SILVER POST-SMASH OUTLOOK / MACLEOD FINANCE

Silver post-smash outlook 

Hedge fund long interest in silver is within a whisker of a 20-year low, which is fortunate because there is little physical liquidity in Comex vaults, mirroring London’s shortage. 

ALASDAIR MACLEOD 

Combined with a massive silver short in Shanghai which will have to be closed or physically delivered of more silver than exists in the future exchange’s vaults, last week’s derivative price smash will almost certainly intensify the bear squeeze which is set to return with increased violence. 

Furthermore, the central banks, sovereign wealth and other very large investors which have been accumulating gold and silver for some time took the advantage to buy more, leaving even less liquidity available.

We shall start with Comex. 

As stated in the introduction, speculative interest among hedge funds is abnormally low:

Usually, the major speculators in Comex gold and silver futures contracts are found in the non-commercial managed money category. 

They are almost entirely comprised of hedge funds trading between dollars and gold or silver futures. 

Very rarely do they take delivery. 

Therefore, the chart above is a good proxy for speculator sentiment and it is saying that they are not interested. 

Furthermore, the numbers for their shorts indicate that they are not much interested in that either.

The most recent Commitment of Traders statistics were for last Tuesday, when Comex open interest stood at 143,180 contracts, since when open interest has declined further to 135,267 contracts on preliminary estimates for Friday. 

Therefore, hedge fund interest in this contract has almost certainly declined further.

The only non-commercial category to see net long demand while open interest declined by 11,582 contracts between 9 December and 3 March was in the non-reported category which increased by 1,836 contracts. 

It is this category which is probably responsible for much of the stand for deliveries, which over the period amounted to 20,116 contracts, an amount shared between non-reported and other reported categories.

The most notable reduction in commercial shorts is in the swaps, comprised of bullion bank traders and market makers. 

Their shorts have decreased by 13,610 contracts since 9 December. 

The chart below puts this decline in context, which is now at an average level historically:

Taking price into account we can see that mark-to-market values are still very high, so there is pressure to reduce their exposure even more. 

That would normally be by buying derivatives in London, where bullion banks in turn are facing liquidity problems.

With such an obvious opportunity to squeeze the shorts on Comex, it is a mystery why speculators haven’t been playing the silver game.

And even the recent decline from $121 to an intraday low of nearly half that in only six trading sessions has seen a limited shake out due to lack of speculator involvement. 

Coupled with frequent backwardations in London’s forward market and spiking lease rates due to limited liquidity, it’s hard to avoid the conclusion that the commercials just want to shut this futures contract down.

It will be interesting to monitor open interest in the run up to March’s contract expiry. 

On Friday, preliminary figures indicate that there are still 76,091 March contracts with only 14 trading days to First Position. 

This is when outstanding contract holders have to cough up the full amount for delivery.

This total will obviously reduce by then. 

But whether there will be enough registered-for-delivery physical silver to cover March contracts standing for delivery will be a close-run thing because as of Friday there was only enough registered to cover 20,501 contracts.

China

While London and Comex derivatives are being badly squeezed by demands for physical, China is different. 

In Shanghai’s gold and futures exchanges, physical metal is also being drained from their vaults, but there has been significant speculative interest along the way. 

And the Chinese love a leveraged speculation.

It has been a mixture of genuine physical demand and speculative activity maintaining significant premiums in Shanghai over London spot. 

And with London and New York desperately backing out of futures and forwards, clearly the market is now controlled in Shanghai.

In a widely publicised move, speculator Bian Ximing through his Zhongcai Group accumulated a silver futures short to the equivalent of 450 tonnes in January, 100 tonnes more than there is in the exchange’s vaults. 

Despite accumulating this short, the silver price continued to rise through January.

The Chinese authorities acted swiftly on Friday to freeze these and related shorts from being increased further, so they can only be maintained until they are closed. 

And when other traders work out that they must be bought back before contract expiry, they will rightly expect a vicious bear squeeze on these positions.

Being serial leveraged punters, Chinese speculator buying will almost certainly make the bear squeeze even more vicious. 

Even hedge fund speculators in London and New York might finally join in.

To summarise and conclude:

· London and Comex are tapped out of physical silver, with yet more substantial delivery obligations to come. 

In effect, these markets have lost control over silver to China and will act further to limit derivative obligations by refusing to deal if necessary.

· China now faces an intensifying paper squeeze in the coming weeks as a major short of over 30,000 SHFE contracts is unwound.

· These derivative problems come at a time of rapidly increasing public demand in Asia ranging from large investors to members of the public — notably in the two most populous nations on earth, China and India, as well as throughout Asia.

· There is highly credible evidence of major industrial and investment buying in big size taking advantage of the rapid decline in silver. 

Far from undermining sentiment, a combination of what appears to be a coordinated hit on silver in the west and Zhongcai Group’s massive short is set to drive silver prices even higher than they were already on course to achieve.

And finally, gold’s reaction whereby it declined from an intraday high of $5,600 to a low of $4,400 in large part was driven by volatility in silver. 

Again, large buyers have grasped the opportunity to buy as much as they can, setting gold up for its next leg higher, intensifying the silver squeeze in the process.