Silver Zephyr

August 11, 2003

Open Interest as reflected on the COMEX weekly chart on August 8th is now 550 million ounces (see below), with Commercials having a net open short position of 352 million ounces as at August 5th. (

On July 21st the comparable net short position was 241 million ounces - ie, in the last three weeks the Commercials have increased their short exposure by 111 million ounces, or by 46%!

Over the same period, the open interest position on TOCOM has increased by 12.7 million ounces (63%), with most of this increase occurring in the June 2004 contract.

On August 8th (in a single day) 1.9 million ounces of silver changed hands on the Huatong (Shanghai) physical market and, since that market started trading, daily volume has been ranging from a low of around 600,000 oz to a high of around 2 million oz, with an average of around 1 million ounces per day.

Consider the following:

There are roughly 250 trading days per year (Monday to Friday) on the Shanghai market. At current levels, this implies that an annualised turnover of roughly 250 million ounces of physical silver will change hands over the coming year. In turn, this is more than the TOTAL stock of silver sold by China onto the World markets last year. (China consumed only 1,800 tons but produced 4,400 tons (155 million ounces) AND reduced its Government stockpiles by 1,600 tons (56 million ounces) Source: Ted Butler reporting on a Dow Jones newswire report)

It is conceivable that this trading on the Shanghai market might represent the same core stock of physical silver being sold and resold, but such activity would amount to purchase for the purpose of resale as opposed to purchase for the purpose of usage. What are the odds of this on a market intended for trading in PHYSICAL stock?

On Friday August 8th, the top grade of silver changed hands at 1442 Renminbi per Kg (35.2 ounces); and the exchange rate on Friday of the US$:Yuan was 1:8.28 - which implies a per ounce price of silver of US$4.95 . In turn, this compares with the $4.98 /oz reported on Kitco. ie There was virtually no arbitrage opportunity.

Logically, if there is no arbitrage opportunity, and there also exist "futures" markets in both Japan and the USA, there is no leveraged financial benefit to flow from trading in and out of physical silver where one does not (typically) trade on margin. It is more logical to conclude that the physical trades have been for pure industrial/investment purposes, and this implies that - at the current volume levels - approximately 250 million ounces of silver (30% of annual World physical demand) will be satisfied on the Shanghai market (and is therefore NOT available to COMEX or TOCOM for delivery against futures contracts). If this proves to be factual it will be HIGHLY significant from the perspective of the risks inherent in the open short positions on these latter markets.

From another perspective, given that the Commercials on Comex increased their open short position by 111 million ounces, and all they managed to achieve was a reduction in the silver price from its peak of approximately $5.20 to a closing of $4.98 on Friday, then the demand/supply position on Comex must be becoming unbearably tight - as further evidenced by the reduction in eligible stocks at Comex to 37.2 million ounces.

The "Technical" perspective

The daily chart of silver shows a "gap" at around $4.80 (see below)

It is probably instructive to explain the implications of a gap on a bar chart.

A "bar" chart typically records the high/low/closing price of the day. If today's opening price is higher than yesterday's high price, a gap manifests on the upside. Alternatively, if today's opening price is lower than yesterday's low price, then a gap manifests on the downside.

In simplistic terms, a gap on the charts is a sign of irrational or emotional behaviour; where the participants in the market take temporary leave of their senses. Theory has it that - when sanity once again prevails - the price will retrace its steps to "cover the gap" before continuing along the previously established Intermediate/Primary Trend.

Empirical observation yields the conclusion that well over 90% of all gaps are eventually covered when sanity prevails. For example, note the "downside" gaps that manifested in March, and the upside gap which manifested in April - all of which were subsequently covered.

But there is one type of gap that is (more often than not) not covered, and that type is referred to as a "breakaway" gap. This type of gap usually occurs at a point where the Intermediate Trend or the Primary Trend changes direction.

If you refer to the chart on one of my earlier articles ( ) you will note that the breakup from the $4.80 level represented a break-up from a three line "fan" formation - which reinforced the fact that the Intermediate Trend of silver was - and would probably continue to be - "up". It was essentially because a fan formation has such a high level of significance, that the silver price gapped up through the third fan line - technicians were more than likely encouraged to place "at best" buy orders.

We are therefore faced with the question of whether or not the gap at $4.80 was a breakaway gap. If not, then the price will likely sag back to $4.80 before continuing upwards (It is likely to continue upwards soon thereafter given that the 3 line fan formation breakout represents a reinforcement of the Intermediate Up Trend).

If the gap is NOT covered, (and it turns out to have been a breakaway gap), then we could see yet another gap - a "runaway gap" occurring at the $5.50 level (the resistance level offered by the last long term downtrend resistance line) and, if this happens then a very important measuring yardstick will manifest:

As a rule of thumb, the near term price destination following a runaway gap is measurable. The minimum move will be the same distance FROM the breakout of the "runaway gap" as the midpoint distance between the breakaway gap and the runaway gap. Thus, as an example, if the price gaps up from $5.50 to (say) $5.70, then the midpoint will be $5.60, and as the midpoint of the breakaway gap was (so far) $4.90 - this implies a 70 cent move from $5.60 - or a near term destination of $6.30 per ounce.

I must emphasise that there is NO WAY to tell at present whether the gap at $4.80 will or will not be covered. However, from my perspective it will make no significant difference. In my view, both the fundamental position (huge open short position plus shortfall of physical supply relative to demand) and the technical position (breakup from the third fan line) are now in bullish synchronicity, and a pullback to $4.80 will represent probably the last bargain basement buying opportunity before the silver price finally confirms its entry into a Primary Bull Trend.

In summary, if the gap is not covered, we will very likely see the type of fireworks one would expect to see when panic short covering occurs. Under these circumstances, we could very well see a SERIES of runaway gaps manifesting as the silver price rockets upwards.


The remarkable explosion of the open short position over the past three weeks - which has (so far) been accompanied by only a relatively minor pullback in the silver price - seems to indicate the potential for a possible "hurricane" in the silver market.

The situation will unfold dependant on whether the $4.80 gap is finally covered.

If the gap is covered, we are likely to see an eventual resumption of the Intermediate Bull Trend, with the Primary Bull Trend finally confirmed when the price eventually breaks above $5.50 (very probable given the third fan line breakout). Under these benign circumstances, the "incline" of the uptrend line will likely remain at its current sedate angle.

However, if the gap is validated as a breakaway gap by the emergence of a runaway gap at or around the $5.50 level, then the angle of incline is likely to sharpen steeply as silver shakes off its soporific torpor and enters a period characterised by panic (and massive) short covering.

The beauty of technical analysis is that it acts like a sort of hearing aid to those who know what to listen for, and the market is starting to whisper its signals more audibly. In truth, we cannot second guess the market's direction in advance. It will go where it wants to and when it wants to. Like a gentle zephyr, the whispering wind may vanish, or it may evolve to become a hurricane. But we can say - with absolute certainty - that the whispering has been growing louder.

1 cubic foot of silver weighs approx 655 pounds whereas 1 cubic foot of gold weighs more than half a ton.