Although silver had its highest monthly closing price in sixteen years, it’s still not that far above its average price for the last decade and a half. While I am sure that the regulators will be quick to jump on the price rise in silver as proof it is responding to the forces of supply and demand and is not being manipulated, that's hogwash. The CFTC and the COMEX would love to have you forget how silver was depressed for decades, in the face of a documented deficit. However, I think the educated silver investor will see through that argument.
Only one thing will tell you when silver is no longer manipulated. That’s the elimination of the excessive dealer short position on the COMEX. The manipulation began in 1982-83 with an excessive dealer short position, and the manipulation will only be pronounced dead when that short position in no longer excessive. What's excessive? Simple - a short position out of line with every other traded commodity; a short position greater than annual world production; a short position several times greater than known world inventories. If you compare silver’s short position, silver’s world production, and known world inventories with every other U.S. exchange-traded commodity, you'll see, clearly, that silver stands out like a sore thumb.
While a few commodities have short positions greater than total inventories, none share the dubious distinction of COMEX silver, which regularly sports a short position greater than world production and total world known inventories combined. This is truly an absurd condition, having a short position many times greater than all the known silver in the world and greater than all the silver that could be produced in an entire year. How can you be short more than what exists or can be produced? And if it's no big deal, as the regulators contend, why doesn't this bizarre condition exist in any other commodity?
Twenty years ago I was a commodity broker/analyst for Drexel, Burnham, Lambert looking for my next investment play. I had just completed (successful) plays in soybeans, orange juice and U.S. Treasury bonds, both on outright and spread positions, as well as conducting a straddle options writing program on the OEX. A client suggested I look at the fundamentals of silver, because he knew I liked to look under the hood. He claimed there was a deficit in silver and that it had peculiar price-inelastic production and consumption characteristics. The client gave the suggestion in the form of a challenge to explain silver's low price, in spite of the deficit, and no voluntary inventory dishoarding.
Even though I had traded silver over the years, I never really studied it, so I took the challenge. For almost a year, I pondered the conundrum of a commodity in a deficit with no sharp price increase. I read and reread everything it was possible to read on silver. At first, I thought it was strictly a perception problem, with investors just not seeing the facts. I went so far as to challenge the statistical reporting agencies, because I thought this might be the problem.
In scanning the Wall Street Journal's commodities page, it looked like silver wasn't out of line in terms of volume and open interest with other markets. Then, it jumped out at me. Rather than just look at the open interest in terms of the tens of thousands of contracts, I converted just what those contracts meant in terms of ounces of silver. I did the same with all the other commodities. When I converted the number of contracts into ounces, and pounds, and tons, and bushels, and barrels, a completely different picture emerged. All the commodities had a total long and short position well below world annual production. All except silver.
While silver's COMEX total short position was greater than world production, other commodities didn't come close. Crude oil had a short position of hundreds of thousands of contracts. When you converted those contracts into equivalent barrels of oil, the short position came to only 2% or 3% of world production. The COMEX gold short position did make up 30% to 50% of world production, but when you factored in known world gold inventories of billions of ounces, the short position was back in the 2% range. Only silver had a short position greater than inventories and production.
If a small group of traders sold massive amounts of any commodity short, like they’ve done with silver, the price of that item would be in the gutter. Imagine what would happen if a group of concentrated shorts got together to sell millions of grain contracts, or tens of millions of oil contracts. There would be extreme price dislocation. Yet this is precisely what has happened in COMEX silver.
The price of silver will stay manipulated as long as the COMEX short position stays at excessive levels. When the COMEX silver short position falls in line with the short vs. production ratio of all other commodities, the manipulation will be over. (If you're looking for a number. I'd guess when the futures open interest falls to 30 to 50 thousand contracts.)
We are at a critical juncture, and I don't think we'll stay near the $7 level for long. The dealer short community is under severe financial pressure, not just from silver, but a whole host of other commodity shorts. But, like a cornered rat, they are not to be underestimated. They will exploit any avenue or news event to cause a sharp sell-off. Against their desperation, the overwhelming evidence of strong industrial demand and growing shortages for commodities dictate that it's just a matter of time before the silver manipulation is broken. Get used to the volatility. Now, more than ever, you should own real silver that’s fully paid for.
-- Posted 23 March, 2004
