Part of last weekend’s edition of the weakly.
The price of silver and futures trading
Are you sure That we are awake? It seems to me That yet we sleep, we dream A Midsummer Night's Dream, Act 4 Sc1
Some thoughts on the way in which silver is being used by market pros to separate you from your money. Last week’s silver futures expiry got a lot more attention than its usually gets, mainly due to the continued efforts from the hardcore silver world insistence there is a silver squeeze to be done and a new and far higher price to set. A continuation from the fleeting time during which the new WallStreetBets people, fresh from what looked like a resounding victory against a large legacy short position in GameStop (GME), turned its attention to the big short held by JP Morgan over the silver market. I’m going to try to be brief, so:
Last week was options expiry week, in which the Silver Squeeze Group (for want of a better title) promoted the idea of taking delivery of your silver contract (rather than roll it over or merely close it out). This was also a popular line to among silver traders back in 2010 and 2011, by the way. The idea is straightforward, the theory states that as the JP Morgan (and other financial entities, but JPM is at the centre) silver short position is much larger than its metal inventory, all one has to do to get silver to rocket higher is to force the counterparty to obey the rules and be obliged to deliver so much physical silver, that it can’t cover its obligations from stock. At that point it will be forced to buy more silver to cover the position, and the short squeeze begins.
That was the theory, in practice it was like taking a knife to a gunfight.
Back at the start of February and for a couple of days, the open market rattled the control of silver (the gap up marks the spot). From that point until today, nothing in that charts speaks of a second loss of control and you will have to excuse the unsavoury expression, but what we saw last week is an example of what the LME traders colloquially call “Date Rape” (apologies, but it is what it is, I merely report). Straightforward to understand, in this case the people wanting to force the dominant silver position into doing something it doesn’t want to do, the Silver Squeeze Group, announce to colleagues in arms they are going to 1) buy silver through the futures market by 2) demanding delivery on their futures position at expiry and therefore 3) making the shorts pay more to cover their position. Supposedly, this pushes the price of silver ever higher until a technical boundary is broken, at which point the shorts have to scramble for cover and the price shoots to whatever impressive target has been posited by the silver proponent.
However, as they say in Spanish “the reality is other” and as you may have witnessed last week, it doesn’t always work. For one, it may have escaped the attention of the Silver Squeeze Group, but the instos and dominant players in the silver market can also read English and often spend time online. They will know the trade set-up being promoted by the Silver Squeeze Group revolves around the “technically critical” U$28/oz line, so what did they do? Why, they ran the price to U$28/oz! Once they had as many in as possible, down we go and instead of the large short having to scramble to cover, it’s now the smaller longs who have to decide whether they really, REALLY want to pay U$28/oz for the silver they bought or whether they should pay plenty under U$27/oz for a similar ounce of silver (simply from a different counterparty). This also puts paid to the longer-term theory that the big naughty short won’t like having to continually pay to keep the short in position at every rollover. Instead, the legacy short has just creamed a dollar per ounce off all those who were daft enough to oppose it.
Please don’t misunderstand me, I’m not saying the potential to squeeze out the silver short doesn’t exist. It does, which is why the concept at least had my attention for a couple of days at the very start when WallStreetBets turned its attention and newly gained firepower on the silver space. However, it takes real financial firepower on a par with the dominant position and what we saw last week wasn’t that. Last week was silverbugs flapping their lips and trying to get OPM to do the dirty work for them. Last week was the knife to the gunfight or perhaps more accurately, it was a futile attempt to disrupt the major trade positions by concentrating efforts on a second-level listing, PSLV, which Van Eck, Comex and JP Morgan could ignore easily while they bounced SLV and spot silver around so yes, ladies and gentlemen, the silver market is manipulated. Of course it is, but the manipulation isn’t on some grand, Bildeberg scale or part of The Great World Plan. Their manipulation scalps trading wins from other traders, the abstract financial games that are played away from the real market for the metal. And for sure, JP Morgan et al move the price of silver around at certain moments, but only when it suits them and at fulcrum points in the market, e.g. options expiry. However, those insistent that silver should be trading at a higher (or even much higher) price deck would do well also to step away from the abstract of the futures market and consider the real price driver for the metal. Like anything else, the long-term price of silver is set by the supply from mines/other against the demand from clients and, as over half of the ounces supplied to the market are taken by industry and consumed, maybe we should look there.
Pertaining to this, a personal limit was passed this week when Sprott USA ran a webcast entitled “Silver Fundamentals Shine Bright”. A nice snappy title, plus they brought in three of their crack team to present the webcast and its 31 page slideshow (download PDF here (17)), but the content was about either a small amount on TA and the chart pricing of silver (hardly fundies), then the larger part on current and expected silver demand. In other words, a supposedly reputable brokerage managed to spend 31 slides on their best takes for demand, but not a single moment on silver supply! Not only is that lapse of them, but it’s self-defeating as there’s no way you can make a reasonable forecast on the third of three variables if you have only studied one of the others. Therefore, and in the spirit of starting the ball rolling on a more complete conversation on silver that better explains its price movements, we offer a few talking points on silver supply:
- As two thirds of the world’s mine supply of silver comes as a by-product of other metal mining (and very typically these days from the large porphyry and/or skarn copper mines dotted around the world), supply is going to happen whatever the ticket price of silver might be. No matter whether the silver is sold by the company on mining or is already under a stream, the cost of production of most of the ounces produced in the world is basically zero and the ounces will get sold no matter what the spot price.
- The main customer for silver is industry. Industry wants lower input prices, always. Therefore, industry knows that there’s no point in paying up when silver starts running hard. Why pay an exorbitant margin to a producer for something that cost most of silver’s producers next to nothing?
- Industry also understands that as supply is constant and regular (they will sell those very cheaply produced ounces at $10, $15 or $20), the only times prices rise sharply is when there is investment/speculative interest in the metal. At those times, supply is taken away by people buying coins, bars and so forth, the result would please Adam Smith and his theories (the price goes up).
- The problem is that as soon as the price stops going up (because industry backs off), there’s no other customer for silver other than retail. Le banque central, c’est vous. This is a fundamental difference between gold and silver, the amount of gold taken away from the market every year is higher than that of silver. Once industry and jewelry are satisfied, gold has two other clients; the investor and the Central Bank, only the investor is likely to return his gold to market and they make up a small percentage of gold owners (a generally estimated 10%). The others, the CBers, are the greatest stackers of them all who will buy large amounts of gold and then hold it indefinitely. That is not the case with silver, as the only reason a price bubble forms in the metal (excess speculative demand disrupting an otherwise regular supply and demand) is when speculators start stacking. Central Banks are not going to retire a large percentage of physical silver from the market every year In effect silver speculators are silver’s Central Bank (Le banque central, c’est vous), they are 30% instead of gold’s 10% and only other place silver has to be stacked and get off-market but, obviously, these are far weaker hands than the reserve holders of entire countries.
- Is industry prepared to pay more for silver? Quite likely yes, it tends to be a minor cost input in most of its manufacturing uses. But that’s a different question to whether industry wants to pay higher prices, that’s always “no” whatever the subject. When the price of gold stalls or falls Central Banks don’t liquidate to take profits, but when the same happens to silver, its speculators will ramp up short-term supply quickly by dumping their positions.
- You, the speculator, are the reason silver is so volatile compared to gold. When speculators fall in love with silver it goes up because new excess demand pushes it up, when they cool on the metal’s prospects it goes down because that excess demand now becomes excess supply. Silver’s major suppliers know that (the porphyry mines that sell their metal at any price), the middlemen know this (JP Morgan has played and won at silver for 13 years and counting), and the majority of end user demand knows this too (industry, that doesn’t want to pay too much for its input cost). It’s time you knew this too, it will help you stop dreaming dreams about the metal.
Bottom line: At a casino, the house wins. Although the comparison is hackneyed, some parts of the stock market truly are casinos and the silver market is one of them. As Warren Buffett correctly calls gambling “a tax on stupidity”, we can equally apply the phrase to taking on the dominant position in any commodity, silver or otherwise, unless you bring the same or greater amount of financial weaponry to the table. Last week it was silver and retail suckers were shorn, date raped at U$28/oz by promoters who told them the story they wanted to hear (“….telling you…$28…it’s the tipping point…”) and then made to pay up by a market that immediately took a dollar from each and every one of them and then said they had three days to pay….or roll over at a loss (J). The Silver Squeeze Group will also claim last week as a great victory and the days ahead will surely be filled with stories of protagonists receiving their physical silver bars. They’ll tell you the squeeze is now on and next expiry will be even more painful for the short counterparties, but my question is to wonder how many “victories” the valiant longs are willing to take when they start with $28 and finish with $26.50 worth of metal? And as for the current highly promotional atmosphere for all things silver, seeing a brokerage (they want to sell you silver company shares, dontchaknow) ignore silver supply completely as it teaches newbies about “the fundamentals of silver” should not be construed as a green flag for the sector and rising interest in the metal (Sprott USA doesn’t tell half a story by pure chance, they are now distributing).