Figure 1

Figure 1 shows a cross plot of Comex silver futures open interest against the silver price since 2001. By looking at the data in this way the time element is removed and the relationship between open interest and price is revealed. On the left side of the chart the data falls within the green dotted ellipse. The long axis of the ellipse is slanted upwards which means that generally the data within the ellipse display a relationship wherein the price of silver increases as open interest increases and it falls as open interest declines. Within the green ellipse there are tightly packed clusters of data that have been enclosed in pink ellipses and are numbered from 1 through 4. Ellipse #1 is almost vertical; this data cluster is from the start of the bull market when silver was trading around $5/oz. Because this data cluster is almost vertical it means that at that time expansion of open interest did not result in an increase in price. In other words, there was sufficient supply of silver in the market that the commercials were ready to keep selling as many contracts short as speculators demanded. If all demand for contracts on the long side was met with eager short selling the price could never rise and it didn’t. The data within ellipse #1 demonstrate that whether the open interest was 60,000 contracts or 120,000 contracts the price remained around $5/oz. It can be seen, however, that this situation gradually changed. The data clusters 2, 3 and 4 are enclosed by ellipses whose long axes tip progressively more toward the horizontal as one goes toward the right of the chart. As the ellipse leans over it means that the price is becoming much more sensitive to the open interest. As open interest increases the sellers are only prepared to meet increasing demand from the speculators at ever increasing prices. The progressively decreasing slope of the long axes of the ellipses 1 through 4 is indicative of a tightening supply of physical silver. As the supply becomes tighter there are less willing sellers so there are only minimal increases in open interest for quite large increases in price.

The exciting revelation comes from ellipse #5 which is shown in red. This encompasses the open interest versus price data since silver went above $22/oz. The long axis of this ellipse is downward dipping. This means that as the price increases the open interest contracts! This means that in general existing shorts are covering their positions as the price rises. This is indicative of a looming chronic shortage. The owners of a commodity should be happy to sell at higher prices but that is not the case in silver. This shows that those who have committed to sell and don’t have the silver are buying back their commitments and those that have silver no longer want to sell it. There is no other way to interpret this change in relationship between open interest and price that has been developing over the last ten years. We have reached the tipping point where physical shortages are going to become more and more apparent.

John Embry in a recent interview with KWN explained how difficult it was to source physical silver for the Sprott Physical Silver Fund. In daily updates in the Midas column of www.lemetropolecafe.com I have shown how Comex silver inventories are shrinking and are not far from ten year lows. The Financial Times just reported on acute shortages of gold bars for investment in Asia.

Let’s now look at gold. Figure 2 shows a cross plot of Comex gold futures open interest against the gold price since 2001. There is a similar pattern to what was seen in silver except the lower volatility of gold results in the clusters being more tightly packed.

Figure 2

There are five ellipses shown in pink and numbered 1 through 5. The long axes of the ellipses tip toward the horizontal as one goes from left to right on the chart. Ellipse #1 encompasses data from very early in the bull market. The ellipse is almost vertical which means that at that time increased demand for gold futures was met willingly by the sellers such that increasing open interest resulted in only minor increases in price. It can be seen from ellipse #1 that an expansion of open interest from 100,000 contracts to 375,000 contracts resulted in the gold price increasing from $260/oz to $425/oz, an increase of $165/oz. The ellipse #5 shows that an increase of around 50,000 contracts (600,000 to 650,000) resulted in an increase in the gold price of almost $200/oz ($1200/oz to $1400/oz). Just as we saw with silver the tendency of the long axes of the ellipses to tilt over as we go from left to right on the chart is an indication of a growing shortage. Ellipse #6 has been marked in red. It is horizontal. That is not yet quite as dramatic as in the case of silver where the ellipse is downward sloping but nonetheless it is indicating a looming chronic physical shortage. This horizontal data cluster means that even as the price rises the sellers, considered overall as a group, can not be persuaded to sell more commitments to deliver gold in the future despite a rising price.

The clear trend in the data clusters that has developed over the last ten years indicates that the gold open interest will soon be declining with a rising price as is the case for silver. Taken together the data shows that in both gold and silver there is a growing reluctance of the traditional short sellers to meet rising demand even at elevated prices. This is strongly indicative of looming physical shortages. This conclusion is corroborated by many other market observations and anecdotal evidence. We are likely very close to the “tipping point” where shortages become exposed and a stampede of investors into precious metals to benefit from the accelerating prices will give rise to a feeding frenzy that will exacerbate the shortages.

Perversely the more the market becomes close to the tipping point the more we can expect the cartel of bullion banks to make bear raids as we have seen this last week because they desperately need to cover their short positions. However, in the case of silver and soon to be the case with gold a negatively correlated open interest to price relationship means that lower prices lead to higher open interest; in other words there is no way to cover at lower prices; the only way to cover is at higher prices. As this becomes increasingly obvious to the cartel the severity of the bear raids will decrease, particularly when the premiums in the physical market are showing that the bear raids are stimulating massive physical offtake making the predicament of the cartel ever more precarious.

This makes the brouhaha about the CFTC imposing position limits on the Comex a complete joke because, as always, the regulators are going to be too late.

Just like all the other nefarious financial engineering schemes that are falling like houses of cards, the scam of selling precious metals that do not exist is fast approaching a rendezvous with its day of reckoning.


Adrian Douglas
Editor of Market Force Analysis
Board Member of GATA

January 15, 2011

www.marketforceanalysis.com
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-- Posted Sunday, 16 January 2011 | Digg This Article