TED BUTLER COMMENTARY

August 14, 2007

Amid The Turmoil, A Great Set Up

(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.)

It’s no secret we have been experiencing highly unusual financial market developments. I can’t recall a time when the financial news flow has been this intense, or price movement so hectic. Conflicting opinions are the order of the day. Housing and mortgage obligation woes, hedge fund blow-ups, credit crunches and central bank rescues, inflation or deflation, boom or bust, correction or crash. I feel worn out. It is especially at times like this that one searches for a constant; a compass to set one’s bearing.

One constant I have long relied upon is the data contained in the Commitment of Traders Report (COT). This is the weekly data, which depicts who is long and short in the futures markets by different groups of traders. In a nutshell, the COT tells you how a market is structured, i.e., what is likely to be the direction of the next significant move, up or down. I follow them on many markets, but generally confine my public remarks to silver and gold.

The data contained in the COTs is always objective, the interpretation of that data is always subjective. Compounding the subjectivity is the fact that there is continual change in what constitutes extremes in traders’ positions and the timing in which those positions are established and liquidated.

As far as the timing of when positions are put on and taken off, very recently there has been a remarkable compression of the time in which traders’ positions have changed. Whereas, in the past, it was usually a matter of waiting a long time for the COTs to play out and work, lately the changes have come so quickly that waiting for the weekly report to be released means you have waited too long. In other words, you have to make your analysis based upon what you feel the structure of the market is on Tuesdays (the day of the cut-off) and not wait until the Friday release. One does this by studying daily pricing, volume and open interest changes. This, obviously, increases the subjectivity factor.

With those caveats, I think we have a great set up in the COTs for silver and gold. The high-volume sharp sell-off last Thursday in gold and silver dramatically improved an already constructive set up. Friday’s high-volume rebound did not appear to be driven by technical fund buying, but rather some intense competition between the commercial T-rex’s and raptors, adding to the constructive picture. As I write this, on Tuesday morning, the price weakness only adds to the positive structure.

The one thing you must remember about COT analysis is that if a "buy signal" is flashing, as I believe is the case now, lower prices only strengthen the buy case. In this sense, the COTs are somewhat incompatible with chart analysis, which long-time readers know I never reference. The simple reason is if I’m buying an item, silver, that I believe is inherently undervalued to start with, I don’t care to sell it if it becomes more undervalued, as a violation of some chart point may dictate. In this sense, I find the COT analysis to be highly compatible with long-term supply/demand fundamental analysis.

Additionally, aside from pure analysis of the COTs, subjectivity and all, there’s a feeling I have down deep that we are about to see some real surprises to the upside in gold and silver, but especially in silver. We have been in a broad trading range in both, for about a year and a half, and it feels like the time is up on remaining in that range. The COTs strongly suggest the next real move is up.