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When the bills come due, then what?

Section: Daily Dispatches

By Theodore Butler
Tuesday, July 19, 2005

What has been the most reliable of guides to short-term moves in
gold and silver, the market structure approach of the commitment of
traders (COT), continues in its remarkable dependability. Maybe
someday we will have to disregard the message of the COTs, but that
day has not yet arrived.

The most recent COT report, as well as extrapolations from the
cutoff date, indicate continued improvements in both gold and
silver. Silver has now removed the complete 35,000 net contracts
(175 million ounces) added in the run up to the price peak amid the
tech fund-buying orgy of a little more than a month ago. In fact,
the dealers have engineered the hapless tech funds completely out of
their big net long silver futures position and into a hefty net
short position. (Please remember that the tech funds are not the
only traders in the non-commercial category.)

In gold, the three-week and almost $30 decline in price has removed
most but perhaps not all of the 110,000 net contracts added in the
rally to the $445 price peak of late June. So maybe we need a bit
more liquidation in gold. But then again, maybe not, as COT extremes
are a moving target.

In any event I am encouraged with the readings of the COTs in both
gold and especially silver. The last report showed not only good net
changes but also good readings in every individual category. These
included declines in fund longs, increases in fund shorts, as well
as increases in the gross long and decreases in the gross short
categories of the commercials.

Due to the remarkable consistency of the COTs in predicting price
movements, I am not surprised with the dramatic increase in
commentary and interest in the study of the COTs. And a lot of the
increased commentary is quite good. I guess it's to be expected that
when something works as well as the COTs have worked, people will
notice and react. Additionally, there has been an increase in the
graphical representations of the COTs, and just this morning I
received an impressive new input from my personal favorite, the
charts provided by my Aussie friend Nick Laird. Here's his new
data series:

The bottom line is that the current COTs are great, particularly in
silver. The risk is low and the potential reward is high. Thanks to
the dealer engineering of the brain-dead tech funds, we are once
again presented with an outstanding buying opportunity. The last few
dollars down in gold and pennies in silver always hurt the most, but
that's just the way it feels emotionally. In reality, the last
little bit of tech fund selling and dealer buying should be
celebrated as a festive time for metal buyers. The only real
question remaining in silver is how the dealers will behave on the
coming certain rally. As always, if they don't sell aggressively to
cap the price, silver will explode.

We should be grateful that the dealers are so corrupt and the tech
funds are so devoid of common sense as to replay the COT game on
such a regular basis that it affords the investing bystander
profitable entrance and exit points. And, to be sure, I am grateful.
But I'd like to raise another aspect to what has been a very
profitable endeavor for those of us who have relied upon the
consistency of the COTs. As profitable as the COTs have been, the
underlying reason why they work so well is as illegal as the day is

To many, whether an activity that may prove profitable on a personal
basis is legal or not may be a moot point. Not to me, but not just
because illegal is inherently wrong. Strictly from an analytical
perspective, the question of illegal behavior is most important.
Simply put, illegal behavior, were it to exist in any market, could
come to be terminated at any moment. This could have a profound
impact on any market. Please hear me out.

U.S. commodity law is quite explicit -- the No. 1 purpose of the law
is to prevent price manipulation. Further, manipulation is defined
as speculators setting the price of a commodity and not the
legitimate producers and consumers of that commodity.

Now think what the market structure analysis of the COTs is all
about. It is about anticipating when the tech funds (speculators)
will get engineered into buying or selling by the commercials (other
speculators). The COT is not at all about what the real producers
and consumers are buying or selling.

The conclusion is that the paper speculators are moving the market
around, not the real producers and consumers. And the speculators
are moving it around in such regular fashion that it has become
profitable to study their activities and trade accordingly.

While we should be grateful for the opportunity to trade profitably
on such a basis, it does not lessen the fact that the tech funds and
dealers are operating in clear violation of commodity law. As such,
it is reasonable to assume that such illegal activities can be
terminated by any number of causes. Such causes could be regulatory
intervention, tech fund recognition of their terribly track record
in gold and silver, or the dealers sensing legal problems in the
future, among other possibilities.

If the paper speculators (the tech funds and dealers alike) do cease
their stranglehold on the silver market, for any reason, what would
be the price impact?

In my opinion, the impact would be bullish beyond belief, because
the dealers would lose their incentive to continue the long-term
price manipulation of silver. Without the certainty that they could
liquidate tech fund long positions, the dealers would lose the
incentive to sell short obscene and uneconomic quantities on silver
rallies. There would be no reason for the dealers to cap the rallies.

It has been the regular skinning of the tech funds that has enabled
the dealers to continue to frustrate the natural law of supply and
demand in silver. So great has been the dealers' futures and option
profits over the years that it would have been almost impossible for
them to turn away from their silver manipulation and terminate the
scam. But nothing lasts forever (especially manipulations), and if
the profit motive was taken away from the dealers, there would be
little reason to expect the manipulation to continue.

In fact, as more observers study and comment on the consistency and
logic of the COTs, I am confident that these same observers will
come to conclude that the very activity that comprises the COTs is
clearly counter to commodity law. For those who ask why the dealers
can't continue the manipulation indefinitely, this is another
reason for consideration. Someday we may have to bid farewell to a
great market tool in the COTs, but we will be welcoming a great
addition in its place -- a free market in silver.


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