Tuesday, March 16, 2010

The CFTC and Manipulation of the Silver Market

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The CFTC (Commodity Futures Trading Commission) will be holding hearings on trading in the precious and base metals on March 25th in its Washington, D.C. offices. Possible manipulation of the silver market is on the agenda. Critics have maintained for years now that a few large banks hold down silver prices by having large concentrations of short positions in the market - and this disadvantages the small trader.

The CFTC has investigated manipulation of the silver market by the big banks before in 2004 and 2008. They found nothing. This should provide little comfort to investors however. The SEC, one of the other major U.S. market regulatory bodies, investigated Bernie Madoff many times over more than a decade and also found nothing. Madoff eventually turned himself in when his $50 billion Ponzi scheme fell apart on its own accord. Madoff had never made any trades in his mega sized scam, so the SEC's examination of his trading records couldn't have been very thorough. Running a simulation of Madoff's claimed trading strategy also would have revealed it didn't work. To invest the money that Madoff held in his fund, it would have been necessary for him to hold more than 100% of some S&P futures contracts, an obvious impossibility. Moreover a whistle blower detailed the Madoff scheme to the SEC years before it demise and large numbers of additional investors were bilked out of their life savings. Yet, the SEC still found nothing amiss. Investors should consider what the Madoff incident indicates about the quality of U.S. market regulation.

Silver futures trading is by no means an even playing field in the United States as is. Small traders can be paid in cash when their positions expire. Delivery of actual metal is guaranteed only for commercial users. This was particularly relevant in the fall of 2008, when the price of silver fell to around $9 an ounce on the futures market. The physical metal wasn't available for anywhere near that price in the open market. Prices of bars and coins were much, much higher. The option of getting silver at the exceptionally low futures price was not open to the little guy however. The CFTC, whose motto is 'Ensuing the Integrity of the Futures and Options Market', sees nothing wrong with this.

Silver has been manipulated in the past of course. The Hunt Brothers were convicted on federal charges in 1988 for trying to corner the market in 1980. At one point they controlled a third of the global supply not held by governments. When silver prices went vertical and got to the $50 level, the CFTC ordered COMEX to halt trading in long silver positions. A market that only allows shorting will of course collapse and this is exactly what happened. Silver prices plummeted.  Rumors at the time alleged that a number of well-connected insiders made fortunes by shorting silver just before the CFTC's action. While the authorities were vigilant in prosecuting traders on the long side of the market, their resolve seems to have been non-existent in looking for misdeeds on the short side. The CFTC mandated halt in silver buying, but not selling, also led to the U.S. government bailing out the Hunt Brothers' lenders with taxpayer money to the tune of $1 billion.

Warren Buffett also bought a large amount of silver around 1997. He purchased 20% of global supply, but took delivery of the physical metal and stored it in a warehouse in England. Buffet bought his silver in the UK markets away from the prying eyes of U.S. regulators, or so he thought. U.S. regulators supposedly called up their UK counterparts to find out who was buying so much silver in the British markets and to try to pressure them to stop it. Buffett proved to be a hard person to stop however.

According to a February 25th Financial Times article, 42% of net short silver positions on COMEX were held by four or fewer traders. A similar level of concentration of short positions has been common for a long time. I wonder how would the CFTC react if this amount of concentration existed on the long side of the market?

To find out more about the CFTC hearing on March 25th, you can email them at: questions@cftc.gov, call them at: 202-418-5000, or see their press release at: http://www.cftc.gov/newsroom/generalpressreleases/2010/pr5782-10.html.

Disclosure: None

NEXT: Past Recessions Provide Insight Into When the Fed Will Raise Rates

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.


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