first majestic silver

Sit Tight

October 7, 2003

The "Open Interest" position on the Precious Metals futures markets is represented by the Bulls - who bought futures and options and who sold puts; and whose cumulative position is offset by an equal and opposite cumulative position of the Bears on the other side - who are made up of those who sold futures and options and who bought puts.

THE BULLS' ARGUMENT: The open interest position is too high. There is no way the shorts can honour their obligations with physical delivery. When the market eventually calls for delivery and/or the shorts are forced to cover, the price will rocket upwards.

THE BEARS' ARGUMENT: As most of the longs are financial arbitrageurs, they are not wedded to their positions and will probably bail out of their futures contracts at the first sign of trouble. Further, if those who are long in futures start to bail - and given that there is huge leverage built into the contract on BOTH the upside AND the downside - there are likely to be stop loss levels that will be triggered. This will offer the shorts a great opportunity to cover our positions at a lower price point. We are quite prepared to wait the Bulls out (we can also manage the options and puts situation by holding the price and by letting them expire out of the money). Finally, because we own the "house", we can contrive to make the longs blink first.

The game is like a game of roulette. Most players are adrenalin junkies, with the longs (speculators and "investors") betting against the house (Commercials). The rules of the game are rigged by the house in favour of the house - in the interests of "orderly markets". Longs are not allowed to demand delivery of large contracts, and the house reserves the right to change the rules and/or close down the roulette wheel if the game turns against them.

All of which says that if you are a short term oriented speculator you are going to get creamed. And you probably deserve to get creamed because trying to wrestle crocodiles in a crocodile infested river is not the smartest thing anyone can do. Losing an arm - or worse - is just a matter of time.

The appropriate approach in any market is to take a long term view and stick with it - through the ups and the downs. Most people who lose money on the market do so because of timing issues. They buy at the wrong time and sell at the wrong time.

When is the "right" time?

If you are short term oriented, your timing decisions are made by reference to indicators such as stochastics, momentum, MACD's and all the other statistical contrivances which lead the naïve traders to believe that they can "systematise" their investment/trading decisions by buying low and selling high. The high IQ investors - who are "clever", but often not as "smart" as they need to be, follow esoteric systems such as Elliott Waves and the like; all of which are so complicated that one needs to be rocket scientist to explain and/or understand exactly why the system failed to work this last time around.

If you are long term oriented, you will attempt to monitor a phenomenon called the "Primary Trend", and you will buy when values are great (high yields) and the Primary Trend turns up; and sell when values are poor (low yields) and the Primary Trend turns down.

So there are two conditions precedent to making money on the markets:

  • Buy great values at market lows
  • Sell overvalued stocks when the Primary Trend changes direction

The problem with this approach is that it requires patience, and extensive Due Diligence to understand intimately whether you are buying actual value or "packaged" value.

In simplistic terms, it is relatively easy to "trade the market" if you are reading the Primary Trend correctly. If the market is trending up, you can literally buy randomly when the trading indicators reach oversold levels and sell blindly when they reach overbought. If the market is trending down, you can sell when the market is overbought, and buy back when the market is oversold.

Unfortunately, there are two structural problems with this approach:

  • Most trading indicators are developed in bull markets, and tend not to work in bear markets
  • Recognising when there has been a genuine change in Primary Trend direction is the single most difficult call of all investment calls. You need to REALLY understand the big picture.

Furthermore, the direction of the Primary Trend of the Precious Metals markets is probably the most difficult of all Primary Trend calls - because in these markets we are dealing with the basest of all human drivers, namely the lust for power in its naked form. These markets are subject to the full weight of external interference by vested interests - right up to Government level; where "money" is no object.

The lust for power, or megalomania, is even worse than greed. It is a sickness which lies at the root of all social disorder. It is what causes politicians to lie, businessmen to cheat, and husbands to cheat (or even beat up) their wives.

I recently published an article called "Power Corrupts". A friend phoned me up and kidded that he couldn't see the relationship between the price of silver in the year 1300 and making a buck in the markets today. He clearly missed the point of that article - which attempted to demonstrate that there are almost unimaginable forces at work which are impacting on Silver and Gold, the prices of which can be likened to the gradations on a thermometer that measures the temperature inside a slumbering volcano. When the volcano is dormant, its temperature is irrelevant, and when it is active, its temperature is only of academic interest to vulcanologists, because most sane people flee the immediate area.

Few people read the change in the Primary Trend correctly. It is probably the most difficult investment call to make, and that's why even the "buy and hold" crowd tend to lose money. They will buy when the Primary Trend is pointing up; and then they will hold all the way up and keep holding when it turns down; and then STILL keep holding right up to the point that they are losing so much money on paper that they can't sleep - at which point they sell out.

…. Which brings us to the question: "Which direction is the Primary Trend pointing now?"

To be brutally honest, as regards the Equities Market, I don't know. The values are certainly not there, but it does not follow that, therefore, the markets will fall. The investment scene has become polluted and "muddied" by the advent of flood quantities of money, the value of which is backed by nothing other than Government decree. How does one define "value" in such an environment?

Certainly, corporations are earning profits which are measured in the same paper currencies that are being used for investment purposes and, certainly, one would anticipate that investment decisions are being "driven" by return on investment criteria. However, if I can sell something tomorrow for more than I bought it today, then that is a positive return.

Using this logic, the Primary Trend for (the US) Equity markets will presumably turn down (again) when the currency in which it is measured is finally perceived to be structurally deteriorating in value relative to other currencies.

If this logic is correct, then the Primary Trend of the US Equity Markets will turn down at the same time as the Primary Trend for the US Dollar (in which it is measured) turns down.

Here is a monthly chart of the US Dollar (source:

Bulls will argue that the Primary Trend is up - based on the facts that the price is above its lows, and the PMO oscillator is reaching for its 1991 low. Bears will argue that the Primary Trend is down, based on a downside penetration of its uptrend and the fact that it is below its Moving Average.

From another perspective, the Point and Figure Chart shows that the US Dollar Index may be reaching for a low at around 92. (source:

The question is: Will this low be penetrated on the downside? If so, it is likely that the US Dollar could continue falling, but it will have to fall a long way before its starts to penetrate "new" low ground relative to other currencies.

Furthermore, based on the following chart, it appears that the short term oscillators of the US Dollar chart are actually giving "buy" signals - indicating that it may have bottomed relative to other currencies (at least in the short term). Note the double bottom in price, and the bounce from lows of both the RSI and the MACD.

So, we are no nearer to being able to determine whether the US Dollar is in a Primary Bear Trend or not and, conversely, if the dollar is still perceived to have "value" and the Fed is going to continue to force dollars down the throats of investors, why wouldn't the equities markets continue to rise?

Dow Theory is a bit iffy at this point for the following reason (source:

A Dow theory buy signal was given in July as the DJIA finally bettered its February high - which confirmed the prior Transports breakthrough.

A tentative sell signal was given a few days ago when both showed falling lows in September.

The strong rally in the past couple of days smacks of money being thrown at the markets but, as yet, the signal has not been negated as both indices are below their recent highs.

Clearly, the position is being clouded by the amount of cash around. In my mind, the DJIA level of around 9,000 and the Transports level of around 2,550 are key support areas which need to be defended by the vested interests. However, I am not holding my breath. No force on earth can buck a Primary Trend, and the values just aren't there for the Primary Trend to be bullish. The equity market may continue rising due to the weight of money but it requires either extraordinary bravery or extraordinary foolishness to try to go along for the ride.

Personally, I believe that investing in listed equities at P/E's of around 30 is a mug's game. I would rather invest in unlisted businesses where the entry cost is sensible and the cash flow can be actively managed.

But what about the Precious Metals markets? What is the direction of THEIR Primary Trend?

This is a whole different ball of wax. Let's take silver as an example (and I am using silver as a proxy for precious metals because I cannot envisage a situation where one is in a Primary Bull Market and the other is in a Primary Bear Market). I believe we are dealing with the early stages of a Primary Bull Market in Silver , for the following reasons:

  • The cost of digging silver ore out of the ground and smelting it is now perilously close to the market price. It is not reasonable to anticipate that the price of silver could continue falling below these levels - regardless of levels of demand - because if the price fell further, supply would shrivel as mines closed.
  • Although demand for photographic uses is waning (marginally), it would have to fall by around 33% before global silver supplies could satisfy remaining global silver demand - even if silver scrap recycling remained constant. CLEARLY, if demand for photographic silver fell by 33%, then availability of scrap from recycled photographic materials would also fall. So one needs to pierce the veil of the vested interests' PR propaganda
  • Silver that is produced as a by product of other metals mined is inelastic in supply, but this is a two edged sword. If the silver price rises, supply from this source is unlikely to rise with it. A rising silver price is therefore likely to feed on itself, unless new silver mines are opened.
  • If you refer to the 600 year silver chart in my recent article entitled "Power Corrupts", you will see a chart phenomenon referred to as an "exhaustion collapse" where, in the past few years, the rate at which the price has declined has accelerated to unsustainable levels. Typically, an exhaustion move precedes a trend reversal. It's a bit like an athlete who runs the last 5% of the relay race on adrenalin, and then collapses at the end of the race - totally spent. In my view, the exhaustion collapse evidences the fact that the vested interests have run out of resources - having thrown everything they had at it in a last ditch effort.
  • The existence and levels of trading on any futures markets must, in the end analysis, be driven by the physical demand for that product. If physical demand exceeds supply, it is not possible manipulate the physical price by means of the futures markets.

And yet, the "fact" is that the silver price (as an example) is still not rising. There can only be two reasons for this:

  • The input information is incorrect - ie demand does NOT exceed supply
  • The market is being illegally tampered with

As a long term investor, I believe the swing factor is "new commercial uses". It is also a FACT that above ground silver inventories have been depleted.

If inventories have been depleted AND there are new uses coming down the turnpike, AND photographic demand has to fall by "depression associated" quantum before mine production exceeds demand - then it is a matter of time before the silver price starts to rise.

Further, when it does start to rise, the shorts will be forced to cover and; at that point, the investment merits of both silver and gold will be subject to laser like scrutiny by the markets as a whole. I foresee a situation where the silver price will explode when it eventually penetrates the $5.50 level on the upside.

In short, I am convinced that the Establishment is just using up oxygen. I believe they have lost the epic battle that has been raging since banking became the dominant force in the world of finance and, in this context, I am sitting tight.

The first use of gold as money occurred around 700 B.C., when Lydian merchants (western Turkey) produced the first coins
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