TED BUTLER COMMENTARY

May 5, 2008

(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

The engineered sell-off of gold and silver by the big commercial shorts continued over the past week. However, there were decidedly mixed results in the dealers’ attempt to force speculative long liquidation in each market, even though gold declined almost $50 and silver $1.20 in the latest reporting week (ended Tuesday). For positions held as of April 29, the Commitment of Traders Report (COT) indicated a further commercial net short reduction of 14,000 contracts in COMEX gold futures, but no liquidation at all in silver.

Over the past two COT reporting weeks, there has been a commercial net short liquidation of almost 20,000 contracts (2 million ounces) in gold on the almost $90 decline in price. But in silver, on a $2 price sell-off, there has been no reduction in the commercial net short position. In fact, the total net commercial silver short position increased by 2,000 contracts (10 million ounces). I don’t recall ever seeing such a large price decline in silver with no dealer short liquidation. What does this mean?

It means one of two things. Either the dealers will continue to press the price to the downside to hunt out speculative silver long liquidation, or that no further liquidation is possible and we will move up in price, perhaps sharply. It’s just my opinion, but I sense a big move up shortly.

Further, this gold liquidation cycle with no silver liquidation is reinforced in the behavior of the big ETFs in gold (GLD) and silver (SLV), as discussed in last week’s article. Since that article was written, there was further liquidation of the physical gold holdings in GLD of 350,000 ounces and an increase (as I wrote that I sensed coming) of 5 million ounces in the SLV. And yes, I still think the explanation lies in an outbreak of common sense, as more recognize the superior relative value of silver compared to gold.

I hope no one interprets my words of the liquidation in gold, both on the COMEX and in GLD, as me being bearish on gold because of that liquidation. That is definitely not the case. Liquidation shakes out weak hands, tech funds and other momentum traders. That strengthens, not weakens, the bullish case for gold. It’s not a case of gold being bearish, it’s just a case of silver being much more bullish than gold’s developing bullish structure.

The latest COT did establish one strong similarity between gold and silver that is not present in any other major market, namely, the outrageous level of the concentrated net short percentage of the largest traders. Even though, as predicted last week, the unusually large number of phony silver spreads that were liquidated would have the effect of boosting the reported concentrated percentages in silver dramatically, that doesn’t come close to telling the whole story. Yes, the silver spread liquidation did result in the largest one-week jump in the stated percentages of the largest short traders (big 4 from 38% to 44.2%, big 8 from 46% to 56.6%) to among the largest reported concentration percentages in history. But the real story is still the true concentrated percentages, once the remaining spreads are subtracted from total open interest.

In fact, the 8 largest traders in COMEX silver set a new sick record of concentration of 83% once the spreads are removed, up from 82% last week. In other words, the near-record reported net short percentage of 56.6% is understated by almost half again. Forget that no other market has, or has had, such a extreme concentration (save gold), no other market even comes close.

In terms of commodity law and common sense, there are no words that come to me that can fully describe just how extreme is the percent of short concentration in silver (and gold). Those that speak with me know I have trouble trying to describe its dimensions. I sit amazed every day that this is allowed to exist. I honestly don’t understand why the regulators and informed market observers are not making a big deal about it. Let me be clear - there is nothing more important in silver or gold.

So large is the concentrated short position in silver that I feel we have just witnessed the high-water mark, that won’t ever be exceeded. I say this for two reasons. One, the arrival of first notice day should reduce the number of shorts held by the big traders in the next COT report due to deliveries, as well should liquidation after the latest COT’s cut-off date. But the most important reason why I don’t think we will ever exceed the 83% mark of the latest report is that it is already so far above even the most extreme levels I could have ever imagined. Surely the regulators can’t be that negligent or incompetent to allow this to occur ever again.

If I’m correct about the 83% threshold not ever being exceeded, the implications for the price of silver (and gold) could be profound. Why? Because it will effectively preclude the big concentrated shorts from adding to their already gigantic short positions. Let’s face it - the CFTC and the NYMEX have been quite as church mice on the issue of concentration. Yet this goes to the heart of the issue of manipulation. Soon, I may call on you to force the regulators to, at least, go on the record to address this concentrated short position, if they continue to ignore it. I can’t predict what they will say, but I can assure you, that with your help, we can get them to be silent no longer. We’ve always been able to achieve that.

The important point is that the big shorts hold such a large and concentrated short position now, after a major sell-off in both gold and silver, that they have expended most of their pricing power at what must be considered a bottom and not a top in prices. What the heck do they do when we do get a rally - sell a lot more? I don’t think so. I think they have left themselves exposed and vulnerable. I don’t want to underestimate the treachery of these ultimate cornered rats, but neither do I want to assume powers they might not have.

When The Levee Breaks

(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

For the past six months, I have been playing that Led Zeppelin song incessantly. It’s off their fourth album from 1971. The CD was sitting on my desk forever, and I guess their reunion concert six months ago prompted me to play it after way too many years. I haven’t been able to stop listening to it since then. The song was originally written by Memphis Minnie and her husband Kansas Joe McCoy, and recorded by him in 1929, in response to the Great Mississippi Flood of 1927.

Thanks to the Internet and Google, you can listen to both versions and others, as well as research the history and story behind the recording and the flood, which is quite interesting. For instance, so widespread was its impact, that the flood contributed significantly to the African-American migration to Chicago and other northern cities. While I don’t necessarily consider myself a Led Head, I am captive, as we all are, to the music I grew up with. I make no apologies for that. Besides, I admit that I really do enjoy the music. Further, I think this is the single most powerful song by this super group, and every time I play it, it transports me to the rain, the flood, and the suffering in its aftermath.

If you guessed that there is a silver connection here, you’d be correct. The connection has to do with the levee system itself. In most low-lying flood prone areas, levee systems of man-made dykes protect the land from being flooded frequently when water levels rise in rivers and bodies of water. While this is a great system to preventing floods every time it rains and water levels rise, the trade off is when a very heavy rain and flood develops, say a hundred year flood, the levee system actually makes matters worse. That’s because the long stretches of decades in which the levee system protects, the inhabitants grow too dependent on the flood protection and are unprepared when a flood breeches the levees.

It seems clear to me that the levee system is very similar to the organized system of large concentrated shorts in COMEX silver (and gold). Both are powerful and artificial barriers. But whereas the levee system protects against rising waters and floods, the COMEX short system has prevented higher free market prices. Without levees, floods would be frequent. Without the COMEX levee, we would have witnessed much higher free market silver prices.

For sure, there are some big differences between the two. While the flood levee system was designed with open intentions and for the collective benefit of all, the COMEX short levee system was conceived privately (and illegally) and was designed to benefit the very few at the expense of the majority and even the very integrity of our free market system. The most important difference, however, is that the unexpected failure of a regular levee system brings flood damage and devastation to all, while the inevitable failure of the COMEX short silver levee will bring great financial rewards to all silver investors.

The greatest similarity between both the legitimate and illegitimate versions is that both can and have served their true purpose for long periods of time, making both versions look invulnerable. But we know that one record rainfall can bring floodwaters that will overwhelm the levees. Similarly, persistent and high levels of physical silver demand will swamp the COMEX concentrated short system. And it feels to me that record silver demand is upon us.