Are Banks Closing their Shorts on Gold and Silver?

Wed, 22 Sep 2010 17:43:00 GMT

In the past few weeks gold and silver have both broken out of their year-long consolidating trading ranges. This breakout came shortly after the announcement that JP Morgan and other banks would close their proprietary commodity trading desks in order to comply with a new "Volker Rule" which states that banks can either trade their own capital or their client's capital, but not both. This news has led to speculation that JP Morgan and others would be forced to close their short positions in gold and silver which has been well documented.

This speculation is overly optimistic, and the evidence proves to the contrary. From August 24th to September 14th the net commercial short position has increased from 82,158 to 94,825. This short position has most likely increased even more since then although it hasn't been reported yet. Gold's net commercial short position also increased from 436,829 to 464,388.

As most gold and silver traders know, this pattern is a typical setup for a takedown that occurs a few times every year. The banks that consist of the commercial category in the chart will continue to sell into the rising strength of the metals until it causes a sharp drop allowing them to cover at a profit.

If the commercial banks actually begin to reduce their gold and silver short positions as the price rises then it will be an indicator that they are exiting the market as some believe. The result would be dramatic as hedge funds would likely try to front run the banks and sellers would vanish. The structure of paper precious metals markets have made this outcome increasingly likely, however it is not probable that the commercial shorts will simply walk away without a fight. The inevitability of the long run is the least likely outcome in the short run because neither the government, nor commercial banks, nor accumulating smart money want gold or silver to spike higher.

Silver analyst Ted Butler was one of the first to bring this structure to the daylight however he is far too optimistic that government regulation or limiting trading positions will lead to this event. It is more likely that the futures market is closed than banks voluntarily ending their game. They may close their proprietary desks and move the positions to another legal entity.

One reason to be cautious is that gold has not touched its 200 day moving average in over a year. This simply means that the gold price has been very strong, but indicates an extended move. However extended moves can be life changing events. Gold's formation above its moving averages is beginning to look like Potash circa early 2007 which was the beginning of a 10 fold move in its price.

Historical evidence indicates that the precious metals will most likely see a sharp correction in the coming weeks. However, if they don't then Jim Sinclair could be collecting money on his $1 million bet early.

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$1 Million From 5 Months in Gold

Mon, 09 Aug 2010 19:28:00 GMT

In April 2008, legendary gold investor Jim Sinclair made a $1 million bet that gold would exceed $1650 by January 14th 2011. At the time, Sinclair had stated that he believed his bet was conservative and that gold would probably be much higher. However, with gold hovering near $1200 the market is betting against him and there are only 5 months remaining. Intrade, a predictive betting market, currently has the odds of gold exceeding 1550 by the end of 2010 at 5 percent. This implies that anyone willing to take Sinclair's bet today from the long side is unlikely to win - but also that the payoff would be enormous if payouts were based on the perceived odds using call options.

A $450 increase in gold would be an increase of 37.5 percent, a rate of $90/month or roughly $4 per trading day for 5 months. On an annual basis, this would be near a 100 percent return. Perhaps there is something that Sinclair knows and others don't.

Projecting an exponential moving average, gold would be around $1300 by January. However, gold tends to have larger seasonal moves during the August to January timeframe. Comparing the change from August lows to January highs over the last 10 years, gold rose by an average of 20 percent. Using this average, gold would be roughly $1440 by January. This isn't enough to win the bet, but few investors would be disappointed with such a move. Once in the last 10 years, the 37.5 percent increase was exceeded. From August 2007 to January 2008, gold rose by 40 percent from $657 to $924. The second largest move was between August 2005 and January 2006 when gold rose by 32 percent from $431 to $569.

Given the above data, the odds of gold topping $1650 by January still seem low - perhaps near 20-25 percent. However, Sinclair may be factoring in the likely hood of an event that could launch gold higher. If any of the events below occur, gold could easily top $1650:

War/and or Oil Crisis - Increased tensions in various strategic locations throughout the world could cut off the supply of oil to the US. Potential locations include Iran, Iraq, Pakistan, Venezuela, and Russia.

Major Currency Devaluation - This could be either the US dollar, Euro, or Yen. It could happen over night or over a weekend. Gold would likely gap much higher on such news, just as when it was revalued in 1933 from $20 to $35 an ounce overnight.

Quantitative Easing 2.0 - The Federal Reserve could initiate another round of financial asset purchases. This would not have the same effect as the first round. Equity markets would likely see little gain; however precious metals would be given a stronger dose of buying.

While it is difficult to estimate the odds of these events, they are more likely than most perceive. Perhaps Sinclair will win his $1 million after all. However, if he proves to be wrong on his bet then investors should be grateful that they have more time to buy gold on dips.

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Are Banks Closing their Shorts on Gold and Silver?

$1 Million From 5 Months in Gold