Largest futures short sellers have nothing to fear from U.S. regulators
ATLANTA – Just before Christmas we featured the huge net short dollar index positioning by commercial traders on the ICE exchange based here in Atlanta. Since that report other commentators have noticed and commented on those veteran commercial trader bets against the greenback.
Well, the ICE commercials covered a part of their net short positions in the DXY over the past week, but they remain very strongly on the short side of the largest and, arguably, the sickest member of the fiat currency leper colony – the U.S. dollar.
Also in this report, the CFTC held a public meeting on Thursday to publicize a new proposal for position limits in energy futures. We weigh in on that spectacle in a special new section just below. Our commentary may surprise some readers.
Lastly, one of our Vulture Bargain Hunter candidates reports a fantastic new drill hole, but they earned the heave-ho from this resource company investor, for good.
First, here’s this week’s closing table:
This Week’s Bottom Line Summary (in bold)
We maintain our neutral bias for gold for now, safely on the sidelines with the majority of our short-term gold ammunition. Our bias remains cautiously bullish for silver because it remains strongly undervalued relative to gold. Indeed, over the holidays we filed this top-pick-for-2010 story for the AOL folks and Steven Halpern’s TheStockAdvisors.com. We chose SLV as our top pick candidate for 2010.
We have, however, moved our stops up on our newest SLV positions to no-loss levels as mentioned below.
This week we have to note negative money flow from both gold and silver ETFs, possibly due to early year profit taking. Large mining shares are underperforming, perhaps for the same reason, but early year demand for the smallest miners has been robust as investors cash in winners and redeploy on down the food chain. (Details below.)
ICE commercials remain staunchly net short the greenback and now more commentators have noticed. (See more below).
We reiterate our longer-term view that the world will most likely continue down a path of fiat currency debasement, weakening confidence in all fiat currencies. We see the setup as long-term very bullish for gold metal and extraordinarily bullish for silver looking well ahead. We believe weakness in precious metals is to be bought rather than strength sold in Q1 2010, but only and always with reasonable trading stops for peace of mind and protection.
Absent another global systemic financial scare, we see nothing which promises to reverse the current flight of wealth out of paper and into real money. With central banks becoming net buyers of gold we should view harsh dips for the metal as buying opportunities – once convinced the corrective reaction is done.
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CFTC proposes position limits for energy futures, eyes precious metals
On Thursday, January 14, the Commodities Futures Trading Commission (CFTC) held a rare public meeting to discuss a new rule proposal imposing Federal position limits in four energy futures contracts. The “hearing” was videotaped and is available for anyone to view at this link. http://www.cftc.gov/newsroom/cftcevents/2010/oeaevent011410.html.
A comprehensive discussion of the proposed new rule is available at this link. The public is invited to comment about the proposal for 90 days. The CFTC will post a link on its website for those who wish to put their comments into the public record.
The rule proposes Federal limits on the number of futures contracts a single entity may hold in all CFTC-regulated exchanges, but of course does not impose limits on exchanges outside the CFTC’s jurisdiction. Instead of fixed size limits, the new rule proposes that limits be set annually by a formula based on the total number of contracts open in those markets.
One of the concerns expressed by Commissioners Michael Dunn and Jill Sommers is that these new position limits, if adopted without the Commission having similar authority over the Over-the-Counter Market (OTC), would have the perverse effect of forcing a higher portion of the trading away from CFTC regulated markets to more opaque, less regulated markets such as the OTC and other markets overseas.
The Commission intends to look into a similar proposal for precious metals in March, according to comments by Commission Chairman Gary Gensler and Commissioner Bart Chilton.
We’ll leave it to other commentators give their blow-by-blow descriptions, hopes and disappointments and focus our commentary on just two main issues that seem important to precious metals investors. The two issues are (i) The Commission seems hell bent to preserve the same or very similar exemptions to the new futures position limits afforded “bona fide hedgers;” and (ii) The limits being proposed for energy are so large as to be only minimally restrictive on speculators, but designed to be lethal to aggregators of long-only investors and commodity futures based ETFs and ETNs.
The proposed formula for setting position limits allows a single trader up to 10% of the first 25,000 contracts and up to 2.5% of the open interest beyond 25,000 contracts across all CFTC regulated markets, including the NYMEX and ICE for energy. According to a Q & A primer released by the Commission, the new proposed limits allow the largest energy traders to accumulate as much as 30% of the all months combined (AMC) action in any one exchange in CFTC regulated markets and up to 2/3 of that amount, or 20% of the market in any one month.
While some commentators were hopeful that the new speculative limits would be applied equally to both sides of the trading battlefield, (both speculators and hedgers), it is crystal clear, both from the documents and from comments by the Commissioners, that the Commission intends to maintain exemptions to the limits for the largest hedgers and short sellers of energy futures (as was our suspicion in previous commentary on the subject last year).
If this same formula were adopted by the Commission for the metals complex later this year, it would have minimal, if any effect on the very concentrated positioning of a few very large, dominant players on the short side of the market in gold and silver. Instead, the effect would be to limit most traders on the long side of the battlefield somewhat, but continue to favor those very large traders who claim “bona fide hedging” with no real effective limits. For example, Swap Dealers would be limited to no more than twice the speculative limit even with an exemption, but bona fide hedgers would not be limited as such.
When the Commission meets to discuss precious metals in March, they may still be under the mistaken impression that investors are worried about the “excesses caused by excessive speculation,” which was the driving force behind their energy market initiative. Instead, what the Commission should be focused on in March should be the overwhelming and commanding position which is currently held by one or two U.S. banks. The banks are able to amass very large positions in excess of the exchange-set position (and accountability) limits because they take advantage of exemptions from those limits as bona fide hedgers.
One key part of the exemption rules allow a “person” to claim an exemption not because of anticipated production, but because of ownership of the physical commodity. Bona fide hedging exemptions currently include exemptions for “traders with inventory or anticipatory purchase or sale transactions in the physical commodity.” We see nothing in the current proposed change to Federal position limits which alters that.
Today bona fide hedging can be utilized to hedge merely financial risk, as opposed to hedging for future production, for example. In fact, for precious metals, a majority of bona fide hedging has nothing whatsoever to do with future production of metal. That’s why it is not a good argument to compare the amount of hedging in precious metals futures markets to future production of the commodity. Future production is a miniscule amount of metal compared to existing metal already above ground. That is especially true for gold, less so for silver.
A bullion bank, for example, that holds (or manages for clients) large amounts of the metal in its vaults, is able to claim an exemption to futures position limits, presumably so it can hedge the risk of the value of the metal held from falling. Some savvy market watchers point out that, perversely, the trading size limit exemptions allow those bullion banks to take such large hedging and short positions that over time they are able to ensure that the price will fall from the weight of their own short selling in that commodity.
Speculative position limits on the long side of the market will not affect the hedger’s positioning as long as the exemptions afforded hedgers are kept as they are.
When the rules favor one side of the market and only the largest actors in that market, it creates short-term distortions in the price discovery mechanism of that market – for a time. Allowing one or two traders the ability to amass overly large positioning on one side of the market, long or short, could lead to disorderly liquidation in that market or even contract default in times of severe market stress.
We can look at the silver market as an example. According to the CFTC Participation of Banks in Futures and Options Markets Report, as of January 5, 2010 fewer than four (probably two) U.S. banks held 579 contracts long in silver and 37,871 contracts short for a net position of 37,292 contracts net short when the entire COMEX open interest for silver was 125,391 contracts and silver closed on the cash market at $17.77.
So, as of January 5, probably two U.S. banks held a net short position in silver equal to 29.7% of all the contracts open on the COMEX. The positioning relative to the total open interest of the U.S. banks in silver futures is shown in the monthly graph just below.
Source for data CFTC for bank positions, cash market for silver.
(Please note: For most of 2008 and all of 2009 the CFTC reported that there were two reporting U.S. banks, but in December the Commission quit reporting the number of banks when the number is less than four. Thus, the actual number of reporting U.S. banks is not currently reported, but was constant at two for the 19 months prior to December 2009. We believe that perhaps 80% to as much as 90% of the U.S. bank positioning in futures markets is through one of the banks, JP Morgan Chase.)
The less than four and probably two U.S. banks held 38,450 silver contracts on both sides of the COMEX market as of January 5, or just over 30% of all the action on that CFTC regulated bourse. Even if the Commission were to impose the same speculative position limits on metals it just announced for the four energy contracts, and even if they were to also apply those same limits to the hedgers (which is very highly improbable), it would have little or no impact to the status quo in the CFTC regulated exchanges.
The dominance of the two U.S. banks in the COMEX futures market cannot be well understood viewing just their position size relative to all contracts open in the COMEX market, but rather we need to understand their positioning in proportion to all commercial hedgers and short sellers. It is there we begin to see just how concentrated the bank’s positioning really is.
The graph below charts the positioning of the U.S. banks net short positioning in silver relative to all traders classed by the CFTC as commercial since 2006. At times during the last year and a half, these two large, well-funded and dominant bullion banks held as much as 98.7% (not a misprint) of all the commercial net short positioning on the COMEX. As of January 5, 2010 the U.S. banks still held 65% of all the commercial net short positioning.
Source for data CFTC for bank positions, cash market for silver.
Again, while some analysts were hopeful that the Commission intended to level the playing field between the long and short sides of the market, and some high profile commentators even seemed pleased that Commissioner Bart Chilton and Chairman Gary Gensler both mentioned the silver market in their remarks, as expected, this new proposed rule for the energy markets, if applied by the Commission in the future to metals, will not deal with the very real issue of over-concentration of one or two very large players on the short side of the market. It won’t because those major actors have been and will be able to avail themselves of liberal exemptions to the position limits based on the bona fide hedger provisions.
Anyone can see why the large banks might welcome the new speculative position limits so long as they are not the ones being limited.
At the same time the CFTC has now proposed position limits for aggregators of long-only funds, such as the United States Oil Fund, treating them as though they are a single trader and, in effect, removing their ability to use the same exemptions for size as the hedgers use. That means that funds will not be able to claim an exemption to size in the market even if they represent hundreds of thousands of like-minded clients. It also probably means that, wherever possible, those aggregators will now seek out less restrictive markets outside the U.S. to do business for their clients.
Anyone commenting on the proposed new position limits should mention that position limits that only restrict the long side (and aggregators of investors on the long side) and limits that are not enforced equally on the short side of the market (through exemptions) are unfair and anti-competitive. Be professional, direct and specific in comments. The issue is NOT a problem of “excessive speculation” in gold and silver futures. The issue is that one or two very large traders could, if they wanted to or felt compelled to, overwhelm the COMEX market with the weight of their own short selling – by virtue of the exemptions the CFTC and the exchanges grant to “bona fide hedgers.” New speculative limits, unless applied to both sides of the trading battlefield equally, are unnecessary, unfair and anti-competitive.
Thankfully, the prices of gold and silver are set globally and not just on the COMEX. Even more thankfully, most precious metals ETFs do not use futures at all, but instead stockpile the actual physical metal.
Please note: Gold Newsletter (GNL) subscribers received this issue of the Got Gold Report Monday morning, January 18. GNL subscribers enjoy access to all Got Gold Reports, technical charts, analysis and information, as well as Brien Lundin’s timely and actionable analysis of specific resource related companies. For more information or to subscribe visit the Gold Newsletter home page.
Now, a closer look at a few of this week’s indicators:
Gold ETFs: SPDR Gold Shares (GLD), by far the largest gold exchange traded fund, reported a net decrease of 6.705 tonnes for the week, to 1,112.836 tonnes of gold bars held by a custodian in London. As of the Friday, January 15 close GLD’s metal holdings were worth US$40 billion.
Source for data SPDR Gold Shares.
Apparently profit taking has been marginally stronger than new buying pressure for GLD over the first two weeks of the new decade. It has been quite a while since GLD has seen significantly stronger buying pressure than selling pressure. Indeed, GLD metal holdings, the best indicator of buying/selling pressure, have been more or less flat since March of 2009.
We suspect that is more of a contrary indicator than a direct indicator. We also suspect that we might see a resumption of stronger buying pressure on gold dips very shortly.
iShares COMEX Gold Trust (IAU), reported no change to its metal holdings this week, showing 79.30 tonnes of gold held in COMEX warehouses.
All five of the gold ETFs sponsored by the World Gold Council (WGC) collectively recorded a decrease of 7.21 tonnes of gold metal, to a combined 1,304.89 tonnes (41,953,461 ounces) worth about US$47.4 billion as of Friday’s close.
We must take note of more selling pressure than buying pressure in the world’s gold ETFs over the past week. We strongly suspect that the primary reason for that selling pressure is early year profit taking by small and large investors.
The authorized market participants for gold ETFs add gold (and increase the number of shares in the trading float) in response to more buying pressure than selling pressure and vice versa.
Silver ETFs: Metal holdings for BlackRock’s iShares Silver Trust (SLV) fell sharply, as expected, by 149.62 tonnes to a reported 9,339.19 tonnes of average 1,000-ounce allocated silver bar inventory for the week. As of the Friday close the largest ETF silver hoard in the world (held by SLV) was worth $5.6 billion or about 13.9% of the value of the largest gold ETF.
Source for data, iShares Silver Trust.
Like GLD, the authorized market participants for SLV add silver (and increase the number of shares in the trading float) in response to more buying pressure than selling pressure and vice versa.
We had anticipated that we might see early-year profit taking on both GLD and SLV. Sure enough, early in the week we noted wider than normal spreads between the SLV price and the implied NAV, which is a sign of more selling pressure than buying pressure. It should not be surprising to see a bit more of that very short term.
Moving on, Gold in U.S. dollar terms closed the week $6.42 (0.6%) below the previous Friday close, showing a last Friday print of $1,130.86 on the cash market. Gold turned in a both a higher high ($1,161.75 Monday) and a higher weekly low ($1,118.78 Wednesday), but closed closer to its low than its high for the week. High-low spreads have come in considerably, which usually precedes a stronger, more definitive action as traders tighten stops in from both directions. Please see the gold charts linked below for more technical commentary.
Silver has been outperforming gold lately and posted a higher weekly high ($18.89 Monday) and a much higher weekly low ($18.15 Tuesday, COT reporting day). The last trade Friday printed $18.40 on the cash market, a dip of seven cents or 0.4% from the prior Friday close. In our notes over the past week we were struck by the determined and amazingly consistent bidding as silver moved below $18.25, but we also noted equally determined supply offered in the $18.70s, especially on Thursday. Note the dramatic tightening of the high-low spreads in the closing table above. The short-term battle lines are well defined going into next week. Please see the silver charts linked below for more technical commentary.
ICE Commercials staunchly short the Greenback
Everyone will remember that we noted the overly large commercial net short positioning of ICE commercials in dollar index futures in our last full report of 2009, just before Christmas. The “ICECOMS,” as we call them, had taken a net short DXY position then of a big 27,292 contracts as of December 15 with the DXY at 76.92. The open interest then was 51,271 contracts, so the ICE commercials had net short dollar index positions equal to an extremely high 53% of the open interest. We thought it interesting enough to make it the headline story of that pre-Christmas Got Gold Report.
Well, in the next COT report for positions on December 22 (released the Monday after Christmas), as the DXY added another 135 ticks up to 78.27 the ICE commercials added another 8,704 contracts, up to a then stunning 35,996 contracts net short. Those who went to our updated graphs during the period would have seen that mentioned and the fact that the ICECOMS were then net short a remarkable 60% of the 59,792 contract open interest. But that wasn’t the peak of the commercial net short positioning for the DXY.
The next COT report, for the December 29 period, showed that as the DXY actually FELL 41 bps to 77.86 the ICE commercials piled on another 5,031 contracts to their net short positions, to show what must be a near record 41,027 contracts net short with the open interest then at 63,184 contracts open. Talk about conviction! As of that December 29 reporting period the ICE commercials were net short the “Dixie” in an amount equal to 65% of the open interest.
By the January 5 COT reporting week, the DXY had dipped another 24 ticks to 77.62, but the ICE commercials still added another 761 net short contracts to show a staggering 41,788 out of 62,056 contracts net short. My goodness, but that was a whopping 67% of the open interest net short by the ICE commercials, was it not? They apparently felt that the dollar had no business with a 77 handle on the DXY to begin the new decade.
That brings us up to this past COT reporting week, for January 12 reporting (released Friday). As the dollar index fell another 84 ticks, back down to 77.02, the ICE commercials finally covered or offset 5,478 contracts of their net short positioning, to show 36,310 contracts net short the buck, but that was as the open interest also plunged to 52,227 contracts open. So even though the ICECOMS reduced their nominal net short positioning, their relative net short positioning is now an even HIGHER and quite simply amazing 69.5% of the total open interest.
We cannot know in advance what the U.S. dollar will do over the short term, but we can see what the ICE commercials believe it will do, or at least what they have positioned for it to do. They are positioned as if they believe the recent dollar rally is already over. It doesn’t mean they are “right,” but it sure does imply they mean business.
The U.S. dollar index chart, with additional commentary, is below in the charts section.
The Gold/Silver Ratio (GSR) has been gradually probing lower (better) territory on the chart since mid-December. That means that silver has been outperforming gold for the period. As of Friday, January 15, the GSR showed 61.46 ounces to buy one ounce of gold metal. That is only slightly lower than the previous Friday GSR of 61.58 but considerably under where it was in our last full report when it printed 64.99 ounces. A falling GSR is a bullish omen and vice versa. See the short-term GSR chart below in the charts section.
Larger, more liquid and well-financed mining shares have been underperforming gold, which is normally a bit of a warning. However, we expected some weakness in the first few weeks of the year as funds and individuals cashed in big gainers from 2009. The present underperformance is therefore excusable, but further relative weakness would raise caution flags. Please see more in the HUI index and HUI/Gold ratio charts below in the charts section.
Smaller, less liquid and more speculative miners and explorers such as those in the Canadian S&P/TSX Venture Index or CDNX have been much stronger relatively speaking. The CDNX closed Friday at 1,593.47, which is down 11.63 points for the week, but it is up 163.27 points from where we last marked it just before Christmas at 1,430.20, an increase of about 11.4% for the period. Apparently we are seeing more and more confidence in the more speculative issues, but they still have a lot of catching up to do. Please see the CDNX and CDNX/HUI ratio graphs below in the charts section.
Gold COT changes: In the Tuesday 1/12 Commodities Futures Trading Commission (CFTC) commitments of traders report (COT) for gold metal the COMEX large commercial’s (LCs) collective combined net short positioning (LCNS) increased a small 3,937 contracts, or 1.4%, from 278,551 to 282,488 contracts net short Tuesday to Tuesday as U.S. dollar spot gold rose $10.70, or 1%, from $1,118.02 to $1,128.72 - while the total open interest jumped 15,623 to 523,266 contracts open.
Gold versus the nominal commercial net short positions as of the COT cutoff:
Source for data CFTC for COT, cash market for gold.
We note that the increase in the LCNS is considerably less than the increase in the open interest.
The chart above looks at just the nominal amount of commercial net short positioning. The chart below compares the COMEX commercial net short position for gold with the total open interest (LCNS:TO). That gives us a better idea of how the largest hedgers and short sellers are positioned relative to the rest of the COMEX traders.
As measured against all COMEX open contracts, the relative commercial net short position is still elevated, equal to 54% of all contracts open on the COMEX, but well under the 60.2% we marked in our last full report just before Christmas.
Source for data CFTC for COT, cash market for gold.
An overly large commercial net short position (above 50%), such as the one in place currently, is normally a warning and is usually not associated with the better times to deploy capital into gold. Ironically it is also the condition that seems to always be in play when gold puts in advances into new record territory.
Silver COT: As silver gained 50 cents or 2.8% COT reporting Tuesday to Tuesday (to $18.27 on the cash market), the large commercial COMEX silver traders (LCs) strongly increased their collective net short positioning (LCNS) by a relatively large 4,356 contracts, or 7.6%, from 57,390 to 61,746 contracts of net short exposure. The total open interest rose a smaller 3,284 contracts to 128,675 COMEX 5,000-ounce contracts open, after adding 1,057 contracts the week prior.
Silver versus the nominal commercial net short positions as of the COT cutoff:
Source for base data CFTC for LCNS, London Silver Fix for silver from LBMA until 2-26-08 then cash market
For context, the chart below compares the silver LCNS to the total number of open contracts on the COMEX (LCNS:TO). That gives us a better idea of how the commercials are positioned relative to all the COMEX traders. Since our last full report in December, there really hasn’t been very much change in the relative commercial net short positioning, which came in at 48% this week.
Source for base data CFTC for LCNS, London Silver Fix for silver from LBMA until 2-26-08 then cash market
As we reported in the last full report, we added new SLV positions then with silver near $17 and SLV in the $16.50s and $16.70s. As of this past Friday, we have moved our trading stops up on those positions to no-loss levels in the mid-$17s.
One new COT marker we may want to highlight from time to time is from the new “disaggregated” COT report, and it is the spread positioning of Swap Dealers. Please take a look at the chart just below, which shows that the swap dealers have so far not seen fit to materially increase their spreading positions.
We will have more about this idea in future reports, but it is based on the theory held by some traders that swap dealers often increase their spreading positions near major turning points for the metals and especially near downward corrections.
As we can see in the graph, the swap dealer spreading position for last week was 1,628 contracts, actually slightly less than the prior week’s 2,001 contracts. What we will be on the lookout for is very large, spiky changes to this new indicator, similar to the one in late November and early December.
General comments
We remain on the hunt for special situations and “vulture opportunities” via “stink bids” for obvious lack-of-liquidity, non-news-related, over-reaction sell-downs on the miners via our Vulture Bargain Hunter Method. Companies we believe have been sold down too far with longer-term high-percentage recovery possibilities, like the candidates Brien Lundin covers in his highly acclaimed Gold Newsletter.
One of the previously-mentioned Vulture Bargain Hunter candidates, one we featured in our presentation at the New Orleans Investment Conference in October, Victoria Gold (TSX: V.VIT), announced another great drill hole this past week at their Santa Fe project in Nevada. Victoria said that assay results showed 284 meters of 2.5 grams of gold per ton in the new hole. However, in a much less widely distributed press release, released just before Christmas, the company also revealed that it had granted its management a staggering 3.2 million options priced at 70 cents. That’s three-point-two-million options at one time!
Why on earth would anyone working for Victoria ever even consider buying their own stock when management shovels it out to themselves by the 100-tonne truckload?
We are glad to see Victoria showing good drill results for all its still current shareholders and we wish them well going forward, but we won’t be along for the ride on Victoria Gold. When management of a company treats the company as their own personal ATM; when the management of a company shows disrespect to its shareholders by showering millions, THAT’S MILLIONS of options on themselves, our interest in following and participating along with that company plunges to near zero.
Henceforth Victoria Gold is no longer a Vulture Bargain Hunter candidate, but we sure have enjoyed the ride up to now. Our final tracking chart will be available for a few more weeks at this link.
Got Gold Report Charts
Below are few samples of the Got Gold Report (GGR) technical charts. Gold Newsletter subscribers enjoy access to all GGR charts and all the GGR reports, commentary and trading ideas.
That’s it from Atlanta this week. Until next time, good luck, good trading and as always, MIND YOUR STOPS. Got gold? Got silver?
The above contains opinion and commentary of the author. Each person should study the issues carefully and, as always, make their own informed decisions. Disclosure: The author and/or his family currently holds a net long position in SPDR Gold Shares, net long iShares Silver Trust, long Permian Basin Royalty Trust (PBT), long the following “Vulture Bargain Hunter Stocks” mentioned in this report or within the last year: Timberline Resources (TLR), Paragon Minerals (PGR.V), Forum Uranium (FDC.V), Odyssey Resources (ODX.V), Radius Gold (RDU.V), Columbus Gold (CGT.V), Terraco Gold (TEN.V), Hathor Uranium (HAT.V), Gold Port Resources (GPO.V), Bravo Vent
