Honore de Balzac, the French novelist of the 19th century, supposedly said, "behind every great fortune is a crime".
Whether it is a crime or not, commodity price manipulation is one of the oldest tricks in the financial markets to enrich oneself. In the past, it was an act of information arbitrage. Prior to a demand spike, due to whatever structural or transitory influence, one enters into contracts that guarantee delivery of an underlying commodity. As the demand increase manifests, the rest of the economy pays a premium to purchase the commodity. Today, things are murkier.
In the past six months, the silver markets have seen a tussle between the longs (buyers) and naked shorts (sellers). This particular tussle has revealed the entire gamut of characteristics that mark today's financial markets: from opaque entities cornering large sections of critical global metals market to regulatory complacency with regards to transparency, wilfully or otherwise.
To a casual onlooker the obscure wars in the commodity markets may seem like an academic exercise, but the many instances of legerdemain and possible front running of commodity prices portends bigger problems than average consumer realises.
It is widely speculated that a major global investment bank has entered into naked short futures contracts on silver. This means, they have sold contracts to sell silver (that they do not owe) in the future.
Many in the trenches and in the wikileaks equivalent of the financial underground openly speculate this bank is JP Morgan.
True to form, many commodity traders who are betting on silver's rise (and many quiet Asian financial heavy weights alongside) have initiated a "crush JP Morgan" campaign.
If the global silver prices were falling, this would have made JP Morgan a substantive profit. But as of now, JP Morgan is estimated (as per Guardian) to be around 3.3 billion ounce short. To cover these positions at the present prices, it would take them around three months.
However, the world commodity markets have increasingly headed higher. From low teens two years ago to high 20s/low 30s these days — silver is on a roll. More instructively, the historical gold to silver ratio is estimated to be around 16 to 1.
Historical ratios
Today, gold has been around $1,400 per ounce. If historical ratios are expected to hold, this translates to around $80 per ounce of silver. Yet, as of writing silver was at $29.77. One doesn't have to be a genius to figure out that if historical demand and supply equilibrium are to hold — the upside is seemingly obvious.
It goes without saying that such back of the envelope calculations are fine and good, but hardly worth betting the family farm over. It is important to understand why is the price rise expected. A widely circulating rumour is that JP Morgan has been acting as an agent for the US Federal Reserve to help prop up the dollar.
It does so by trying to reduce the price of silver, and thus implicitly making the US dollar a relatively attractive asset.
Whether this rumour is true or not (notwithstanding the belief that most market rumours often are true!) a decline in silver does indeed make the US dollar denominated assets attractive. Yet, the reality is increasingly difficult to avoid.
Simple calculations reveal that if we were to return to the dollar-gold levels of 1972 — despite the seemingly high $1400 levels we see today — gold is still under priced. One can then easily extrapolate what this means for silver. Anticipating all this, sharp market investors have been purchasing physical silver as well.
So, whenever the contracts expire — and the buyers of the contract demand delivery from the short-seller, the short seller and commodity exchanges with registered silver are expected to try to cover.
Staggering losses and defaults are expected. As if this were not enough, another large buyer has manifested in the copper market — nearly 50 per cent to 80 per cent of the reserves in the London Metal Exchange have been bought off. The claim is that this is a hedge against possible losses from silver trades.
What we know for sure is that the Commodities and Futures Trading Commission has acknowledged one "trader" owns nearly 40 per cent of the market. (Their words were "fraudulent efforts" to "deviously control".)
Earlier, the CFTC had plans to provide greater transparency on speculative limits by mid January; but for reasons unspecified they have declared such deadlines can't be met. The opaqueness of this market continues. Not to make too fine a point, what is known is that since 2009, the CFTC has been investigating JP Morgan after whistle blower revelations made clear that market manipulations were de facto reality. In essence, some form of showdown is inevitable. The only question is: how bad will it hurt?
- The columnist works for a major European investment bank in New York City. All opinions are personal and don't reflect any institutional perspectives.
