ATLANTA -- This is a little different format for the Got Gold Report this weekend, and it's looking more and more like there won't be one next weekend on account of travel conflicts. Please accept apologies for that in advance.
First up, something several readers forwarded to us, but some may not have had the opportunity to see it yet.
Adrian Douglas on gold and silver puts/calls
Adrian Douglas may be onto something with his analysis of the gold and silver put/call options positions and open interest on the COMEX, division of NYMEX in New York. Here is a link to a PDF copy of his April 29 memo:
Titled “BIG MONEY MOVING INTO COMEX GOLD & SILVER CALL OPTIONS,” Douglas’ work begins with this teaser:
“It just recently came to my attention from two different confidential sources that JPMorgan (JPM) and Goldman Sachs (GS) have been buying large amounts of Calls in gold and silver.”
That certainly aroused my interest, especially since nearly all of the commercial net short positioning can be attributed to just two big U.S. banks. If JPM and GS (two big U.S. banks) are really buying calls in very large numbers, one might reason, it might be a signal they are feeling a little isolated in their overly-large short positioning in those markets.
Although many think the case could be made for somewhat lower prices just ahead, longer term the indications could not be more bullish for silver, and Douglas’ report, if accurate, lends more fuel to the silver fire indeed.
Silver COT bullish
Next, the gold COT report was not all that much of a change from the last report, but the changes in silver are worth mentioning this weekend.
In the Friday CFTC commitments of traders report, we find that as silver rose 46 cents, or 3.8%, Tuesday to Tuesday the large, well-funded and presumably well-informed traders classed by the CFTC as commercial added a large 2,289 contracts (9.1%) to their net short positioning, to show a collective 27,460 COMEX 5,000-ounce contracts net short (LCNS). This, as the total number of contracts open FELL a big 5,590 to just 90,687 contracts open.
The total open interest has fallen a bit more since Tuesday, to under 90,000 contracts, suggesting, at least on the surface, a quick speculative “get-out.” Curiously, I think it is interesting that such a large number of contracts disappeared as First Notice Day arrived for the May contract, yet the price of silver really didn’t cut any new ground to the downside as the open interest fell so much.
Silver has since tested as low as $12.05 on Friday morning (about where it was the previous COT Tuesday) before a bit of a late (short covering?) rally and a Friday last print of $12.50 on the cash market. Here’s the silver LCNS nominal graph:
Comparing the LCNS to the total open interest (LCNS:TO), we find that the COMEX commercial traders’ collective net short positioning now represents 30.3% of all the open contracts.
That is up about four percentage points from last week, but still near the LCNS:TO basement historically speaking. Please consider that for a long time now the LCNS:TO has ventured below the 30% level only very rarely and only just prior to significant and extended moves higher for silver metal as the graph below plainly shows.
Source for base data CFTC for LCNS, London Silver Fix for silver from LBMA until 2-26-08 then cash market
“Heads up?”
To highlight the two previous recent examples of the LCNS:TO moving below 30%, it did so in the August 28, 2007, COT report with silver then at $11.83. The LCNS:TO continued lower one reporting week, ultimately bottoming with the September 4 report at 23% with silver at $12.09. As can be seen on the graph above, that action preceded the move higher for silver, which peaked the following March, a little over five months later, near $21, an advance of 70%-plus trough to peak for silver.
The more recent example occurred during the height of the sell-anything-with-a-bid panic last year. The LCNS:TO first edged into the sub-30% region with the September 30, 2008, COT report. With silver plunging through $12.01 the ounce, the ratio had fallen to 27.7% that last day of September, but the ratio would not bottom for another three weeks.
The bottom for the LCNS:TO finally showed on October 21, when the collective net short positioning of commercial traders showed just 22,268 out of 95,873 contracts open, or a very, very low 23.2%. That was with silver closing at $9.19 after testing as low as $8.38 on the cash market.
What the 23.2% LCNS:TO reading was screaming to us was that there was very little appetite on the collective part of all commercial traders to take the short side of silver futures with silver then showing a $9 handle.
Silver then ground its way in a volatile sideways-to-slightly higher “sausage grinder” for another six weeks, finally setting course decidedly higher in December on its way to a February pinnacle in the $14.60s, some 70%-plus higher than the October/November lows.
Thus, both of the above noted examples, the only two examples of the LCNS:TO moving below 30% since at least 2005, occurred just prior to major, high-percentage (more than 70%) advances for silver metal as priced in U.S. dollars.
Notice, please, that the LCNS:TO arrived below 30% this time with silver about $3 the ounce higher than it did the last time ($12.02 last week versus $9.19 in October). Notice also, and this may be equally or even more important, the LCNS:TO arrived at sub-30% levels almost precisely, within a couple dimes, of where it did in 2007 ($11.83 in 2007 versus $12.02 last week). That is close enough on both to call it $12 for our purposes.
Can we conclude, then, that the largest and best-informed futures traders have become collectively more uncomfortable taking on short positions as silver metal reaches the $12 neighborhood, and that the collapse to $9.00 or lower last October was a panic-inspired anomaly?
In other words, now that we have seen the LCNS:TO plunge to less than 30% (which is historically extraordinarily bullish for silver) near $12 in 2007, near $9 in 2008 and, now again near $12, can we conclude that near $12 is where silver now finds it more difficult to fall than to rise? Will the $12 - $9 - $12 LCNS:TO below 30% condition end up being a kind of wide reverse head and shoulders bottom indication?
In truth we humans cannot know for certain in advance. It is certainly possible that the LCNS:TO could move even lower than it has already. It is certainly possible that silver could be on its way harshly and dramatically lower. That’s possible, of course, but if, as Dennis Gartman is wont to say, the “past is prologue to the future,” then this most important of all the indicators we follow has already reached the point where bullish, buy-on-weakness flags are raised, as we did in this report three weeks ago.
We know from previous work shared with all of you that nearly all of the commercial net short positioning for silver is held by just two big U.S. banks. Now we hear from Adrian Douglas that two big U.S. banks are “hedging” those short positions via inexpensive, out-of-the-money calls in the options market.
This comes at a time when the inventory of silver metal listed in COMEX warehouses has come down sharply in recent weeks.
It also comes at a time when COMEX silver futures still reflect a very tight, near flat contango, with the difference between the near-active July contract and the December 09 contract now a tiny 3.9 cents. The list below is courtesy of Barcharts.com.
Many analysts believe that a flat contango or a “strip” that has gone into the opposite condition, backwardation, reflects a market that is pricing in tight supplies. While some of the tightness of contango can be attributed to unusually low interest rates presently, not all of it can.
It doesn’t take a genius to understand that a difference of just seven-cents the ounce would not cover the cost of carry and storage between the July 2009 and July 2010 contracts shown above. That, friends, is a razor-thin contango. There is precious little incentive under the current circumstances to sell silver forward in other words.
So, the futures market “says” that supplies of physical silver are becoming tighter.
SLV metal holdings
Next, here’s the usual graph for SLV metal holdings. The interesting thing about it is that despite pressure on silver this week, there were no redemptions of shares or reductions in the amount of silver metal held by the trust.
The amount of silver holdings for SLV has not changed at all since March 3, with silver then at $12.83.
And no, SLV still has not named an additional custodian or sub-custodian, so they continue to hold about five million ounces more silver than the custodian agreement with JP Morgan Chase, London called for.
Barclays, the sponsor and creator of iShares Silver Trust, has a deal pending to sell its iShares division to a Cayman Islands based company called Blue Sparkle, L.P., reportedly an investment vehicle for private equity funds affiliated with CVC Capital Partners Group SICAV-FIS S.A., a private equity and investment advisory firm, with offices in San Francisco, California ( CVC).
According to news reports, the $4.4 billion sale is owner financed by Barclays and Barclays stands to participate if CVC resells iShares in the future for a profit.
While we wait for SLV to publicly announce who the new custodian will be (also the amount of silver storage space and the potential amount of silver to go in it that will be allotted to SLV by the new arrangement), we are left to wonder if the now growing awareness that silver supplies are in short supply will escalate right away or will instead still simmer just under the surface a while longer.
Before moving on, a bottom line of sorts for the silver market.
This report remains convinced that the world is rapidly approaching the point where awareness of a true shortage of physical silver will surface in the more mainstream press. Until it does, we have a “golden opportunity” to add silver metal and silver ETFs on strong to very strong dips opportunistically. Please see the previous Got Gold Report for more about that.
The little guys improve
In other items of interest this weekend, remember this ratio graph from January 2?
The ratio measures the Canadian S&P TSX Venture index “priced” in gold. I left the original comments from January on the graph. Since then it has “improved” about 35%. It is about 49% higher from its November panic nadir. That’s a big move for a ratio, but it sure looks like this index ratio remains a long way from where it will eventually settle into a new range. A very long way really, but again, only if the world holds it together.
It has been good to see some of the companies we all followed crawling back up out of the abyss they nearly all fell into during the October 2008 panic crash. I think we can finally report that a little confidence is beginning to return to the lower end of the resource company totem pole. A little confidence is a good thing, a very good thing compared to shear panic in November and the completely morose attitudes prevalent in Q4 of 2008.
Obviously things are still tenuous and uncertain for many junior miners, explorers and small producers. It wouldn’t take all that much to derail these beginning signs of a recovery for the sector, but for now we can take a little comfort in that the CDNX appears to be improving in terms of gold. Click here to see the relative performance graph courtesy of Stockcharts.com.
Repeating from previous Got Gold Reports: “This report continues to believe that now, when just about no one wants them [the small miners and explorers] and prices are a quarter or a fifth or even a tenth of what they were just a year ago; now when meaningfully large positions in promising miners and explorers with good management and real prospects can be had with relatively tiny capital (the kind of companies Gold Newsletter is focused on for subscribers); now when there are oceans of blood in the proverbial streets; right now is a small resource company speculator’s opportunity of a generation.”
Natural gas idea
Take a look at the chart below:
Briefly, without getting too far into the trees and staying instead where we can see the entire forest, our thesis is the relentless “death plunge” for natural gas is nearing its ultimate conclusion. Indeed a reversal is probably imminent, almost certainly measured at most in a few weeks.
Yes, the unprecedented rise in prices for energy in 2007 and 2008 sent way too many drilling rigs out into the moose pastures and ancient basins of North America and too many gas wells came on line too fast. Yes, the very high NG prices above $10 were “too high” and the antidote for high prices is high prices, as always.
Since reaching a speculator-driven peak over $13 per MMBtu in June 2008, the price of NG has completely collapsed by over 75% in a 10-consecutive month bloodbath for anyone who might have tried to catch that gaseous falling knife. Earlier this week the June NG contract fell below $3.30 for the first time since 2002.
At the same time we have a market-caused contraction in natural gas consumption we had an over-abundance of natural gas production. We’ve had a “nat gas” boom, now we are witnessing the bust.
Just as fast as the industry moved to over-supply to answer higher prices it is moving to over-answer the collapse in prices. Producers hit the brakes big time. Onshore rig utilization rates have plunged to less than half of their record 2008 levels, big natural gas producers are shutting in production because it doesn’t pay to sell it for less than it costs to send it into the pipeline, and so-on up and down the gas food chain. Still, last Thursday, the EIA reported yet another (bearish) injection of 82 billion cubic feet (bcf) into storage to bring inventories very close to a five-year record high for the annual time period.
Natural gas inventories are bulging at the seems and NG is becoming “too cheap.” How cheap? Well, in terms of price natural gas fell below $3.30 MMBtu this week basis the June contract. Perhaps a better measure would be in terms of gold. Please consider this comparison chart:
Any questions? Either gold is extremely expensive or natural gas is extremely cheap, or both. The “pure” spread trade here would be to sell gold and buy natural gas, but since we are not all that bearish on gold short or long term, the latter of the two has my interest.
During the last nat gas bust, the one in 2002, Henry Hub prices fell 82% to the $2.25 range (sustained support) before it violently corrected higher. That’s equivalent to about $2.65 today adjusted for inflation. This past week June nat gas fell below $3.30 briefly just 85-cents higher.
So why focus on a market that is in the throes of a meltdown? Because it is likely about to bottom and then melt up instead – probably sooner than many people think too.
Media commentators tend to agree that if the economy doesn’t re-collapse nat gas is probably going to see higher prices in the fall or this winter. Many of them are keenly aware of all the reasons why nat gas inventories will stay high and thus prices low until then, they say. The problem is that the nat gas market discounts and trades well in advance of those changes. It is the nature of the beast.
For 10 consecutive months NG has relentlessly fallen at an average pace of about $1.10 per month. We have all heard that markets never go straight up or straight down? Well, in monthly terms nat gas is the exception. Arguably, 10-consecutive months in one direction IS straight – straight down. Consider this monthly chart for evidence:
At the current 10-month average pace of decline, nat gas would reach zero in a few months. Natural gas is not going to zero.
The thing is, natural gas rarely trades sideways at major tops and bottoms. Instead it tends to get repelled away from those tops and bottoms, violently, “unexpectedly” and in very large percentages.
Short covering spikes tend to occur well BEFORE we learn of drops in the rates of production, for example. One reason is apparently because there are well-placed people in the business that sniff them out well in advance. They literally have to because their interests, their needs for energy, cause them to lock in longer term prices and/or hedge for gas they will need for years to come. They know because it is their business to know.
Just recently companies that are directly connected to the price of natural gas, companies like Chesapeake (CHK), San Juan Basin Trust (SJT) and Devon Energy (DVN) have completely failed to answer lower prices for natural gas. Instead they have put in or are attempting to put in bottom-looking formations. They are perhaps one of the more interesting ways to play if one agrees the signs point to a near-term natural gas reversal higher.
Today one can also play one of the ETFs that track the commodity, such as the United States Natural Gas Fund (UNG),which trades on the NYSE. UNG closed Friday at $13.77 and it trades at very roughly four times the price of the near-active natural gas contract.
Not knowing in advance when an expected reversal might surface, but confident that when it does gas will move in high percentages, one could adopt the “buy-down” strategy for one of the ETFs for example. Setting up a “buy ladder” in advance, a series of small, progressively lower incremental good-till-cancel orders that would automatically take advantage of lower natural gas prices should they occur is certainly one way to play.
Buying something down can be dangerous and it is not for everyone, but in this case natural gas is very highly unlikely to go to zero, so a well thought out buy-down, one that sets the last potential “buy” well below carefully considered expectations in order to arrive at a reasonable average price for the overall position seems not only logical with the commodity already off by 76%, it could be fun.
The idea is to be involved in case the market jumps limit-up one day for some unexpected reason, leaving a planned entry in the dust.
Bottom line
Silver supplies are tight now and probably growing tighter in the weeks and months ahead. We remain bullish for silver. Buy-on-weakness into strong to very strong dips in incremental “bites” or “units” with an idea of building a significant position for longer term investment. If silver goes materially lower, good, we can add some. If it takes off from here, good, we have some. Try not to fire all the ammo at the first few targets in anything though, and don’t even think about not having appropriate money management stops or carefully chosen long-dated options as insurance just in case.
Small resource companies don’t seem quite as sick as they did last winter, but it wouldn’t take all that much to give them the flu again, so easy does it. Add the better ones on ridiculously harsh drops that still occur from time to time as they nearly all still suffer from “thin-trade disease.” Tremendous, very high percentage opportunities abound in this sub-sector.
Finally, in this report’s opinion it is not too soon to be setting targets and positioning for what looks like will be yet another violent and very high percentage reversal for natural gas and the companies that produce it.
All with the caveat of: If the world holds it together.
Got Gold Report Charts
2-year weekly gold
2-year weekly silver
3-year weekly HUI
2-year weekly Gold:HUI ratio
That’s it for this Got Gold Report. Until next time, as always, MIND YOUR STOPS.
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 currently holds a net long position in iShares Silver Trust, net long SPDR Gold Shares, net long ETN DXO, net long UNG, long TLR, long SJT and holds various long positions in mining and exploration companies.