a rapid decline of 50% or more such as with silver) usually only occur when there is a glut of something, not a shortage. Those who can ignore the emotion of the moment and understand that what we witnessed was a distortion of the spot price by capital dislocations and blatant market manipulation by two U.S. banks; those who calmly added to their “inventory” of physical silver or silver ETFs during the recent panic are to be congratulated. 

No one can see the future, so we can’t know if there will be yet another test of the most recent lows, but it seems likely at this point there will more, not less, interest in precious metals if that test arrives.

Despite some improvement for spot prices since the last full update, premiums for physical gold and silver remained quite strong, as reported by the Coin Dealer Newsletter (CDN), a very respected and widely used source by the coin and bullion industry on January 2. Premiums are the amount over the spot price paid and charged by dealers for bullion products.

The continued very high premiums hint that physical supplies of the most popular silver and gold bullion items remain difficult for dealers to source. The unusually high spreads also suggest that demand for physical bullion remains robust.   

U.S. one-ounce gold eagles, probably the most popular gold bullion coin in the U.S.,   saw dealer to dealer premiums of $41.70 bid over spot gold of $874.60 as of January 2 according to CDN. That’s a $4.90 lower premium than the last report a month ago, but spot gold increased by $55.20 since then. 

Another way to say that is that as gold increased $55.20 an ounce the amount of premium charged and paid by dealers over spot declined by $4.90. 

Premiums for South African one-ounce gold krugerrands also eased lower by $5.00 from $35.00 over to $30.00 over spot as of January 2 according to the CDN.  

The quoted premium for U.S. one-ounce silver eagles eased a little lower since the last report, down to a reported $3.31 over spot dealer to dealer with spot silver reported at $10.78. Silver eagles in smaller quantities are still retailing at $4.00 to $5.00 over spot in most small coin shops with limited availability.  

Finally, U.S. 90% silver coins in $1,000 face value bags were quoted by CDN as bid $9,300.00 dealer to dealer January 2 with spot silver at $10.78. That is equivalent to $13.01 the ounce, or $2.23 the ounce over spot bid, or about a 20.66% premium over spot for the most versatile silver bullion product. 

As recently as June of 2008, when cash silver was just under $17.00 an ounce, bags of 90% were available in quantity at a 3% discount to the cash price of silver.  

Got Gold Report Charts

1-year daily gold

2-year weekly gold

1-year daily silver

2-year weekly silver

3-year weekly HUI

2-year weekly Gold:HUI ratio

2-year weekly U.S. dollar index 

That’s it for this offering of the Got Gold Report. Until next time, as always, MIND YOUR STOPS.   

The above contains opinion and commentary of the author. Each person should study the issues carefully and, as always, make their own informed decisions. Disclosure: The author currently holds a long position in iShares Silver Trust, net long SPDR Gold Shares and holds various long positions in mining and exploration companies.    

ABOUT THE AUTHOR
Gene Arensberg

A land developer, professional numismatist, self-taught bullion trader and investor since 1980, Gene Arensberg analyzes developments in the precious metals markets. In 2000 Gene started sharing his own market research with fellow traders and fund managers. Those email reports evolved into his popular Got Gold Report, a biweekly look at important indicators for gold and silver published on the web.

Gene’s more in-depth market reports, insights and trading ideas are soon to be an added feature for subscribers of the very popular Gold Newsletter (GNL). GNL is edited and published by Jefferson, Louisiana based Jefferson Direct, Brien Lundin, President. Brien hosts the acclaimed New Orleans Investment Conference each year which has brought investors together with some of the best and most sought after financial experts and investment authorities in the world for over three decades. For more information seeGoldNewsletter.com or New Orleans Investment Conferences.

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