Monday, December 05, 2011

Silver in Giant Flag or Pennant Formation

Consolidation staging for resolution likely just ahead. 

Largest futures traders positioned for one direction – up – are they right?   

HOUSTON --  In our linked charts for subscribers we noted this past weekend that the Commodity Futures Trading Commission (CFTC) commitments of traders report for silver (COT) remains more bullish than bearish.  We put notations directly into the charts we share with Vultures (Got Gold Report Subscribers) so they can read at a glance our impressions of the COT action.

The main reason for that more bullish than bearish “read” is because the traders the CFTC classes as “commercial,” which includes bullion banks and swap dealers combined, are presently at a very low level of “net shortness.” 

Not everyone does, but we subscribe to the theory that the collective positioning of the largest futures traders on the planet is a kind of window into their expectations for the price.  The simple-Simon way of looking at the commercial COT positioning is that when the combined commercials are at a very low net short level (like right now), it means (to us) that they are not, repeat not, positioning as if THEY think the price of silver is heading a lot lower … and vice versa.

Just below is the graph we use to track the combined collective commercial net short positioning (LCNS) for COMEX silver futures, aka the “legacy COT” report.  In the graph, note just how low the blue line is and how rare it is for that line to be this low. 

Source CFTC for COT, Cash Market for silver. 


Wide Consolidation Unfolding, Support Evident

In the most recent COT report (released Friday, December 2, data as of Tuesday November 29), as the price of silver fell $0.80 from $32.70 to $31.90 Tuesday to Tuesday, the combined commercial traders reduced their net short positioning by 1,043 lots to show 20,688 contracts net short.  That was as the total open interest fell by a very large 9,589 to 98,959 lots open.  (A large portion of the drop in open interest was from non-commercial spread trades being taken off, by the way.)  Not only are the combined commercials not taking a big net short stand at the moment, but the open interest for silver futures is also at a very low level as we mentioned in the previous web log post.  See:

Very low open interest suggests a lack of speculative enthusiasm for futures and low open interest readings are generally found at or near interim or turning bottoms.  It is exceedingly rare to have a major top at low open interest levels.   

One of the reasons for the very low LCNS is because one particular class of commercial trader, the traders the CFTC classes as Swap Dealers, is actually the most net long they have ever been in our records.  Just below is a chart reflecting the net positioning of COMEX Swap Dealers for comparison.  As of Tuesday they reported a record 14,273 contracts net long.  


Source CFTC for COT, Cash Market for silver. 

Our impression is that the Swap Dealer commercials are the more mercenary of the commercials and therefore are more likely to change their net positioning or bias, whereas the Producer Merchant commercials, which includes bullion banks, are more likely to be primarily hedgers and are thus less likely to change their net bias. 

For comparison, just below is the graph showing the Producer Merchant positioning.  Since their position is expressed as a negative number (in this case -34,961 contracts) … as their net short position falls the blue line rises and vice versa.  The Producer Merchant commercials are not all that more net short silver than they were during the 2008 panic as shown on the chart. 

Source CFTC for COT, Cash Market for silver.

Silver has been in a long consolidation since it peaked in April near $50 and although it has not shown signs of enthusiastic buying of late, it has at the same time shown pretty strong “support” near the $30 to $32 level (roughly $29 to $31 SLV).  We think that the very low level of commercial net short positioning presently “says” that the largest, best funded and presumably the best informed commercial traders on the COMEX are not positioning as though they believe silver has very much downside left in it.

So how does that relate to the technical picture for silver? 

Well, looking at the graph below for iShares Silver Trust (NYSE:SLV), a reasonable proxy for silver metal, we are struck with the thought that what we are witnessing is a giant technical “flag” or perhaps a “pennant” formation playing out while traders adjust to the news and the May sell-down aftereffects. 

SLV, 18-months, daily.  

As we look at SLV in the chart, we can point to several lines in the “support” sand from $24 to about $30 (very roughly $25 to $31 silver), with the idea that if silver were to see another leg down just ahead we ought to see very staunch support coming in that range. 

A convincing break below that blue “flag” line would be a bad, bearish signal.  On the other hand, should silver catch a year-end bid, a key area to watch is the upper “resistance” trend line currently crossing through about SLV $36.  A convincing breakout above that line of implied resistance would be a buy-stop triggering signal that silver “wants” to go much higher.

Between those two thoughts SLV remains in the flag or pennant consolidation for now. 

The one point we wish to relate in this offering is that flag or pennant breakdowns or breakouts, even overly large ones like the one shown above, are important technical signals that will indeed influence technically minded traders all over the world.

With the largest commercial traders currently near their least net short positioning since 2003 right now, we can conclude that the traditional Big Sellers are not really counting on the developing flag or pennant breaking down.  Indeed we pretty much have to conclude they have positioned as though they are in preparation for the opposite.

That doesn’t necessarily mean the commercial traders are “right,” mind us all, but it does give us comfort for the stash of physical silver we have already accumulated for now, and we think it gives us “cover” to jump in and add more should silver test one or more of those lower lines in the flag or pennant formation.

That is for adding to our physical metal as well as for the short-term trading ammo we have set back for metal bargains, and, of course, only with appropriate trading stops for peace of mind and protection for the leveraged short-term trading we might attempt. 

And in the back of our mind is the notion that if what we are actually witnessing is a giant flag or pennant formation ... and if that flag eventually resolves to the upside, as the commercials are apparently positioning for, ... well, it just might be the mother of all midpoint consolidations for silver metal. 

That is all for now, but there is more to come. 


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

Contact Us