Wednesday, February 11, 2009

Silver and Gold shorts

Strongly positioned for lower gold prices, not so much for silver

ATLANTA -- The very largest traders for gold and silver are, wouldn’t you know it, big U.S. banks. It looks like a few big banks, some of the same ones whose brilliant management helped spawn a global financial crisis, have the largest positioning in gold and silver futures. As of February 3, their positioning in gold and silver futures was big all right – big and short the market for gold, somewhat less short silver comparatively speaking.

A short position means the trader profits if prices fall. 

Bank participation in the COMEX 

According to the monthly CFTC Bank Participation in Futures and Options Market report released Friday, February 6, two large reporting U.S. banks held zero long and 27,189 short futures positions in COMEX silver futures as of February 3. All commercial traders as a group held a net short silver position of 33,173 contracts that same day; so just two banks held 81.96% of all the COMEX commercial net short positioning for silver.  

It should be obvious that these two very large banks could exert a disproportionate share of influence on the small silver futures market if they were so inclined. When just two traders are allowed by the Commodities Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) to accumulate so massive a position that it constitutes an overwhelmingly large percentage of the action; when the authorities allow just two banks to literally dominate a market with the weight of their own trading, traders are left to speculate on what the largest traders are going to do instead of concentrating on the supply/demand fundamentals and legitimate price discovery. 

Isn’t that the equivalent of subjects wondering what price the King will decree rather than citizens all haggling in their own self interest to determine a market price? Or, as one trader put it recently, is the COMEX silver market waiting on JP Morgan Chase to show its hand or make a move?  

In fairness, it is quite possible that the positions taken by the banks are for the most part legitimate hedges, offsetting corresponding positions in markets outside the COMEX. However, the sheer size of the positions taken by just two banks raise questions as to the legitimacy of the price discovery process on the COMEX, division of NYMEX. 

Intuitively, it should be plain to anyone that positions of overly large size could compel defensive, rather than passive, action on the part of the position holders regardless of whether or not they are hedges. 

For gold, the bank positioning is similar. Although not quite as dominant as in silver, just three U.S. banks held a collective net short position of 111,190 contracts while all commercial traders as a group reported a net short positioning of 177,589 contracts. So, three U.S. banks represent a shockingly large 60.57% of all the commercial net short positioning on the COMEX for gold.  

From January 6 to February 3, the three banks added 27,367 contracts or 34% to their net short positioning as gold rose $37.09 or 4.3% from $864.16 to $901.25. That is about an 8:1 ratio, meaning the banks strongly expect lower gold prices. 

Again, the very large commercial net short positioning doesn’t necessarily mean that the commercials are “right.” It just signals clearly what they are positioning for. 

Some analysts assume that the banks can actually drive prices lower temporarily if they don’t get what they expect. If true we have to wonder then why they haven’t done so before now? Or if, perhaps, “they” have been doing that all along. We’ll see, but back in October 2005, gold reached an obvious technical resistance zone in the $470s and the big commercial traders took a then staggeringly large net short position of 212,714 contracts, or a huge 57.36% of all open contracts.

Obviously they were even more convinced then, in October 2005, that gold was poised to plunge. As we all know now, gold did indeed pull back $20 or so by November 2005, just before it exploded higher by 55% to $730 the following May.

The point of that anecdote is twofold. First, the commercials are big yes, influential, yes, but infallible they are not. The other point is that although a very high LCNS is usually short-term bearish it can, every so often, be high octane rally fuel if a meaningful and convincing runaway breakout rally gets underway.      

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