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A look at the decline in purchases of U.S. government debt by central banks

Section: Daily Dispatches

By Theodore Butler
Tuesday, February 8, 2005

First, a few words about the latest Commitment of
Traders Report (COT).

In silver, there were no surprises, and the market
structure continues to improve. All told, the dealers'
net short position has declined (improved) by some
42,000 futures contracts (210 million ounces) since
the top in early December. I wish there were another
way, but improvement in the market structure entails
lower prices and tech fund selling. You'll never get a
market bottom with good price action and everyone
feeling great.

Gold's market structure also remains positive and has
gotten better. Some were disappointed with the small
improvement in the latest weekly gold report,
considering the large decline in total open interest.
What many have overlooked was the automatic and
mechanical reduction in open interest as a result of
heavy deliveries on the first two days of the February
COMEX gold contract and the reduction in spread

Also, there were some very obvious reporting errors by
the CFTC in the last two gold COT reports, in which
they botched categories between large reporting and
small non-reporting traders. I made a big deal about this
last year and got the CFTC to amend a similar error in
silver, but I'm not going to bother this time. Been there
and done that. Besides, bottom-line is that it doesn't
matter much this time, as it does not alter the fact that
almost 12 million ounces of gold (120,000 net futures
contracts) have been aggressively sold by the tech funds.

We have hit new lows in gold, exceeding the January
lows by several dollars, while silver has held those lows,
so far, as more tech funds have been lured into selling.
The last remaining significant moving average in gold
(the 200-day) is under assault, accompanied by dollar
currency strength, that while painful, actually fortifies
the market structure in the metals. In addition, it has
clearly been technical fund buying of the dollar that is
the prime price mover in that market. This reinforces
the selling in the metals and becomes a self-fulfilling

Once the tech funds have completed their dollar buying
and gold and silver selling, a large move the other way
-- a dollar fall and metals rally -- is all but certain. In fact,
what we are really attempting to measure is just how
brain-dead the brain-dead technical funds really are.
They always go too far. Two months ago they were
loaded to the gills long gold and silver, and short the
dollar. That argued for caution and a change in trend,
which we got in spades. Now most of those long tech
fund metal positions have been sold and their dollar
shorts have been bought back. It is precisely this tech
fund selling in the metals that caused the price decline.

It is important to put things in perspective. Two to three
months ago I was worried about the tech funds' extreme
long/dealer short position in the metals, even to the point
of writing about a real "thumper" to the downside. We got
that thumper. Now the market is no longer structured for
another such drubbing. If anything, the market is
structured for an upside surprise. Maybe a very big
surprise. While the last $10 of a $50 gold decline and the
last 20 to 30 cents of a $1.50 silver decline always feels
the worst -- that's because of human emotion. The first
$10 down in gold, or the first 30 cents down in silver is
always taken in stride. The last $10 or 30 cents is the
killer. It always feels terrible at market bottoms.

In reality, we should be focused on something else
entirely -- what the dealers will do when, not if, we break
to the upside. Sooner or later we will cross above the
moving averages that we are now below, and when that
occurs, the same brain-dead tech funds will be buying
just as aggressively and recklessly as they have been
selling. When we "break through to the other side,"
the question will be how the dealers will react. Will they
short-sell into this coming tech fund buying and cap the
price rally (as usual), or will they stand aside and let the
price zoom?

While no one knows the answer to that question, what I
do know is that it should be played like the dealers won't
sell. If the dealers do sell, there will be time to adjust to
that. If they don't sell, then we explode and it will be very
hard to get aboard the long side then. You have to play it,
in my opinion, like they won't sell and we will explode.

One thing that I have noticed is the extent to which the COTs have
been included in more and more analytical commentary. This is as it
should be, in my opinion, because this approach has been remarkably
reliable and it is natural for more folks to pick up on it. In other
words, more people every day realize that the main short-term price
driver in many markets, certainly including gold and silver, is the
ongoing battle between the tech funds and the dealers on the COMEX.
As this realization grows, what becomes even more remarkable is the
refusal of the silver miners (notably PAAS, CDE, HL, and SIL) to
recognize the obvious. Speculative trading is setting the price of
their main product, contrary to the main intent of commodity law,
and these companies continue to look the other way. It's just

There has been renewed talk about a coming silver exchange-traded
fund (EFT) modeled after the gold ETFs already introduced. In these
ETFs, actual metal is deposited and stored for each share created
according to a specific formula. In the three gold ETFs successfully
introduced by the World Gold Council (WGC), some 8 million ounces of
gold has been secured and deposited, creating shares worth some $3.5

Some have questioned how the price of gold could have declined with
some 5 million ounces being taken off the market since the
introduction of the U.S. version in November.

The answer is relatively simple. While the price of gold did
increase for a couple of weeks after that introduction, the reason
the gold price declined thereafter is because of the aggressive
selling of the equivalent of some 12 million gold ounces on the
COMEX by the tech funds. The math is simple -- aggressive selling of
12 million ounces of futures equivalent gold trumps 5 million ounces
created in a gold ETF. The good news, of course, is that the sale of
the 12 million ounces is completed and its market impact is in the

As far as a silver ETF is concerned, I still have my doubts, as I
wrote back at the time of the U.S. introduction of the gold ETF.
There just isn't enough real silver to back a legitimate ETF.
Three and a half billion dollars is more than three times all the
known silver bullion in the world. According to the WGC, there are
5 billion ounces of gold in the world, so the 8 million ounces that
back their three ETFs, even though it carries a price tag of $3.5
billion, is little more than one-tenth of 1 percent of total gold

That's the main difference between gold and silver. Because there
is so much more gold than silver, and because the price of gold is
more than 60 times the price of silver, $3.5 billion worth of gold
hardly impacts the price at all, while that same amount of money
would be impossible to be put into silver south of $100 per ounce.

Common sense should tell you that while there is clearly enough
gold to back many ETFs, there is not close to enough silver to
back a single ETF. Just because a large financial firm predicts
otherwise (in this case, Barclay's), don't hold your breath.

A few months back there was much talk about how the new Chicago
Board of Trade electronic contracts on gold and silver would
break the COMEX's grip and be a big deal. I wrote that it would
be no big deal. After many months of trading, the CBOT's
contracts have open contracts of maybe 1 percent that of the
COMEX, in spite of an aggressive marketing campaign.

My point is that you should rely on your own common sense and not
wishful thinking and self-serving announcements by those with an

While I doubt that a silver ETF will ever come to fruition, I would
much prefer to be proven wrong. It actually is a very good idea,
even more logical than a gold ETF, because storage is a problem in
silver in that you get such an incredible amount of material for
your money.

The important point is that you don't have to wait to for someone
else to bring out a silver ETF, or bring out a silver ETF at much
higher than current prices. You can set up your own equivalent
silver ETF, as many thousands of investors have done already.
A "personalized silver ETF" is nothing more than bonded and insured
storage of 1,000-ounce silver bars, with documentation as to serial
numbers and bar weights and the specific authorization of ability to
receive actual possession at your demand. You can accomplish this
through a reputable dealer or via futures delivery today. Or wait
for the silver ETF that may never come, or come at a much higher

Finally, just a quick note on the latest metals controversy -- the
possible sale of gold by the International Monetary Fund. Since
there is no objective way to determine what will actually occur, I
will not attempt to handicap it, other than to say I doubt it will
happen. I think the gold price is bottoming or has bottomed and a
powerful rally will start soon. But I would like to make a different
point -- that this is one more reason to consider silver in lieu of
gold. Regardless of whether the IMF actually sells gold, this will
not be the last time a governmental authority publicly threatens to
sell gold. Those threats just do not exist in silver.


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