Gold Silver Worlds: Silver is poised for a massive recovery upleg in 2014, a mean reversion from last year’s dismal action. The main driver of silver’s initial strength will be American futures speculators covering shorts. These bearish bets on silver soared to a bull-record high last month, which will require exceptional buying to unwind. Futures speculators as a herd always bet wrong at major lows, they are a fantastic contrarian indicator.
Because futures trading is such a hyper-leveraged zero-sum game, futures traders have a reputation of being smart and sophisticated. And they are to a great extent, futures are so unforgiving that survival of the fittest rules. Capital naturally flows from the poor traders to the good ones. Nevertheless, within their chests thump the same hopelessly emotional human hearts that are such a liability in the markets.
Even good futures traders succumb to groupthink, getting too greedy or too scared with the rest of the herd. They flood into silver futures after the metal has already surged in strong uplegs, buying into the popular euphoria. Then they flee silver after it has plunged, waxing bearish with everyone else. This leads to buying high and selling low, the same emotional affliction that torments nearly every trader.
Futures trading is one of the purest forms of speculation, making leveraged up-or-down directional bets on underlying prices. When these traders buy silver futures, they expect its price to rise imminently so they are effectively bullish on the metal. When they sell, they expect silver to fall in the near future so they are bearish. Thus looking at their aggregate bets on silver reveals their collective sentiment on it.
Thankfully this useful data is readily available. All silver futures buying and selling gets distilled into the famous Commitments of Traders reports from the US Commodity Futures Trading Commission. These weekly reports show how futures speculators as a group are betting on silver. They’ve always been the most bearish, as evidenced by the most selling, right when silver happens to be carving major bottoms.
Futures are a zero-sum game, every contract has a trader on the long side betting a price will rise and an opposing trader on the short side betting that same price will fall. Every dollar won by one trader is a direct dollar lost by the trader on the other side of that contract. The total number of longs and shorts in silver futures always nets to zero. But the classic CoT reports divide traders into three separate groups.
They are commonly known as commercial hedgers, large speculators, and small speculators. Of course the first group actually produces or consumes physical silver for business purposes. They are simply trying to lock in future prices to better manage their cashflows. The latter two groups of speculators take the opposing side of those hedging trades, and it is their bets that are a powerful contrarian indicator.
This first chart looks at the net-long and net-short positions among these broad categories of traders. The more net-long silver-futures speculators get, the more bullish they are on silver’s price. But the opposite extreme is far more interesting today. The less net-long or even net-short speculators become on silver, the more bearish they are on it. And in recent weeks that bearishness has approached record extremes.
Recently in early December as silver slumped back towards its brutal June lows, futures speculators’ net-long positions plunged. The large specs’ net-long futures contracts held fell to just 2.9k. How low is that? Between 2009 and 2012 before last year’s epic precious-metals selling anomaly, large specs averaged net-long positions of 28.1k contracts. A month ago they were merely 1/10th normal levels.