Silver Commercials Tale Revisited

by John Lee

10/25/2006

To the perennial silver bugs, the tale of unusual commercial bullion bank short position is not new. The story goes like this. The commercials bullion banks (JP Morgan, HSBC, Scotia etc) from the 80s to early 2000 made good money shorting the silver market. Then they got greedy and pressed the market too much and created themselves a large, un-coverable short position. When their short positions got too uncomfortable, they engineered a sell off, picking the pockets of speculative funds that follow technical indicators.

We are not here to argue the validity of such a theory. However, the commercial silver short position is obscenely large. At times the short positions have been nearly 100,000 contacts. At 5,000 oz per contract, that’s a short position of 500 million oz. The current known above ground silver inventory is generously estimated at 200 million oz. On surface, the situation is dire and ripe for a default by commercials for failing to deliver the silver they shorted.

Then I look at copper and it’s the same story repeating. Commercials are currently short 32,000 contracts at 25,000 pounds each contract.  They are shorting 800 million pounds when the LME copper inventory is at 23,000 tons, or 80 million pounds.

Here, I want to use the Commitment of Traders (COT) Chart and Silver Chart to explain how they may help with timing the peaks and bottoms of the silver market. There is a positive correlation between the bottom of commercial short positions and a bottom in the silver price.

The commercial shorts reached a low in Feb 2006.  Not surprisingly the silver price bottomed at $9 in February and rose to $14+ just 2 months later. Again the commercial shorts reached a low in late July of 2006.  Sure enough, silver touched a low of $9 in late July, and sprang to $13+ by late September.

There are obviously exceptions to this rule, as witnessed in Nov 2005 when commercial shorts were at a peak however silver price leaped from $8 to over $12 in the ensuing 6 months.

We don’t always know the bottoms in the silver market and commercial short positions (as it always happens in hindsight), so we can’t catch the turning point precisely. However what I can gather from the current low commercial position is that silver has been given the green light to go up. Whether or when it does go up is the question.