Commercial Signal Failure

Silver closed for the day at $19.81, so I came within 19 cents of entitling this entry "Where did the 20th century go?"  We are that close to reaching my 2008 target for silver with ten months to spare.  Gold has done well too, at $974.30, but as I had hoped, silver is outperforming gold as it should.  There will be pullbacks along the way, and volatility will increase, but I expect gold and silver to go MUCH higher from these levels.

Why?  Because the COMEX has been ground zero for manipulation of the commodity markets.  A group of large commerical traders are short roughly 300 million ounces of silver.  To put it mildly, they are really in a pickle.  Each time silver goes up $1/oz (which was almost every day this week) they lose another $300 million.

This group of bullion banks and other financial institutions have made out like bandits for the past ten years.  They sell short silver contracts to the hedge funds, which come in on the long side. The funds drive up the price of silver until their buying power is exhausted.  Then the commercials continue to sell short, driving down the price until the funds start receiving margin calls and have to liquidate their positions. This selling drives down the price still further, and it ends in a rout.  Then the commercials buy back some of their shorts at fire-sale prices.

This happened over and over.  The open interest (total number of outstanding contracts, long and short) would expand as the price went up, and collapsed when the commercials crash the price, and the funds sell out.  Now I will say the four most dangerous words in investing:

This time it's different.

But it really IS different.  The silver open interest climbed as the silver price climbed.  But now the price went vertical, and the open interest is dropping.  To me, this means the commercials are getting overrun, and they are selling out.  I believe the weakest of the commericals are getting margin calls, and was forced to liquidate with huge losses. 

For several years, the size of the commercial short position and open interest were good indicators of the safety of the silver market.  When those numbers were low, it was safe to own silver contracts.  But when those numbers were elevated, silver was due for a correction.  The signal always worked.  But not any more.  A couple of weeks ago, silver appeared overbought by past standards, but now the commercial signal has failed.

It is possible that this is only a short term spike in the price of silver.  But if there were a temporary shortage, and the market expected prices to come back down, we would see backwardation, i.e. a spot price higher than futures prices.  That is not the case.  We still have a normal contango, and all futures prices are higher than the spot price.

I believe the silver bull still has a long way to run.