silver supply getting very tight-ted butler

  1. 5,382 Posts.
    G'day fellow silver bulls and others
    I have been wondering why the recent nymex wharehouse stocks had such a small amount of movements, lots of zero's on the chart there. I thought ted would have something to say about this, his comments are very interesting, for me anyway.
    cheers
    Rod

    Tightening the Noose

    By Theodore Butler


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

    Last week, I wrote that I would update the COMEX September silver contract delivery situation. It looked unusual to me after the first two notice of delivery days. As of September 9, there have been seven notice of delivery days for this delivery month, with about three weeks to go before last notice day on the 29th. While I don't think there will necessarily be a "problem" in this delivery period, I am more than convinced that one is coming. The progressive tightening in successive COMEX delivery months that I have written about, is continuing. The silver delivery noose is tightening for the shorts.

    First, I’ll give the facts, then some analysis and speculation. First day, and the combined first seven days silver deliveries were the smallest in 15 years. There were only 1005 contracts (a little over 5 million ounces) delivered on the first day, and less than 1500 for the first seven days (these include redeliveries from the first day's deliveries and do not, usually, represent "new" silver). Of the 1005 deliveries on first notice day, 982 (98%) were issued by one Silver Manager, the Bank of Nova Scotia (Mocatta). I find it odd that only one firm can issue such a high percentage of a world commodity's total first day's deliveries. It just doesn't sound like a true competitive and free market.

    Contrast this historically low number of first day and first week deliveries with the largest (in my memory) first day silver deliveries of 12,000 contracts (60 million ounces), some 15 years ago. First day silver deliveries on the current Sept. COMEX contract were less than 10% of what the deliveries were at the peak, 15 years ago. More importantly, first day deliveries have trended lower since the December '02 contract (when I first started writing about delivery tightness). July, the delivery month immediately preceding the current September delivery, had the then-smallest number of first day deliveries in history, at 1816 contracts. Now, September's are almost 45% smaller than the previous lows. What gives? Why are COMEX silver deliveries so low?

    It would seem there are only two possible explanations to that question. Either there is less demand for actual COMEX silver deliveries, or there is a growing inability of the shorts to deliver the actual silver. So what is it - too little demand for actual silver, or not enough supply? Let's analyze it.

    We can quickly eliminate too little demand, at least in this specific case, because on that first notice day, August 29, when the 1005 contracts were delivered, there was an open interest of 4711 contracts in the September contract. This means there were more than 4.5 times the number of contracts willing to take delivery, than were delivered. Subsequently, the open interest in the September contract has declined significantly. But the actual numbers on the first notice day rule out too little demand as the reason for the record small number of deliveries. Now, let's review the other possibility - the shorts couldn't deliver as much as was demanded.

    First, some background. It is the short, in all commodities, that determines when the delivery is made. A long, or person accepting delivery has no say in when delivery is made, save it must be delivered by last delivery day. When it comes to deliveries against a futures contract, most deliveries come early in the month, with the first delivery day invariably the largest delivery day. This is true for good reason. A short in the current delivery month, who intends to deliver, gains nothing economically by waiting past first notice day to actually deliver. His price is already fixed, and it is to the short's advantage to convert his deliverable material to cash as quickly as possible, and to put that cash to work. Not delivering at the very first opportunity, does not benefit the short.

    Having established that it wasn't because of lack of demand by the longs, nor is there economic benefit to the shorts to delay delivery, we are basically left with the only plausible explanation for why there were such few deliveries in the September contract - the shorts didn't have the merchandise to deliver. Thus the pattern continues of the tightening of COMEX silver stocks. The simple truth is that this is entirely logical. If you are in a documented and verifiable structural deficit, as we are in silver, available inventories must, inevitably, become less available.

    So far, I have stuck to simple facts and basic analysis. Now, permit me to speculate a bit. Another feature of the low of deliveries of the July and September deliveries has been the basic disappearance of two of the three prime silver issuers and stoppers, AIG and HSBC. You may recall that just prior to the July delivery, in an article titled, The Silver Managers, I identified these two firms (along with Scotia-Mocatta) as making and taking massive amounts of silver on first notice day for many years. I wrote that this made no apparent economic sense, and that the CFTC should examine this phenomenon. Perhaps it made more sense to these Silver Managers to stop the delivery daisy chain, than have to explain it.

    Something else that I see, or think I see, in this September delivery is the jawboning or arm-twisting of large long holders in the September contract to liquidate their contracts, rather than take delivery. I base this on the unusually large liquidation of September futures contracts after first delivery day, when the unusually small deliveries were made. This liquidation appeared odd. Here's my reasoning - a long position holder in the September futures contract, who carried his position into the first delivery day, upon seeing the record low number of deliveries, would logically want to hold his position even more strongly, if not add to it. Liquidating a long position when it appears that the other side may have trouble coming up with the real goods, makes no sense. The only plausible explanation, to me, is that something must have overrode good economic sense, like a persuasive call from an exchange official. This could only be done with a few large holders, as attempts to dissuade many small holders would backfire immediately. Remember, this is my speculation.

    Speaking of small holders, one of the main proofs of the progressive tightening in COMEX silver stocks for delivery, is the continuous delay that small traders are experiencing in deliveries against their futures contracts. Recently, the delays have even stretched to last delivery day and beyond. I'd like you to think about that for a moment. Delayed deliveries. Isn't that the same as shortage?

    The great thing about these small traders taking delivery is that they are very strong hands. They are paying cash for real material. There is no borrowing or leverage. These real buyers and holders of silver are immune from margin calls, rule changes, and taxation mark to market considerations. These cash buyers are smart money.

    Not for an instant am I suggesting that anyone take delivery of silver to "squeeze" the shorts, or cause prices to move higher. That would be tantamount to encouraging an artificial manipulation to the upside. Silver doesn't need any artificial gimmick to go higher. The deficit guarantees that silver will go higher. My encouragement of folks to buy real silver (including taking delivery of COMEX silver) is strictly on the investment merits. Buy what is cheap and has value and is in the form that will be in the most demand in the future. The same form and for the same reasons that the world's most successful investor, Warren Buffett, bought silver.

    The bottom line is that, at current prices, there will be a certain and inevitable delivery problem on the COMEX. That's because of the deficit and the law of supply and demand. The only way such a coming delivery problem can be avoided is the same way the deficit will eventually be eliminated - with sharply higher silver prices. In the meantime, real physical silver is the best investment value available.

    Today, September 9, the price of silver traded up to a multi-year high, with gold continuing to surge higher. The main cause of the run to date, particularly in gold, has been large speculative buying on the COMEX, where the price of gold and silver is set. The Commitment of Traders Report (COT) reflects this, with the most recent COT showing record extreme long positions by the technical funds in gold, with a corresponding record short position by the commercial dealers. Interestingly, the public (small traders) have been subdued on the gold rally, with their long position much below levels seen at the previous highs in late January of this year. In gold, this has been strictly a fund versus dealer battle.

    Right now, the gold speculators have the upper hand, and appear to be overpowering the dealer shorts. It may turn out that the dealers are crushed on this move and are forced to cover their shorts at much higher prices. If that does occur, it will be the first time that has ever happened, or at least in 20 years. But it has not happened yet. The dealers still appear to be adding to their shorts, as the tech funds add to their longs. In fact, it's kind of remarkable that the overall position has grown so extreme on the price movement of this gold price leg, some $35 to $40. Basically, the size of the gold poker pot has grown to extreme levels, but the game is still being played and the winner has not been revealed yet. One thing I've noticed is that many more people are discussing and analyzing the COTs, and I think for good reason. They tell you the market structure and prepare you for what may come. Let's face it - if the dealers do try to cover their shorts at this stage, we will see it in explosive upside action, while if it is the tech funds who succumb to technical sell signals, we'll see that too.

    In silver, the COTs are close to historical levels, but have not grown to new historical extremes, as has gold. But there is a very big difference between gold and silver, or for that matter, silver and any other traded commodity. In gold, the dealer COMEX net short position (futures only) has grown to around 17 million ounces, way higher than the 12.5 million ounces at the previous record in January. Even though that's a record, by far, 17 million ounces is a very, very tiny percentage (less than one percent) of total known gold inventories, which are measured in the billions of ounces. In silver, the dealer COMEX net short position of over 350 million ounces (300 million held by 8 or less traders) is more than double visible world inventories. There's a big difference between a short position that is less than 1% of known inventory, and one that is 200% greater than known inventory.

    You want to keep these things in perspective. While I admit to not knowing how this COT drama will play out short term in gold and silver, in the long run, it does not matter. Stick to what is known. I do know that silver has the largest net short position ever witnessed. I do know that silver has been in a structural deficit for many, many years, verified by a shocking decline in world inventories. I do know that in a commodity deficit, inventories will become unavailable, at some point. I do see, with my own eyes, that COMEX silver deliveries are getting progressively tighter. And I have not heard, from anyone, how a free market can remain in a long term deficit, without sharply higher prices.

 
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