Wednesday, December 28, 2011

Got Gold Report – COMEX Futures for Silver Near Extreme Bullish Levels

  • Largest combined commercial traders least net short silver since 2001, when silver traded for $4.20 the ounce.
  • Traders classed as Swap Dealers report record net long futures position. 
  • Just since November 15, as silver fell $4.98 or 14.4%, combined commercial traders reduce their collective net short positioning by stunning 43.6%.  

Please note:  This article originally appeared in our Got Gold Report subscriber pages on Monday, December 26.  It is being reprinted here in full for our entire readership as a holiday courtesy.  

HOUSTON -- Just below is a holiday look at the COMEX silver futures positioning as of the December 23 Commodity Futures Trading Commission (CFTC) commitments of traders (COT) report, for data as of Tuesday, December 20. We are at a remarkable and very unusual condition that can only occur after a very large change the price structure with one-sided sentiment and with unenthusiastic Spec trader expectations.  Very short term, expect anything, but longer term this COT setup is about as bullish as they come.  A tremendous amount of bull-side “horsepower” is resting on the sidelines of the New York futures bourse.

We See the COT as Supportive of Our Planned Position Taking Just Ahead

The closest we have seen to the large trader positioning we see now occurred during the heat of the 2008 panic, back when the world thought there was a good chance of a full blown banking collapse. That is to say that this current positioning is extraordinary and likely very meaningful.  We are not convinced it is very, very short term bullish (because momentum strongly favors the bears), but we are convinced it is extremely medium to long term bullish.  We believe the positioning we see below gives us cover to begin adding in our green target box for silver with reasonable confidence, for the first time in over a year, if only the Trading Gods will allow it. (Vultures refer to our linked silver charts for that box placement.)

Absent a full-blown global meltdown ahead we believe that silver has used up a good deal of its inherent volatility to the downside, and we also believe that trader exhaustion has already begun.  Thus the potential for a wild, backbreaker event and potential capitulation and then a major reversal has become much more likely.  One can sense traders watching computer screens worldwide looking for it and ready to pounce.    

Momentum certainly favors the bears very short term, but the largest of the largest traders of silver futures are definitely not positioning as if they see a great deal more downside for silver.  That doesn’t mean they are “right” but we think it does indeed mean the large commercial traders are not piling on the short side of silver following its roughly 47% correction. To the contrary.  See if you agree with that assessment given the large trader positioning, charts and a very few comments by us for context just below.

Continued…  ***

Lowest LCNS in a Decade, We Kid You Not 

As usual we look first at the legacy COT report, which traders have followed for decades.  The report combines traders into just three categories, commercial, non-commercial and non-reportable traders. 

For the COT week, as silver fell $1.21 or 3.9% Tues/Tues, from $30.74 to $29.53 (the first sub-$30 close in silver on a COT reporting date since February 1, 2011, almost 11 months), the combined COMEX large commercial traders, as a group, strongly reduced their combined collective large commercial net short positioning (LCNS) by 4,940 contracts or a big 25% from an already very low 19,765 to a stunning 14,825 contracts net short. 

Just below is the nominal LCNS graph for silver futures.  


Source for all charts CFTC for COT data, Cash Market for silver.

The open interest for silver rose 2,854 lots to 101,165 contracts open.

For a visual impression of just how low the current LCNS is for silver futures, please see the graph below that tracks this important indicator all the way back to 2003. The current LCNS is the lowest on the graph, meaning that the combined commercial traders have not had such a low net short position since at least 2003.  


Indeed, we have to go all the way back to December 4, 2001 to find a COT report with a lower LCNS for the combined commercial traders. That’s back to when silver was trading at $4.20 the ounce, by the way.  This is the least net short silver futures for the combined commercial traders in a decade.  We can say that as of December 20, 2011, the usual Big Sellers of silver futures, as a group, were about as confident of silver falling to lower levels as they were a decade ago with silver then trading at $4.20.    

The current LCNS condition is rare.  We have only witnessed such low readings of LCNS two times in a decade.     

Remember that part of the reason for the low level of combined commercial net short positioning is because one class of commercial trader, the more mercenary Swap Dealers are currently holding their largest net long position in silver futures in our records.  More about that in a moment. 

Just since November 15 (five reporting weeks) as silver fell $4.98 or about 14.4% (from $34.51 to $29.53 on COT Tuesdays), the combined LCNS has cratered by 11,467 lots or a remarkable 43.6%.  Silver may not rally from here right away, but the largest, best funded and presumably the best informed commercial traders seem to us to be positioning more for silver strength than for silver weakness.      

As we do with gold, we compare the nominal silver LCNS to the total open interest.  We think that gives us a better idea of the relative positioning of the largest hedgers and short sellers – the Producer/Merchants and the Swap Dealers (and probably some Other Reportables) combined into a single category – compared to all the other traders on the COMEX

The relative combined commercial net short positioning (LCNS:TO) for silver plunges again this week from an already low 20.1% to an exceedingly low and potentially very bullish 14.65% of all COMEX contracts open – the lowest LCNS:TO going all the way back to September 4, 2001 (14.6% then with silver then $4.17!). Witness the lowest relative commercial net short position in a decade too.    

The silver LCNS:TO graph is just below.


Here’s a chart of the most important tracking graph for silver futures we cover going back to the year 2000 for context.  It is a very large, very wide chart that we have to reduce quite a bit to get it to fit a normal page, but even so paints an extraordinary picture of just how bloody rare it is to see the LCNS:TO this low.  We call attention to the lowest readings looking back in time in the long term chart below.  Look what happened to the silver price just following the extreme lows in October 2008, in September 2007, and in September 2005 as examples.  In each case, as the LCNS:TO reached very low levels the price of silver was at or near important turning lows and was materially higher in the weeks and months following those lows.  


Clearly the current combined commercial net short positioning relative to the total open interest is near its ultimate lows of the last decade, which we believe is the same thing as saying that the Big Sellers of silver futures are not very confident of lower silver prices just ahead.

If they were confident of silver plunging even further, shouldn’t they be positioning for it?  If the Big Sellers of silver futures thought that silver was headed, say for something under $20, doesn’t it follow that they would be positioning with larger net short positions, not the smallest in a decade? 


Let’s move on to the disaggregated COT reports for more “color” on this remarkable and very unusual stance by the paper silver traders, all of whom end up answering to the much larger markets for physical silver and forwards in the overseas OTC markets.  The OTC markets (as well as ETFs) are gaining in influence and in market share ‘thanks’ to the high margins at the CME and the abomination of the painfully idiotic Dodd-Frank legislation in the U.S.  We’ll leave that comment right there and move on … for now.   

First up, the graph for the Producer Merchant commercial traders, showing a net short position (LCNS) of 32,813 contracts, which is 3,354 contracts less net short than last week and within a whisker of their October 4 least net short position of the year (then -29,874 lots).  That October 4 net short position was the least net short for the bullion banks and large dealers since Oct 28, 2008 (-28,092 then), during the heat of the 2008 panic, when silver was then trading at $9.19. 


We think it should be obvious, but in case it isn’t, the large commercial hedgers have rarely been this “small” in their net short positioning since at least 2007.  We believe that the LCNS for the PMs is a valuable window into their longer term expectations.  The lower the LCNS (the higher the blue line on the chart) the more we see the bullion banks reducing their net short bets, thus, the lower their expectation for lower silver prices just ahead.  Perhaps more important for this graph is when we see very large changes following large price moves, but that is not what we see this week. 

On a general level, note that as the blue line in the graph reaches its peaks, that tends to correspond with important lows in the price of silver.  The PM commercials are about the same level of “net shortness” as they were during the 2008 panic, when the world thought there was a chance of financial Armageddon, back when the price of silver had collapsed to under $10 the ounce.  Hello! 

Want to bet on strongly lower silver prices with that chart in view?  Go ahead, if you dare, but the largest traditional hedgers of silver are not positioning as though they think silver has much downside.  The hedgers have large inventory either on the way or already in storage they manage and attempt to earn a return on.  As the price of sivler reaches levels the commercials deem as “high” their propensity to hedge increases and vice versa.  As of right now the hedgers apparently have a lot less motivation to hedge than, for example, on August 23.  Silver was then $43.70 and the PMs were then net short 50,111 contracts versus 32,813 now.

Swap Dealers Record Net Long

Moving on to the traders the CFTC classes as Swap Dealers, large firms who make a market for pension funds, insurance companies and other very large “passives” in OTC swaps, then use COMEX futures to hedge, among other things.  With the December 20 data the more mercenary Swap Dealers reported being net long a record 17,988 contracts.  Disaggregated COT data goes back to the middle of 2006 and the Swap Dealers have never been so net long silver futures.

If we extrapolate the Swap Dealers net long position to generally mean an offset of corresponding opposite short positions in other markets, we can guess that a good portion of the passive community is net short silver (primarily as a hedge for them, for longer term long positions we’d wager), so in our simple way of looking at things, nothing powers the silver market more strongly than when large hedge positions are unwound.  The “longer” the Swap Dealers get the more pent up upside short-covering fuel there likely is in the much larger OTC and forwards market – once there is a definitive change in trend back to the upside for silver prices.  


For reference, the highest net long position the Swap Dealers had reported until now was back in April of 2009, when they got all the way up to 12,316 contracts net long with silver then recovering up from the abyss to then $12.02.  They are net long 5,672 more contracts than then now or about 46% more net long than their previous high net long position.  It pays to remember that the Swap Dealers are considered “commercial” traders and are a big reason that the legacy commercial net short position is at decade lows. 

Next is the chart for the traders the CFTC classes as Managed Money, which is hedge funds, large portfolio managing firms that trade futures for other people, mostly, not their own book.  Believe it or not, the Managed Money traders dumped about half of their remaining net long positioning in silver futures this reporting week, down from 10,990 to 5,879 contracts net long.  They did that mostly by adding a large number of new short contracts (likely year-end hedges).  To quantify that, Managed Money reported an increase in pure short positions from 6,979 to 11,554 contracts (+66%!) while they slightly decreased their long positions from 17,966 to 17,433 lots.  Clearly they wanted less long exposure and were willing to sell silver short to offset their longs PDQ.


We have to look back to that same April 21, 2009 COT report to find a lower net long position for Managed Money, with silver then $12.02 following the 2008 panic and staging for a major rally.  For reference, the lowest “net long” position in our records for the MMs was actually a slightly net short position of 92 contracts on September 4, 2007 with silver then also at $12.09. Managed Money traders are very near their 2008 panic lows net long right now, but silver sports a $29 handle, not a $9 handle.  

The pathetic demand for paper silver futures by hedge funds is Sherlock Holmes’ dog that isn’t barking in the paper silver market. All we need do is to look back in time to previous iterations of very low net long positions for the MMs and note carefully when they occurred, what the price of silver was at the time, and then, more importantly, what happened to silver in the weeks and months thereafter – to know that such a low level of “net longness” for the MMs may be very, very short term bearish, but it is absolutely and very strongly longer term bullish.  It should come as no surprise then that as we look at the chart above the lowest net long positions for the MMs coincide very well with lows for silver. 

As we like to think about it, looking back in time the Managed Money traders have had as high as 48,532 contracts of long-side “ammunition” (September 28, 2010, silver then $21.74 and about to go up a price escalator).  As of December 20, all but 5,879 lots of those “bullets” were loaded in the hedge fund magazines, unfired. 

In the very near future, should the MMs actually get to the net flat line or even slightly net short, that would be a time to consider going leveraged long silver in meaningful size.  (Always and only with appropriate new trade trading stops of course, just in case the wheels come off again.  We wish to live to fight another day in short term trading.)   

Next comes the mysterious brand of traders the CFTC classes as Other Reportables (ORs).  We are given to believe that the ORs are very large individuals and proprietary firms trading futures for their own accounts and not trading for others, among other explanations.  For the week, the ORs reduced their very small net long exposure by 1,128 to show 2,677 contracts net long, but these veteran traders have been close to net flat for quite a while.  This is the least useful of the trader categories, as it defies any attempt to find a predictive thread in the limited amount of data we have for it.


That leaves the category of traders the CFTC classes as Non Reportables (NRs), which is everyone that doesn’t fit into a reportable category, smaller traders and punters. 

The NRs actually increased their net longs for silver futures by a “whopping” 759 lots from 6,638 to 7,397 contracts as of December 20, but the Little Guys are actually UNDER their very low net long positioning at the depths of the 2008 panic, as shown on the chart below.  (On December 9, 2008 the NRs showed an extremely low 7,868 contracts net long with $9.83 silver!)

Can we say that the small silver traders have been demoralized by this point?  You bet we can.  Notice, please that, like the Managed Money traders, the lowest net long positions for the NRs are usually associated with important lows in the price of silver.  There is no other way to say it than as of December 20 the expectations of The Little Guys in silver futures were extremely subdued and definitely morose – a position for contrarians to be watching closely. 


Last week was the lowest net long position for the smaller traders in the entire disaggregated COT dataset going back to 2006 (just 6,638 contracts net long December 13).  That was lower even than their December 9, 2008 lowest mark of just 7,868 lots with silver then $9.83.  

But notice please, in the chart just below, that the smaller traders have recently pulled way back on what had been an extremely high short position just six reporting weeks ago on November 8.  In that report the NRs showed 16,481 contracts short with silver then $34.94.  They also held 28,252 contracts long in that report, but since then they have pared their shorts back by 5,011 contracts (30%) and sold down their longs by 9,385 lots (33%). 

The chart below tracks just the NRs short positions.  So while they may not be aggressively positioning for a major silver rally at present, they are also not positioning for a further collapse of silver, at least not very much.  We think this is an important sign.  A sign that suggests that we can expect very, very strong bargain hunting in silver on further price dips.  A sign that shows that ordinary traders have not “bought” the notion that silver is broken.   


For those who believe that The Little Guys always get it wrong, consider the action above and re-think that notion.  Some of them don’t always get it wrong if their short positions are any guide.  

Bottom Line for the Silver COT Report for December 20

Okay, so can we summarize what the COT report is showing? 

Well, it’s pretty simple, really.  The largest commercial traders as a combined group are at their least net short position since 2001, and that means they are not positioning as though they believe that silver has a great deal of downside in it. 

The largest, best funded and presumably the best informed commercial hedgers, the PMs, are very near their least net short positioning for silver futures since the 2008 panic.  We have to believe that if the bullion banks thought there was a great deal more downside to silver they would not have such a small net short position.

For whatever reasons, Managed Money is still running scared, unwilling to put on new long positions in silver futures and indeed still liquidating them at a fast clip. (And even piling on on shorts just ahead of year-end to offset long exposure adding to future bull-side firepower in the bargain.) Managed Money traders are very near (within 6,000 contracts of) their lowest net long position in our records in fact.  

The fact that this unusual positioning by the largest traders in the futures markets is occurring with silver still sporting a $29 handle is not just important, it is an essential sign that the world has now come to accept these “higher” prices for silver and now considers the potential bottom for the second most popular precious metal as being a multiple of what it did in the 2008 panic period, just three years prior. (Silver cratered to an $8 handle in the 2008 panic, as no doubt everyone recalls.) 

It is subjective, but we can make the case that the current backwardation in a portion of the silver futures strip and the large trader positioning above both argue strongly that the global market now views the potential bottom for silver as being about 3X the 2008 lows, give or take a USD under-backed fiat paper $5 bill.

Battle Stations for this Vulture

Right, wrong, win or lose, if we are given the opportunity by the Trading Gods to add to our physical holdings of silver metal in the green target box on our linked technical charts we plan to begin adding there.  When silver reached all the way up to nearly $50 in April it managed to get to about 77% above its 200-dma.  We sincerely doubt that a mirror correction is in the cards, but something closer to 30% below the 200-dma would not be out of the ordinary in a major correction and that fits neatly into our green box. (200-dma = $36.55 X .7 = ~$25.60). As shown on the linked charts, that would also coincide with the lower edge of the Giant Flag setup theory we have for the silver market. 

That may or may not end up being The Bottom for silver (if it even gets there from here), but we think it’s close enough, or rather low enough to begin adding to our physical silver stash after a preponderance of all the available data.  We also think that silver has already used up a good measure of its potential volatility to the downside, and thus we figure that the remaining downside volatility will be met with strong to robust dip buying.  If the price has gotten down to where even we are willing to add there must be others similarly situated around the world.  

As we have said so many times in the past, we already hold a reasonable long position in physical silver, so we have the luxury of waiting for a super correction to add to it.  We believe this is very likely the best correction opportunity we are likely to get, (absent a major global market meltdown), so we personally move to Silver Battle Stations in anticipation of a “backbreaker downside attempt” by silver bears just ahead.  If so, look for us on the bid – in “the green” to start, in tranches and with an increasing appetite for more once the 50% correction level is obtained ($24.90 or so). 

We are convinced that supplies of commercial sized bars of physical silver metal remain constrained relative to the potential demand and it is but a matter of time until the market recognizes it and accounts for it.  We are as sure of that condition showing up again in the future as we are unsure of the timing of it – in advance. 

Please see the technical charts on the subscriber pages for more on silver.  

(End of the December 26 offering.)

One of our silver charts is just below.  Our valued Vulture Subscribers have access to all of our one-dozen technical charts for gold, silver, mining share indexes, important ratios, as well as about 35 technical charts for our Guru-chosen small resource companies – our Vulture Bargain Hunting issues we have been accumulating on extreme weakness in the last half of 2011 as a play for 2012.   




The Original
Vulture Speculator

Trading gold, silver and mining shares since 1980 with a focus on taking advantage of volatility extremes, Gene Arensberg analyses the markets through a basket of technical and fundamental indicators and shares his findings from time to time here at Got Gold Report. Mr. Arensberg has been quoted in the Wall Street Journal, Dow Jones MarketWatch, USA Today and dozens of other news organizations.

"I've been a huge fan of Gene and his amazing work for years..."

Brien Lundin, CEO, Jefferson Financial, Host of the annual New Orleans Investment Conference and Publisher of Gold Newsletter

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