Dan Norcini: Silver longs again failed to go in for the kill

By Dan Norcini
www.JSMineSet.com
Friday, March 7, 2008

I mentioned last week that I would be eagerly awaiting today's release of the commitment of traders data so that we might perhaps get a better look at what is happening inside the gold and silver markets. You might want to reference the charts as you look this over.

Let me start with gold. There was a very significant drop in the outright fund long position of nearly 10,000 contracts from Wednesday of last week through Tuesday of this week. Alongside this there was also an increase of nearly 4,000 new short positions by that same fund category. The combination resulted in a sizeable drop in the fund net long position of 13,583 contracts to be exact.

Among the commercial category of traders, we witnessed a drop in that category of longs of just about 3,800 contracts while the short category (the bullion banks) covered a rather noteworthy 16,000 contracts. That nets out to a reduction of 12,166 in their net short position.

On the surface that appears to be out of the ordinary, but a closer comparison of price movement and open interest data suggests that the bulk of those covered shorts occurred on Tuesday this week when gold had that heart-stopping $32 swing in price from a high of $990 to a session low of $958. Anyone who was trading the market that day will long remember that one.

It is important for analytical purposes to note that from the close of Tuesday last week at $948.90 in April gold, that contract moved to a high of $990.30 on Tuesday this week, a gain of a bit better than $41 at one point. That is the period over which the COT data is collected.

Tuesday this week gold was rocked by huge selling, which knocked it down that $32 off the intraday peak all the way down to a session low of $958.30. That is a mere $9.40 gain from the previous Tuesday close. It spent 4 days moving higher and on the fifth day notched a further upside move producing a gain of $41 from Tuesday to Tuesday only to have all but $9 of that move wiped out in a single trading session.

Many if not most of the buyers from Wednesday last week through this week's Tuesday session were no doubt stopped out after a price plunge of that extent.

In watching the actual market trade during the day, I noted the swiftness at which the market collapsed could attributed only to determined selling resistance at the top that engendered long liquidation that snowballed into downside stop selling and broad liquidation among speculators and commercials. That can be verified by examining the daily open interest data, which showed a contraction of more than 6,000 contracts in the Tuesday session.

It was evident that some powerful entity was continuing to resist the upward price movement even in the face of determined speculative buying that was fundamentally based.

Enter the commercial shorts, who were selling at the peak just beneath $1,000 hoping to produce the plunge. They got their wish on Tuesday and then used that plunge to cover some if not all of those new shorts plus some more for good measure.

The point in all this is to detail that we are nowhere yet near a commercial signal failure in the gold market as much as some of us would dearly love to see one. After all, it could not happen to a more deserving group of folks. Nonetheless, they are still with us and are still opposing the price rise in gold as could once again clearly be seen from today's nauseating price action in gold, which was stuffed even as the dollar embarked on a further descent into the nether regions.

During a commercial signal failure, one does not see determined selling on the part of some entity attempting to hold down price. What they see instead is panic buying by trapped shorts who are furiously buying, not selling, on the way up. Examine again, for an example, that price chart I sent last week of Minneapolis wheat.

Let's face it: The same cartel that has resisted the rise in price of gold from $250 to now nearly $1,000 is going to be with us for a while longer. After all, the reason for commercial signal failures is that paper losses on losing short positions become unsustainable. This gang has had massive paper losses on their shorts for so long that I can no longer keep track of them, nor do I care at this point. Yes, they have managed to make back some of those losses during periods in which they precipitated severe downdrafts in the gold price, but all in all, theirs has been a losing proposition in gold if you consider only what they have going on at the Comex.

These people are using other avenues in gold to profit, as they are not stupid.

As far as the exchanges go, losing positions need to meet margin calls daily regardless of whether those positions are held by speculators or hedgers. To guarantee the integrity of the futures markets, clearinghouses demand that all margin calls be met that day or the next morning no matter by whom they are owed. The paper losses of the commercial shorts in gold have been so far under water that they no doubt have had to meet many a margin call. But amazingly enough, this never seems to be an obstacle that prevents them from continuing to hold their positions or even increasing them.

When one considers the plight of many commercial hedgers in the grain industry and the horrendously difficult time they are having to meet margin calls on hedged grain positions due to tightness in the credit markets and the unwillingness of many banks to extend them credit to cover paper losses incurred by hedged positions that are under water, I find it most odd to see these commercial gold shorts continuing to coast through life with nary a care when it comes to continuing to carry these losing paper short gold positions.

Where is all that money coming from to cover the margin calls?

One would think that under normal circumstances a phone call would be made from the COO or the CFO demanding that the losses be cut to keep the company from facing severe financial distress. After all, how many firms have we been seeing of late that are running into major difficulties because their traders somehow managed to skirt company safeguards and stuck the firms with huge paper losses? That same Minneapolis wheat market just recently brought about a huge forced selling event by some trader who managed to stick the company with millions of dollars of losses in the wheat market.

A firm that does not exercise control over its trading arm and lets it incur paper loss after paper loss is asking for a whirlwind of trouble.

Yet at the risk of beating a dead horse, the commercial gold shorts seem to never experience such difficulties. Don’t you find that odd?

Now we move onto silver. Last week I wrote that it appeared that we were witnessing the inception of a commercial signal failure in silver because of the rather unusual occurrence of the commercial shorts buying silver on the way up rather than buying or covering shorts only on the way down. I mentioned that we would need to watch price action this week to see whether that would indeed occur.

Well, this week sure started out like gangbusters in silver and it appeared that we were indeed going to be watching a spectacular and rare occurrence.

Monday morning silver shot up better than 80 cents and it looked like we were off to the races. Then it began to fade, closing up only 27 cents on the day and well off the high.

The next day, Tuesday, the bottom fell out of the market after it again looked like it might be off to the races. Silver closed down 34 cents on the day and 84 cents off the session high. The shorts were unexplainably let off the ropes and given a new lease on life. It is through this day that the COT data is relevant.

That data is difficult to decipher because of the wild price swings that silver experienced last week, particularly Monday and Tuesday of this week, in which there was no doubt that many small spec shorts would have their heads handed to them after piling on a large number of fresh short positions last week. They paid dearly for that mistake and I do wonder how many a novice small speculator ended his trading career due to messing with silver this week. Regardless, the silver COT data shows the funds reducing the number of outright longs and adding to the number of outright shorts. The result was a reduction in their net long position of 3,300 contracts.

Meanwhile, the commercial category saw a small dip in their longs of 135 contracts, while their massive short position was reduced slightly by shy of 2,400 contracts.

After the wild ride on Monday and Tuesday it is difficult to say exactly when those commercial shorts were covered, but it would seem logical to suggest that they were covered on Tuesday's huge swing lower. That would be more in character from what we have seen them do in times past. I submit that the silver longs missed a huge opportunity to punish these arrogant commercial shorts and instead let them off the hook by refusing to stand their ground and take them on.

This is why hedge funds will never be a match for commercial shorts who sell with impunity. The hedge funds do not know how to press their advantage and squeeze the losing side to the point where they break their backs and force them out. I am of the opinion that it is the computerized trading algorithms the hedge funds employ that are their Achilles' heel, a serious weakness that market-savvy operators know full well how to use to their advantage.

System traders, such as these hedge funds, believe -- wrongly, in my opinion -- that their computerized systems produce better results than discretionary traders such as myself and a few others. Dinosaurs such as we have learned from experience that it is the person who understands the market hes trades in and knows how to spot an untenable position on one side or the other, and knows how to press an advantage, who will come out on top of what is a zero-sum game.

After all, if you cannot call the bluff of your opponents, why should they run, especially if they know that your system will buckle and force you out if they can but put enough pressure on the market to kick the brainless machine into taking you out at exactly the moment when you should be adding on and making your enemy's life miserable? Whoever blinks first in this war loses, and those who have a machine blinking for them are doomed to lose every time until they learn to turn the thing off and think for themselves and then act accordingly.

But enough of that. Let's just say that as of today's data I do not yet see evidence of a commercial signal failure in silver, though it is still entirely possible should the longs stop running and stand their ground and refuse to sell. That is all it would take to massacre the silver shorts and be rid of them forever.

A market that refuses to break lower must and will move higher. It is as simple as that. Will it happen? Sure, it will at some point, though not until we get a big-enough entity on the long side in silver who knows how to play a market and cans the damned algorithms.

I thought we were beginning to see that last week. Let's hope we see it soon instead of watching defeat being snatched from the jaws of victory.

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