HOUSTON -- Trend following hedge funds have built up a record high number of short contracts in silver futures, but evidence we study shows that it is more likely a form of “insurance” than a simple one-way bet.
For part of the evidence consider that the number of long contracts, or bets that silver will advance in price, have varied only marginally since the beginning of the year. In fact, since January 7 the number of long contracts held by Managed Money traders has been confined in a range of only about 7,000 contracts, with a low of 29,670 contracts and a high of 36,611 long contracts. As of June 10, Managed Money long contracts are closer to the high number than the lower number (35,455 lots).
The selling pressure on silver futures cannot be attributed to long liquidation by hedge funds in other words.
Below is the long, short and spreading data from the futures only DCOT ending June 10.
We all know that the number of short contracts is near a DCOT record high right now (39,270 contracts short). Notice that since February 25 the number of Managed Money shorts has exploded higher, from 9,525 to as high as 42,804 shorts June 3.
Here is what the graph of the COMEX Managed Money silver shorts looks like again.
The Managed Money traders are trend followers and they are unlikely to have a dogmatic point of view as to price looking ahead. The longer a trend is in play the more likely they are to have a large position in the direction of the trend.
Now we can posit a theory that the high number of short positions in silver futures gives the Fund Guys the ability to profit from the down trend, yes, but it also gives them the ability to improve the condition of their long contracts by the upward pressure short covering provides.
In other words, by putting on a record number of shorts, once the Funds are of the opinion that the downtrend is done, they can help their keeper long side contracts by covering the heck out of their “insurance” shorts in rapid fashion. If that pays out as expected, then following a major rally for silver we ought to see the number of short contracts plunge off a cliff while the long side stays relatively flat or increases some.
Short covering takes on a somewhat different character under this theory, does it not? The Funds protecting their long exposure with insurance shorts? Kind of makes sense, doesn’t it? Consider it a form of hedging on the fly, or just a form of insurance to protect a longer term long position.
We will likely see if it goes according to the plan in the fullness of time and possibly sooner rather than later. And, it would kind of explain why we might see very large percentage advances that are not immediately corrected looking ahead.
That is all.
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