Today In Silver

Last night, they were at it again. The silver price took yet another vicious dive during the Asian session. Who is “they”? Call them the commercial shorts, call them the Hung Brothers, it doesn’t matter. They know what they are doing and they expect us to remain bewildered and ignorant. Too bad for them.

I’m seldom Jim Cramer’s biggest fan, but I like the way he explains his “insider truths” about the investment world. It’s a little bit like that fat uncle who whispers “here is how it works” as he sneaks you off into a corner so that he can betray your father who just got through showing you his latest awesome magic trick. Except Cramer screams.

So, pssst . . . I mean BOOYA! . . . here is how it works. You see, most traders (especially in leveraged markets) have two “stops” where they should (or must) exit a position. The first kind of stop is a stop loss order, which I will call the voluntary stop. This stop may be physically entered as an order (hard stop) or it may just be a “mental” order (soft stop). The second kind of stop is the margin call, which of course is an involuntary stop. Now, it is generally a very bad idea to place the voluntary stop close to the involuntary stop. For obvious reasons, it is even a worse idea to place the voluntary stop further away from the entry price than the involuntary stop. Sometimes it’s not an idea though. In fast moving markets, often it just happens. I’m talking about shi(f)t. One second you have a perfectly good setup with defined entry, exit and stop points. The next second silver has shifted a dollar lower as if by teleportation.

Indeed, shi(f)t is the major risk faced by the new longs who are willing to take positions in COMEX silver at this point. Here is an example. For absolutely no reason, silver traded through a 45 cent range on the 1-minute bar at 9:54 P.M. PST last night. Silver futures traders are geared to seeing this type of move over the course of an entire day, and then only if the market is very active. Orderly price movements allow them to properly place voluntary stop loss orders (ideally hard stop) so they won’t ever have to face involuntary stop losses. A 45 cent range on a 1-minute bar is distressing to them. It magnifies the risk of placing a voluntary stop further out than the involuntary stop.

What I’m trying to say is that the silver market of late has been the trading equivalent of warfare with deep psychological consequences. Imagine a reconnaissance patrol getting pinned down for a whole week by fierce crossfire between the enemy and its own side. That is the silver bull in COMEX and CBOT right now, and her psyche is completely ruined. The troops have been scared beyond stiff and they are refusing to go back behind enemy lines.

And it (the psychological warfare) is working. Other than the preexisting bids that suck up the voluntary (and sometimes involuntary) stop loss sells during these manic price drops, I am seeing no strong buyers stepping up to the plate at these ridiculous low prices. It seems the “once in a century” bargain is appearing too often for COMEX traders’ taste. Meanwhile, retail buyers can’t get enough and SLV buyers can’t get enough. But COMEX buyers have had enough. As a result, market depth is virtually nonexistent especially when these 1-minute bars are bleeding Leprechaun blood (a reference to the default green color of my TradeStation display).

I don’t mean to sound conspiratorial here. There is no conspiracy. What’s going on is quite obvious. The fat uncle doesn’t have much to spoil. Simply put, it still doesn’t appear the commercials have covered their short positions to any large extent as evidenced by the 139,000 contract open interest in COMEX silver last Friday. The latest $1.50 drop in silver managed to reduce open interest by only 1,000 contracts compared to 140,000 on Thursday. That is phenomenal, but not in a good way.

Now for the sleight of hand. Although the commercials have not yet covered their short positions (by reducing their gross short interest), I’m almost certain they will start doing so as silver starts to make its way back up legitimately. Stated alternatively, silver will start a legitimate rally when the commercials start to cover their short positions. Why? Because they are the only strong-handed buyers left. In the meantime, shell-shocked silver traders will still be trying to figure out which way is up.

If what I’ve said above is true, we could see a remarkable rally in silver at some point. Perhaps as much as $3-4 dollars over the course of a few days (from what level I know not). But only if we get a significant decline in open interest, indicating that commercial short covering (the only type of real buying out there) is underway. Conversely, a rally in silver not accompanied by a decent drop in open interest, or absent a substantial fundamental driver, is probably doomed to fail.

And this brings us back to the evening swoons in silver of late. Just suppose for a moment that what I’ve said above is not only the truth but that the Hung Brothers are well aware of it. Should they not then look at the latest open interest figures as reported each evening and act accordingly? Meaning that if daily open interest remains steady or increases, they should sell. And if daily open interest drops by a significant amount, they should buy. Could it be that simple? Yes. But what do I know, I’m just the fat uncle trying to spoil the magic trick. Still, it might be interesting to compare the timing of the release of daily open interest figures and the clownish behavior of silver during the past few fine summer evenings.

UPDATE: As I’m getting ready to post this, NYMEX is showing preliminary market data that has open interest in September COMEX silver dropping by 4,000 contracts between yesterday and today with no corresponding increase in December, the next active month.

silverax Windbag Wisdom