Rising silver prices prove dilemma to banks

It has been quite a week for gold (COMEX:GCU13) and silver (COMEX:SIU13), with gold extending its rally from the Aug. 7 low of $1,272 to highs of $1,370 and silver from $19.12 to $23.15 in Asian trading last night. The market seemed to be on the verge of a bear-squeeze for much of the week before prices finally broke out dramatically yesterday.

This performance was more remarkable because at the same time equities and bonds slumped, with the Dow losing 225 points. This sends a message that the market correlations that hedge fund managers’ bet on when they take out positions in gold and silver have broken down.

If the market dips today on pre-weekend profit taking it should resume its uptrend early next week. Technical analysis that dominates trading decisions and is often cited as the reason to short the metals, is turning better with a vengeance. Furthermore the deteriorating political situation in Egypt is helping to maintain high oil and energy prices, which are generally positive for gold.

The best charts to sum up the trading background for both gold and silver are of the banks’ net positions, taken from the monthly Bank Participation Reports updated to Aug. 6, the start of this bullish phase.

First gold.

 

The U.S. banks on Aug. 6 were net long 59,473 contracts, which as the chart shows is extreme. At the same time the non-U.S. banks, most of which are also members of the LBMA have maintained pretty average short positions of 22,000 contracts. Remember these banks also have uncovered gold liabilities on unallocated accounts in London as well. This sharp difference between the two bank categories is a dangerous imbalance, because the U.S. banks are likely to demand physical delivery to lift their own low levels of physical inventory, squeezing the London bullion bank community badly.

The broader point is the U.S. banks control Comex gold futures, and with short positions everywhere they are in a position of tremendous power. Expect them to use it.

Now silver.

 

The U.S. banks have been unable to close their silver shorts, but have managed to halve their net exposure to just under 20,000 contracts. Meanwhile non-U.S. banks remain uncomfortably short at 11,607 contracts net. At current silver prices, it is proving difficult for the banks to reduce their shorts further because industrial users, who probably incorporated a silver price of $30+ in their business plans for 2013, are locking in windfall prices to improve profit margins.

This gives the banks a dilemma. Do they hold the line and mark-to-market at favorable prices, or do they cut-and-run letting the price rise to over $30 to stem industrial demand?

Yesterday’s powerful move upwards suggests time has run out for standing their ground and that silver must move much higher to find its price equilibrium.

Next Week

A very quiet week for announcements: good for maintaining the bear-squeeze perhaps!

Monday. Nothing important expected.

Tuesday.  Belgium Consumer Confidence, Mexico GDP (I’m struggling here for meaningful stats.).

Wednesday. UK Public Sector Net Borrowing, CBI Industrial Trends. US Existing Home Sales.

Thursday. Eurozone Flash Composite, Manufacturing and Services PMIs. US Initial Claims, Flash Manufacturing PMI, Leading Indicator.

Friday. UK BBA Mortgage Approvals, GDP (2nd est.) Eurozone Flash Consumer Sentiment. US New Home Sales. 

About the Author
Alasdair Macleod

Alasdair Macleod is head of research for GoldMoney. He also runs FinanceAndEconomics.org, a website dedicated to sound money and demystifying finance and economics. He has a background as a stockbroker, banker and economist. He can be contacted at Alasdair.Macleod@GMYF.org and followed on Twitter @MacleodFinance.

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