A HIDDEN SILVER DEFAULT?
By Theodore Butler
Mid-June 2008
(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)
Today I am going to write on a subject that I feel is of the utmost importance to all silver investors. It’s particularly important to those holding shares of the Barclays silver ETF, traded on the American Stock Exchange under the symbol SLV. Because this may prove to be quite controversial as well, I will attempt to be thorough in my discussion, in the hopes that my words will not be misinterpreted. Although I will try to keep it short and simple, there is much to discuss.
It is just over two years that SLV has been in existence. Trading commenced at the end of April 2006. I started writing about this Silver Trust three years ago when it was first proposed, and have written many articles since then. I have always maintained that the silver ETF was big doings for silver. In just two years the amount of silver held in SLV has grown to 195 million ounces, the largest known stockpile on the face of the earth. Throw in two new silver ETFs from London and Switzerland and total silver ETF holdings jump to more than 220 million ounces. That’s a lot of silver.
It’s no secret why the silver ETFs have proven to be so popular. For the first time in history, they enabled institutional and retirement funds and other stock-only type accounts to easily buy and hold silver. Given silver’s unique dual role, as industrial commodity and investment asset, this was no small development. It is also clear that the advent of the ETF had an important impact on the price of silver. Not as much as I had expected, but still significant. After all, the price of silver tripled after the SLV was proposed. While there were other factors, it was the introduction of SLV that exerted the most influence on the price. Prior to the SLV, silver was locked in a $4 to $5 trading range.
As a silver analyst, I have always recognized the importance of the SLV in the silver supply and demand equation. Key to that issue was the matter of whether real silver backed up the assets of the trust, as Barclays claimed. While some commentators doubted that all the silver claimed to be in the trust was really there, others suggested the silver was being leased out or was being used to suppress the price of silver. However, I always believed that the silver claimed to be on deposit was actually in the custodian’s vaults. I still do. What I will be discussing today doesn’t involve the silver claimed to be on deposit. So much time and attention has been placed on the silver already deposited (or not) in the SLV, that the most important issue has been overlooked. That involves silver not claimed to be on deposit.
(A brief side note here. I’m a (very) independent silver analyst. I write what I feel should be written about concerning silver, with little or no concern for what others may think. I’ve written more than 300 articles in the past seven years that have been underwritten by Investment Rarities, Inc., and made available at no charge to all who care to read them. Not once have I written that readers should buy silver from them, although I do hold them in the highest regard. Nor have I ever taken any potshots at the SLV, perhaps much to the chagrin of the president of IRI, Jim Cook, who rightly views the SLV as a competitor to what his firm sells. I want to thank Mr. Cook for never trying to interfere or influence my analysis on the SLV or any other issue I chose to write on.)
After Barclays decided to follow my public suggestion that they openly list all the weights, serial numbers and hallmarks of the bars on deposit, my conviction that the silver said to be on deposit was reaffirmed. I publicly congratulated Barclays for doing the right thing.
However, I did mention in past articles that I noticed delays, from time to time, in the depositing of silver into the trust for new shares that were purchased. I attributed this to the logistics of physically procuring and transporting the silver to the custodian’s vaults in London. This wasn’t the way the prospectus clearly dictated, namely, that the silver had to be deposited before any new shares were issued or, allowed to be purchased. However, I wanted to save my critiques for more important issues. You learn to pick your battles, and I chose not to harp about a short delay, of a week or two, of a few million ounces of silver being deposited into the trust.
I began to notice this pattern of delay in depositing silver into the trust about six to eight months ago. In fact, the pattern became so regular that I could tell, fairly precisely, when and how much silver would be deposited. I did this by observing the price and volume patterns in the trading of SLV shares. I shared this information with close associates, and could see they were surprised with the accuracy of the pattern.
One thing became clear - in obvious conflict with what the prospectus dictated, there were regular periods when the trust did not have all the silver it should have. In other words, SLV had the silver it said it had, but, at times, there should have been more silver than that. It was also clear to me the mechanism by which this delay could be effected. Buyers of new shares could be issued those shares without new additional silver being deposited through the short selling of shares to these buyers.
Aside from a fascination with observing the pattern, my main take from the consistent delays in depositing silver into the SLV, was that silver was not readily available in London. As an analyst, this told me that the supply of wholesale quantities of silver was much tighter than was generally known. This coincided, of course, with a well-known tightness in retail forms of silver, especially US Silver Eagles (thanks to Izzy’s article)
So here we had evidence of delays in the delivery of both retail and wholesale silver. Many are loath to utter the word "shortage" in connection with silver. They believe that to be impossible or they think the word means no availability at any price. That definition is silly, as there will always be some quantity available at some price. A commodity shortage doesn’t mean that all the silver (or any other commodity) in the world suddenly disappears. The correct definition of a commodity shortage would revolve around delivery delays, not unavailability. In other words, a delay in delivery of both retail and wholesale forms of silver would constitute a shortage. Maybe not a severe shortage, but a shortage nevertheless. Such evidence of delivery delays, in the face of declining prices, should disturb believers in free market principles.
Although these delivery delays into the SLV well after the shares were purchased bothered me, I chose not to complain. (By the way, this pattern can be discerned by the uneven deposit pattern into the SLV compared to its trading volume). The main thing that bothered me was that the shares were being shorted at all.
I am going to make a very straight-forward statement. I don’t think short-selling of any kind should be allowed in the shares of the SLV, nor in the shares of the two publicly-traded gold ETFs, GLD and IAU. Of all the tens of thousands of different common stock and other traded securities that are regulated by the US Securities and Exchange Commission (SEC), these three metal ETFs are very unique and distinct from the rest. Out of tens of thousands of different securities, only SLV, GLD, and IAU call for a rigid metal backing, 10 ounces of silver behind each share of SLV, one-tenth of an ounce of gold behind each share of either GLD or IAU. Investors buy shares of these ETFs because they are assured that this specific metal backing exists. Investors buy shares knowing that the sponsors and custodians guarantee the metal to be there.
But what happens when someone buys shares in these ETFs and the seller is selling those shares short? Does the short seller deposit metal to back up the buyer’s purchase? No. The short seller just sells the shares short without depositing metal, perhaps borrowing other shares first, perhaps not. The buyer doesn’t know who he is buying from, he gets a confirmation of his purchase from his broker, pays for it and assumes, according the representations in the prospectus, that he is buying new shares issued by the sponsor who has deposited metal, or from an existing shareholder who has decided to liquidate his shares. It never occurs to the buyer that he is buying from a short seller who is not depositing metal. In essence, the short seller is circumventing what is promised in the prospectus. That party is short-circuiting and destroying the promise clearly laid out in the prospectus that real metal backs every share sold.
Here’s the disturbing question - which buyers’ shares are left without silver backing when short sellers are involved in the transaction? Just the hapless and unsuspecting buyer who was unlucky enough to happen to have his purchase short sold, or do all SLV shareholders get shaved proportionately, like a silver coin clipped in olden times? Don’t look to the prospectus for answers, because you won’t find any.
For those who were unaware of this and don’t understand how shares can be sold with no metal backing (or doubt my contention), there is hard proof. There is a short position list reported that proves short selling exists. Currently, the SLV shows a small published short position on the American Stock Exchange of around 250,000 shares, or the equivalent of 2.5 million ounces. On March 11, this reported short position hit almost 1 million shares, or nearly 10 million ounces. So, there can be no doubt that some short selling exists, which raises all sorts of disturbing questions. In my opinion, this aspect of the metal-only ETFs wasn‘t fully thought through before their introduction. Unfortunately, the problem may be worse than just this SLV short selling; maybe much worse.
WHAT’S GOING ON?
Around this past April 15 I began to notice a more pronounced delay of silver deliveries into the SLV. This was for much larger amounts of silver than I previously observed. In fact, the amount of short selling in SLV shares began to look extreme.
Just a short word on short-selling. Please don’t confuse this discussion on the short selling of shares of the SLV (and GLD and IAU) with the short selling I continually discuss in COMEX silver futures. I know this can be a complicated topic, but it is important for you to understand it. In futures, there must be a short for every long. Therefore, the problem in silver futures is not the presence of shorts, but the documented concentrated nature of this short position, namely, an extremely large short position held by just a few traders. Less extreme concentrations in other commodities have always been considered manipulative by the CFTC in the past; just not now in silver (and gold), for some reason.
In securities, there is no requirement that there be a short position for every share of stock. In fact, that would be absurd. But, due to relaxations in the restrictions on short selling over the past decade by the SEC, the new phenomenon of naked short selling has exploded. Naked short selling in stocks doesn’t involve first borrowing the shares in which to sell short. The naked short seller just sells short without borrowing shares. The short seller then fails to deliver the shares to the buyer on settlement date. The punishment for what is essentially a delivery default? The SEC puts out a (long) list of stocks which have fails to deliver. That’s all it does, it makes a list. No fines, no forced buy backs, no identification of who is naked short selling, no staying after school for detention. And yes, SLV is on that list from time to time. To SLV owners, that should be disturbing.
One last kick in the teeth for SLV and silver investors. All investors who purchase SLV shares must pay in full for their shares (or borrow from their brokers at sky-high margin interest rates). Not only do the naked short sellers not have to deposit a dime for their short sales, nor deposit one ounce of real silver, they receive the full cash proceeds that the buyers put up and get to earn interest and deploy that cash until they buy back their short sales. Which may be never, as no one is pressuring them. This is a Wall Street scam and fleecing of the first order.
While it is simple to prove that both short selling and naked short selling in the SLV exists, it is not easy to quantify the amount. I’m convinced much of the naked short selling is done on an unreported basis. My best current guess of the amount of cumulative short selling in SLV shares since April 15, is between 2.5 to 5 million shares. This represents an amount of silver of between 25 to 50 million ounces. Let me be clear. I believe that buyers have paid for and hold shares in SLV for more than 25 to 50 million ounces of silver than are deposited in the trust. Can I prove this? No. Do I make this statement loosely and without careful consideration? No. Could the amount of naked short sales of SLV be less than my estimate? Yes. Could the amount of naked short sales be more than my estimate? Yes.
In the interest of full disclosure, I did try to take the high road in this matter. Several weeks ago, I notified Barclays Global Investors (BGI), of my specific concerns and asked them to resolve the issue privately. Since I have seen no effort on their part to do so, nor to refute my contentions, I decided to go public with this. In addition, a colleague of mine, Carl Loeb, also wrote to Barclays, which resulted in an exchange that either confirmed or did not deny the information I am describing today.
So what does this all mean to the silver market and, especially, to SLV investors? For the silver market, nothing could be more bullish or more disturbing. If I am correct, one or more Authorized Participants (APs), perhaps even Barclays, are the most likely candidates to be the big naked shorts in SLV. And it is hard to imagine that such naked short sellers of SLV are not one and the same as the big concentrated COMEX shorts.
What makes this so bullish for silver is that there is only one good reason for anyone to naked short sell SLV shares - because the available silver needed to be purchased and put into the custodian’s vault doesn’t exist. Rather than go out and aggressively bid up the price of world silver, it is infinitely easier just to sell shares of SLV short. No one would be the wiser and it keeps the price nice and orderly. But this also confirms that real silver may be unavailable in wholesale quantities. In other words, this would be proof of a wholesale shortage of silver to go along with a retail shortage.
What is disturbing, if my numbers are as correct, is that the same fraud and manipulation of the concentrated shorting in COMEX silver futures, has now spread to the SLV. And, if so, probably by the very same entities. Think about it - why would anyone willing to be short hundreds of millions of ounces of COMEX silver futures, hesitate to sell tens of millions of ounces more in SLV to keep the scam going? In for a penny, in for a pound. In fact, the pressure that has been put on the concentrated COMEX shorts may have forced the manipulators to sell the SLV short, in order to keep the COMEX short position from growing.
But what is most disturbing of all is that, aside from the manipulation connection, the short selling in SLV shares represents something that was only expected to be realized in the future in COMEX silver - a delivery default. If there is the equivalent of 25 to 50 millions of silver sold short in SLV (maybe less, but maybe more), that is equal of 5000 to 10,000 COMEX contracts. If buyers stood for the delivery of 5000 to 10,000 contracts of COMEX silver, and the sellers failed to deliver within the required contract period of time, everyone would know that was a major default and it would result in the most serious (bullish) impact possible for the price of silver and the exchange.
I ask you to use your common sense. If buyers bought and paid for 25 to 50 million ounces of silver in the SLV, as I claim, and the sellers did not deposit the silver as required, but instead just sold shares short, is that not a clear default? Is that not the same as 10,000 contracts defaulting on the COMEX? Just because no one knew it happened, until it was explained to them, does that make it less of a default?
Finally, even if my calculation of how much naked shorting of SLV shares is wide of the mark, I have laid out a scenario that could happen easily and that, to my knowledge, has never been publicly aired. Short selling (and naked short selling) of these shares does exist and those shares do not have silver behind them. At the very least, this should all be nipped in the bud by Barclays and the SEC and any short selling of SLV shares of any type should be strictly forbidden. Keep the short sellers confined to the COMEX and derivatives cesspool. All silver (and gold) investors should be concerned because the unique nature of these ETFs, with their direct connection and convertibility into metal, renders them as potential tools of fraud, manipulation and default.
What should SLV investors do about this? I think a few things. First, don’t rush to sell your SLV shares in disgust and walk away from the silver market. That would be like cutting your nose to spite your face. Silver is close to exploding in price, in my opinion, and to sell out just before that happens would be foolish and cause you to rue the day you did so. But neither should you sit passively with your SLV shares and pretend this short selling is unimportant.
If you can, make the switch to real silver, either in your own possession or in bona fide professional storage. A switch means a simultaneous transfer of one asset to another. Make the arrangements to buy real silver before you sell your SLV shares. Don’t get cute and try to time the market. And for the umpteenth time, professional storage (of 1000 oz bars) involves getting the serial numbers, weights, hallmarks of all bars certified to be specifically owned by you, having the ability of taking actual delivery of these same bars at your demand and storing your silver apart and distinct from the dealer you bought it from. Please don’t ask me about this or that program, just make sure it conforms to these rules.
THE REAL SPECULATORS
By Theodore Butler
(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)
The unprecedented price volatility in crude oil, grain and other commodities has galvanized opinion. "Too much speculation" is the cry of the day. The most visible culprit for the excessive speculation is said to be the commodity index funds. These are huge institutional funds that hold significant long positions in many commodity futures markets (but not in COMEX gold or silver futures). I have previously written about index funds.
http://www.investmentrarities.com/01-16-07.html
http://www.investmentrarities.com/03-04-08.html
http://www.investmentrarities.com/04-01-08.html
There seems to be a political frenzy developing for regulation of the index funds, and perhaps to even force them into selling their long positions and lowering the price of oil and other commodities. While I question whether these index funds should have been allowed to amass such a large position they were permitted to amass their positions legally and openly. Before the index funds are tarred and feathered, let’s clear up a misconception that an influx of index fund buying caused the recent increase in the price of crude. That is not true. The index funds are holding the same size long position in crude oil that they held 10 months ago, when crude oil was $70/barrel. The data clearly shows that long traders on the NYMEX have not been buying aggressively and running up the price of crude. The speculative shorts have been doing the buying. Public COT data proves this. The buying back of previously sold short futures contracts, primarily in the commercial category, account for the bulk of the buying over the past eight months.
There is a short for every long position in every commodity futures contract. When enough shorts panic and buy back their short positions aggressively, prices soar. Oil prices jumped because enough shorts bought back contracts they previously sold short. This prevented their losses from getting larger. To a large extent, this is the trading pattern of most markets.
The real hidden problem with current speculation is that large numbers of shorts are, effectively, trapped in their short positions. Because the index funds hold and don’t sell, regardless of whether prices rise or fall, large numbers of shorts can’t exit their short positions, even if prices fall. The shorts are trapped because the index funds buy and hold for the long term. That doesn’t mean prices can’t go down sharply. For example, the wheat market rose almost 100% and then fell by 40% with hardly a change in the index funds’ large position. When prices do fall, there are no complaints about index funds, just when prices rise.
Recently, some commentators have labeled the index funds as not playing fairly, because they don’t sell, but instead invest for the long term. But there is no rule that anyone can’t invest in futures for the long term. The index funds were clear in their intentions when they came into the futures market over the past several years. Everyone knew beforehand how they behaved and they certainly didn’t sneak into the market. Because they were so big, you could see them coming a mile away. The shorts initially licked their chops, because they knew the index funds wouldn’t demand delivery and thereby attempt to squeeze the shorts. The shorts also knew the index funds would have to roll over their positions constantly, giving the shorts an opportunity to extort spread advantages due to the mandatory roll-over behavior of the index funds.
But there is such a thing as the law of unintended consequences, and that law has prevailed in trading between the index funds and the shorts. When the index funds initially established their positions in oil or grain futures, there was no tight supply. That’s why great numbers of shorts sold into the index fund buying. But then conditions tightened up and the shorts are on the wrong side. Now they are looking for a way out. The easiest solution for the shorts is to have the regulators mandate that the index funds sell.
It doesn’t seem fair to me to label the index funds as guilty speculators when they back their purchases with the full cash value of the contracts and hold for the long term. Now is it fair to cast the short speculators, who are out for a quick buck, as innocent victims? If the regulators want to change the rules against the index funds, don’t pretend these funds are evil and the shorts are blameless. If we get shortages in oil or grain or any other commodity, prices will go higher, with or without the index funds.
There is no index fund participation in COMEX gold and silver futures (the index funds buy gold and silver through the ETFs and directly). So, any arbitrary edict to limit index fund positions will not involve liquidation of gold and silver futures. In fact, any liquidation of index fund futures contracts may limit the choice of where large participants can invest, causing additional buying of precious metals. Lately, I have been struck with the thought of just how few alternatives are available other than silver.
THE REAL ISSUE
The real, but unspoken, motivation in the current index fund debate is the existence of a large number of shorts who are trapped and can’t easily fulfill the contract delivery requirements, nor extricate themselves from their short obligations by buying back their contracts. How can the shorts be secretly rescued from the folly of their own creation that threatens to send many prices explosively higher? Nowhere is the problem of the trapped shorts more extreme than in COMEX silver (and secondarily, gold). Precisely because there is no index fund long presence in COMEX silver futures, the problem for the shorts is worse. The long position is relatively diverse and not subject to an arbitrary edict of forced liquidation. The big shorts in COMEX silver and gold probably wish there was an index fund, or some other big concentrated long position, that they could attack and lobby against to get the shorts off the hook. But the real situation, to the shorts’ dismay, is as opposite as it can get.
While it is my contention that there is a large contingent of short positions trapped in many commodities, only in COMEX silver and gold is that trapped position held in a super-concentrated form. This elevates and intensifies the problem to the highest level. Whereas there is much debate about too much speculation in our markets, such as oil, there is no talk of concentration or the intent to manipulate, two vital components in manipulation. That’s because there is no concentration or intent to manipulate in most markets. Except, of course, in silver (and gold). I don’t think the shorts intentionally manipulated oil or grain prices upward, or that they held a concentrated position. But, public data confirms the opposite in silver and gold, namely, an intentional and documented short-side manipulation.
In the most recent COT for positions held as of June 3, the percentage of the entire NYMEX crude oil futures market held net by the 8 largest shorts was 12.8%. This concentration percentage is generally low compared to most other futures markets, mainly because the crude oil market is one of the largest futures markets. But it is striking compared to the concentrations in silver and gold. The reported concentration of the 8 largest short traders in silver is 53.8% and 57.2% in gold, each more than 4 times the reported short concentration in oil.
These reported figures grossly understate the real concentrations in these markets. When you remove the spread transactions, [long and short at the same time in different months] that makes the comparisons more stark. Removing all the spreads in crude oil raises the true net concentration of the 8 largest short traders to around 19% of the entire market, while the silver percentage jumps to 79% and gold jumps to a new record of 84%, How 8 traders controlling 79% and 84% of an entire market can not be a manipulation, in and of itself, is beyond me.
In terms of equivalent days of world production, the comparisons are off the charts. In crude oil, the 8 largest short traders represent 2 days of world oil production (174 million barrels held short vs. 85 million barrels daily production). In gold, the 8 traders hold short 103 days of world mine production (22.8 million ounces vs. 220,000 daily world mine production). In silver, the 8 largest traders hold short 183 days of world mine production (330 million ounces vs. 1.8 million ounces daily mine production). Under this comparison, gold has a concentrated short position more than 50 times the concentration in oil, while silver is 90 times more concentrated than oil. This is simply astounding.
Now here comes the most important message of this piece. If you think I’m just complaining about the super short concentration in silver and gold in terms of proving they are manipulated in price, you are only partially correct. I want to convey something else. If you agree with my premise that the most plausible explanation for the sudden sharp jump in crude oil prices was due to some panicky short covering, then I ask you to contemplate just what is likely to be the price result when the big shorts try to buy back silver?
I rant and rave about the manipulative and depressing impact of the concentrated short position in silver, but there are big benefits in this manipulation. The price-support this short position places below the market and the explosive effect it will have on future prices must be appreciated. If a small amount of short covering in oil can have a big impact on price, it is hard to imagine what the impact might be from short covering in the much smaller silver market.
This is the beauty of the short concentration in silver (and gold). Because the concentrated position is so large (on both a percentage and real world basis) and held by so few participants, any short covering by any of these short traders is virtually guaranteed to profoundly impact prices. In fact, it is this growing extreme concentration that should tell everyone that the game is coming to an end. That fewer and fewer traders want anything to do with the short side in silver (and gold) means that the manipulators are having to increase their short position and are growing more isolated and desperate. If silver and gold were such good short candidates, more and more participants would be shorting them, not less.
To those who think these short traders are in control and can extend the manipulation in silver indefinitely, please think again. What assures that the short manipulators will fail at some point, are the realities of the physical realm. The shorts can play all the paper games in the world, but the moment a wholesale physical shortage becomes evident, the shorts are toast. I intend to publish information in the near future, which should provide such evidence.
In the meantime, we must try to decipher the events of the day as they occur. I think oil prices recently shot up, just as did wheat and cotton not so long ago, because a number of shorts decided to buy back short positions in a hurry. I know that the short position in silver is held by very few participants, so when they cover, it will not be an event measured at the margin. It will be an event characterized by a change at the core of the market. The short covering in oil, wheat and cotton are just a hint of what’s to come when the shorts cover in silver.
INFLATION NATION
By James R. Cook
Last week the Wall Street Journal started a front-page article on worsening inflation with these words: "Inflation worries are heating up around the world and jolting financial markets in the process." Also last week the government advised that the U.S. inflation rate for the past 12 months was 3.8%. In the face of much higher prices for oil, food and services, the governments figures seem far fetched.
According to the great free-market economist, Ludwig von Mises, inflation is not an accident, it’s a deliberate government policy. Nor is inflation a policy that can last. It must either run away or it must end, thus leading to contraction and a bust. Our monetary authorities don’t want a recession, they intend to inflate at all costs. Mises taught that once the people begin to believe that inflating is a policy that will not end, the currency faces the likelihood of hyperinflation.
The greatest danger to American prosperity would come from the world rejecting the dollar as its reserve currency. If inflation erodes the dollar’s value too quickly, this possibility exists. Then we’d be like any other country, subject to fierce devaluations for our budgetary sins. Balance of payments deficits would be out of the question. Government spending for social programs, subsidies and military adventures would be cut to the bone.
It may sound implausible to you, but runaway inflation has become a distinct possibility. You can see that inflation is worsening and the monetary authorities are continuing to ease aggressively. In this environment, holding all your money in stocks, bond, annuities and savings accounts becomes more risky. If inflation explodes, you can be wiped out. The purchasing power of your money can wither away. That’s why putting 10% of your net worth into tangible silver seems more prudent than ever.
By Theodore Butler
Mid-June 2008
(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)
Today I am going to write on a subject that I feel is of the utmost importance to all silver investors. It’s particularly important to those holding shares of the Barclays silver ETF, traded on the American Stock Exchange under the symbol SLV. Because this may prove to be quite controversial as well, I will attempt to be thorough in my discussion, in the hopes that my words will not be misinterpreted. Although I will try to keep it short and simple, there is much to discuss.
It is just over two years that SLV has been in existence. Trading commenced at the end of April 2006. I started writing about this Silver Trust three years ago when it was first proposed, and have written many articles since then. I have always maintained that the silver ETF was big doings for silver. In just two years the amount of silver held in SLV has grown to 195 million ounces, the largest known stockpile on the face of the earth. Throw in two new silver ETFs from London and Switzerland and total silver ETF holdings jump to more than 220 million ounces. That’s a lot of silver.
It’s no secret why the silver ETFs have proven to be so popular. For the first time in history, they enabled institutional and retirement funds and other stock-only type accounts to easily buy and hold silver. Given silver’s unique dual role, as industrial commodity and investment asset, this was no small development. It is also clear that the advent of the ETF had an important impact on the price of silver. Not as much as I had expected, but still significant. After all, the price of silver tripled after the SLV was proposed. While there were other factors, it was the introduction of SLV that exerted the most influence on the price. Prior to the SLV, silver was locked in a $4 to $5 trading range.
As a silver analyst, I have always recognized the importance of the SLV in the silver supply and demand equation. Key to that issue was the matter of whether real silver backed up the assets of the trust, as Barclays claimed. While some commentators doubted that all the silver claimed to be in the trust was really there, others suggested the silver was being leased out or was being used to suppress the price of silver. However, I always believed that the silver claimed to be on deposit was actually in the custodian’s vaults. I still do. What I will be discussing today doesn’t involve the silver claimed to be on deposit. So much time and attention has been placed on the silver already deposited (or not) in the SLV, that the most important issue has been overlooked. That involves silver not claimed to be on deposit.
(A brief side note here. I’m a (very) independent silver analyst. I write what I feel should be written about concerning silver, with little or no concern for what others may think. I’ve written more than 300 articles in the past seven years that have been underwritten by Investment Rarities, Inc., and made available at no charge to all who care to read them. Not once have I written that readers should buy silver from them, although I do hold them in the highest regard. Nor have I ever taken any potshots at the SLV, perhaps much to the chagrin of the president of IRI, Jim Cook, who rightly views the SLV as a competitor to what his firm sells. I want to thank Mr. Cook for never trying to interfere or influence my analysis on the SLV or any other issue I chose to write on.)
After Barclays decided to follow my public suggestion that they openly list all the weights, serial numbers and hallmarks of the bars on deposit, my conviction that the silver said to be on deposit was reaffirmed. I publicly congratulated Barclays for doing the right thing.
However, I did mention in past articles that I noticed delays, from time to time, in the depositing of silver into the trust for new shares that were purchased. I attributed this to the logistics of physically procuring and transporting the silver to the custodian’s vaults in London. This wasn’t the way the prospectus clearly dictated, namely, that the silver had to be deposited before any new shares were issued or, allowed to be purchased. However, I wanted to save my critiques for more important issues. You learn to pick your battles, and I chose not to harp about a short delay, of a week or two, of a few million ounces of silver being deposited into the trust.
I began to notice this pattern of delay in depositing silver into the trust about six to eight months ago. In fact, the pattern became so regular that I could tell, fairly precisely, when and how much silver would be deposited. I did this by observing the price and volume patterns in the trading of SLV shares. I shared this information with close associates, and could see they were surprised with the accuracy of the pattern.
One thing became clear - in obvious conflict with what the prospectus dictated, there were regular periods when the trust did not have all the silver it should have. In other words, SLV had the silver it said it had, but, at times, there should have been more silver than that. It was also clear to me the mechanism by which this delay could be effected. Buyers of new shares could be issued those shares without new additional silver being deposited through the short selling of shares to these buyers.
Aside from a fascination with observing the pattern, my main take from the consistent delays in depositing silver into the SLV, was that silver was not readily available in London. As an analyst, this told me that the supply of wholesale quantities of silver was much tighter than was generally known. This coincided, of course, with a well-known tightness in retail forms of silver, especially US Silver Eagles (thanks to Izzy’s article)
So here we had evidence of delays in the delivery of both retail and wholesale silver. Many are loath to utter the word "shortage" in connection with silver. They believe that to be impossible or they think the word means no availability at any price. That definition is silly, as there will always be some quantity available at some price. A commodity shortage doesn’t mean that all the silver (or any other commodity) in the world suddenly disappears. The correct definition of a commodity shortage would revolve around delivery delays, not unavailability. In other words, a delay in delivery of both retail and wholesale forms of silver would constitute a shortage. Maybe not a severe shortage, but a shortage nevertheless. Such evidence of delivery delays, in the face of declining prices, should disturb believers in free market principles.
Although these delivery delays into the SLV well after the shares were purchased bothered me, I chose not to complain. (By the way, this pattern can be discerned by the uneven deposit pattern into the SLV compared to its trading volume). The main thing that bothered me was that the shares were being shorted at all.
I am going to make a very straight-forward statement. I don’t think short-selling of any kind should be allowed in the shares of the SLV, nor in the shares of the two publicly-traded gold ETFs, GLD and IAU. Of all the tens of thousands of different common stock and other traded securities that are regulated by the US Securities and Exchange Commission (SEC), these three metal ETFs are very unique and distinct from the rest. Out of tens of thousands of different securities, only SLV, GLD, and IAU call for a rigid metal backing, 10 ounces of silver behind each share of SLV, one-tenth of an ounce of gold behind each share of either GLD or IAU. Investors buy shares of these ETFs because they are assured that this specific metal backing exists. Investors buy shares knowing that the sponsors and custodians guarantee the metal to be there.
But what happens when someone buys shares in these ETFs and the seller is selling those shares short? Does the short seller deposit metal to back up the buyer’s purchase? No. The short seller just sells the shares short without depositing metal, perhaps borrowing other shares first, perhaps not. The buyer doesn’t know who he is buying from, he gets a confirmation of his purchase from his broker, pays for it and assumes, according the representations in the prospectus, that he is buying new shares issued by the sponsor who has deposited metal, or from an existing shareholder who has decided to liquidate his shares. It never occurs to the buyer that he is buying from a short seller who is not depositing metal. In essence, the short seller is circumventing what is promised in the prospectus. That party is short-circuiting and destroying the promise clearly laid out in the prospectus that real metal backs every share sold.
Here’s the disturbing question - which buyers’ shares are left without silver backing when short sellers are involved in the transaction? Just the hapless and unsuspecting buyer who was unlucky enough to happen to have his purchase short sold, or do all SLV shareholders get shaved proportionately, like a silver coin clipped in olden times? Don’t look to the prospectus for answers, because you won’t find any.
For those who were unaware of this and don’t understand how shares can be sold with no metal backing (or doubt my contention), there is hard proof. There is a short position list reported that proves short selling exists. Currently, the SLV shows a small published short position on the American Stock Exchange of around 250,000 shares, or the equivalent of 2.5 million ounces. On March 11, this reported short position hit almost 1 million shares, or nearly 10 million ounces. So, there can be no doubt that some short selling exists, which raises all sorts of disturbing questions. In my opinion, this aspect of the metal-only ETFs wasn‘t fully thought through before their introduction. Unfortunately, the problem may be worse than just this SLV short selling; maybe much worse.
WHAT’S GOING ON?
Around this past April 15 I began to notice a more pronounced delay of silver deliveries into the SLV. This was for much larger amounts of silver than I previously observed. In fact, the amount of short selling in SLV shares began to look extreme.
Just a short word on short-selling. Please don’t confuse this discussion on the short selling of shares of the SLV (and GLD and IAU) with the short selling I continually discuss in COMEX silver futures. I know this can be a complicated topic, but it is important for you to understand it. In futures, there must be a short for every long. Therefore, the problem in silver futures is not the presence of shorts, but the documented concentrated nature of this short position, namely, an extremely large short position held by just a few traders. Less extreme concentrations in other commodities have always been considered manipulative by the CFTC in the past; just not now in silver (and gold), for some reason.
In securities, there is no requirement that there be a short position for every share of stock. In fact, that would be absurd. But, due to relaxations in the restrictions on short selling over the past decade by the SEC, the new phenomenon of naked short selling has exploded. Naked short selling in stocks doesn’t involve first borrowing the shares in which to sell short. The naked short seller just sells short without borrowing shares. The short seller then fails to deliver the shares to the buyer on settlement date. The punishment for what is essentially a delivery default? The SEC puts out a (long) list of stocks which have fails to deliver. That’s all it does, it makes a list. No fines, no forced buy backs, no identification of who is naked short selling, no staying after school for detention. And yes, SLV is on that list from time to time. To SLV owners, that should be disturbing.
One last kick in the teeth for SLV and silver investors. All investors who purchase SLV shares must pay in full for their shares (or borrow from their brokers at sky-high margin interest rates). Not only do the naked short sellers not have to deposit a dime for their short sales, nor deposit one ounce of real silver, they receive the full cash proceeds that the buyers put up and get to earn interest and deploy that cash until they buy back their short sales. Which may be never, as no one is pressuring them. This is a Wall Street scam and fleecing of the first order.
While it is simple to prove that both short selling and naked short selling in the SLV exists, it is not easy to quantify the amount. I’m convinced much of the naked short selling is done on an unreported basis. My best current guess of the amount of cumulative short selling in SLV shares since April 15, is between 2.5 to 5 million shares. This represents an amount of silver of between 25 to 50 million ounces. Let me be clear. I believe that buyers have paid for and hold shares in SLV for more than 25 to 50 million ounces of silver than are deposited in the trust. Can I prove this? No. Do I make this statement loosely and without careful consideration? No. Could the amount of naked short sales of SLV be less than my estimate? Yes. Could the amount of naked short sales be more than my estimate? Yes.
In the interest of full disclosure, I did try to take the high road in this matter. Several weeks ago, I notified Barclays Global Investors (BGI), of my specific concerns and asked them to resolve the issue privately. Since I have seen no effort on their part to do so, nor to refute my contentions, I decided to go public with this. In addition, a colleague of mine, Carl Loeb, also wrote to Barclays, which resulted in an exchange that either confirmed or did not deny the information I am describing today.
So what does this all mean to the silver market and, especially, to SLV investors? For the silver market, nothing could be more bullish or more disturbing. If I am correct, one or more Authorized Participants (APs), perhaps even Barclays, are the most likely candidates to be the big naked shorts in SLV. And it is hard to imagine that such naked short sellers of SLV are not one and the same as the big concentrated COMEX shorts.
What makes this so bullish for silver is that there is only one good reason for anyone to naked short sell SLV shares - because the available silver needed to be purchased and put into the custodian’s vault doesn’t exist. Rather than go out and aggressively bid up the price of world silver, it is infinitely easier just to sell shares of SLV short. No one would be the wiser and it keeps the price nice and orderly. But this also confirms that real silver may be unavailable in wholesale quantities. In other words, this would be proof of a wholesale shortage of silver to go along with a retail shortage.
What is disturbing, if my numbers are as correct, is that the same fraud and manipulation of the concentrated shorting in COMEX silver futures, has now spread to the SLV. And, if so, probably by the very same entities. Think about it - why would anyone willing to be short hundreds of millions of ounces of COMEX silver futures, hesitate to sell tens of millions of ounces more in SLV to keep the scam going? In for a penny, in for a pound. In fact, the pressure that has been put on the concentrated COMEX shorts may have forced the manipulators to sell the SLV short, in order to keep the COMEX short position from growing.
But what is most disturbing of all is that, aside from the manipulation connection, the short selling in SLV shares represents something that was only expected to be realized in the future in COMEX silver - a delivery default. If there is the equivalent of 25 to 50 millions of silver sold short in SLV (maybe less, but maybe more), that is equal of 5000 to 10,000 COMEX contracts. If buyers stood for the delivery of 5000 to 10,000 contracts of COMEX silver, and the sellers failed to deliver within the required contract period of time, everyone would know that was a major default and it would result in the most serious (bullish) impact possible for the price of silver and the exchange.
I ask you to use your common sense. If buyers bought and paid for 25 to 50 million ounces of silver in the SLV, as I claim, and the sellers did not deposit the silver as required, but instead just sold shares short, is that not a clear default? Is that not the same as 10,000 contracts defaulting on the COMEX? Just because no one knew it happened, until it was explained to them, does that make it less of a default?
Finally, even if my calculation of how much naked shorting of SLV shares is wide of the mark, I have laid out a scenario that could happen easily and that, to my knowledge, has never been publicly aired. Short selling (and naked short selling) of these shares does exist and those shares do not have silver behind them. At the very least, this should all be nipped in the bud by Barclays and the SEC and any short selling of SLV shares of any type should be strictly forbidden. Keep the short sellers confined to the COMEX and derivatives cesspool. All silver (and gold) investors should be concerned because the unique nature of these ETFs, with their direct connection and convertibility into metal, renders them as potential tools of fraud, manipulation and default.
What should SLV investors do about this? I think a few things. First, don’t rush to sell your SLV shares in disgust and walk away from the silver market. That would be like cutting your nose to spite your face. Silver is close to exploding in price, in my opinion, and to sell out just before that happens would be foolish and cause you to rue the day you did so. But neither should you sit passively with your SLV shares and pretend this short selling is unimportant.
If you can, make the switch to real silver, either in your own possession or in bona fide professional storage. A switch means a simultaneous transfer of one asset to another. Make the arrangements to buy real silver before you sell your SLV shares. Don’t get cute and try to time the market. And for the umpteenth time, professional storage (of 1000 oz bars) involves getting the serial numbers, weights, hallmarks of all bars certified to be specifically owned by you, having the ability of taking actual delivery of these same bars at your demand and storing your silver apart and distinct from the dealer you bought it from. Please don’t ask me about this or that program, just make sure it conforms to these rules.
THE REAL SPECULATORS
By Theodore Butler
(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)
The unprecedented price volatility in crude oil, grain and other commodities has galvanized opinion. "Too much speculation" is the cry of the day. The most visible culprit for the excessive speculation is said to be the commodity index funds. These are huge institutional funds that hold significant long positions in many commodity futures markets (but not in COMEX gold or silver futures). I have previously written about index funds.
http://www.investmentrarities.com/01-16-07.html
http://www.investmentrarities.com/03-04-08.html
http://www.investmentrarities.com/04-01-08.html
There seems to be a political frenzy developing for regulation of the index funds, and perhaps to even force them into selling their long positions and lowering the price of oil and other commodities. While I question whether these index funds should have been allowed to amass such a large position they were permitted to amass their positions legally and openly. Before the index funds are tarred and feathered, let’s clear up a misconception that an influx of index fund buying caused the recent increase in the price of crude. That is not true. The index funds are holding the same size long position in crude oil that they held 10 months ago, when crude oil was $70/barrel. The data clearly shows that long traders on the NYMEX have not been buying aggressively and running up the price of crude. The speculative shorts have been doing the buying. Public COT data proves this. The buying back of previously sold short futures contracts, primarily in the commercial category, account for the bulk of the buying over the past eight months.
There is a short for every long position in every commodity futures contract. When enough shorts panic and buy back their short positions aggressively, prices soar. Oil prices jumped because enough shorts bought back contracts they previously sold short. This prevented their losses from getting larger. To a large extent, this is the trading pattern of most markets.
The real hidden problem with current speculation is that large numbers of shorts are, effectively, trapped in their short positions. Because the index funds hold and don’t sell, regardless of whether prices rise or fall, large numbers of shorts can’t exit their short positions, even if prices fall. The shorts are trapped because the index funds buy and hold for the long term. That doesn’t mean prices can’t go down sharply. For example, the wheat market rose almost 100% and then fell by 40% with hardly a change in the index funds’ large position. When prices do fall, there are no complaints about index funds, just when prices rise.
Recently, some commentators have labeled the index funds as not playing fairly, because they don’t sell, but instead invest for the long term. But there is no rule that anyone can’t invest in futures for the long term. The index funds were clear in their intentions when they came into the futures market over the past several years. Everyone knew beforehand how they behaved and they certainly didn’t sneak into the market. Because they were so big, you could see them coming a mile away. The shorts initially licked their chops, because they knew the index funds wouldn’t demand delivery and thereby attempt to squeeze the shorts. The shorts also knew the index funds would have to roll over their positions constantly, giving the shorts an opportunity to extort spread advantages due to the mandatory roll-over behavior of the index funds.
But there is such a thing as the law of unintended consequences, and that law has prevailed in trading between the index funds and the shorts. When the index funds initially established their positions in oil or grain futures, there was no tight supply. That’s why great numbers of shorts sold into the index fund buying. But then conditions tightened up and the shorts are on the wrong side. Now they are looking for a way out. The easiest solution for the shorts is to have the regulators mandate that the index funds sell.
It doesn’t seem fair to me to label the index funds as guilty speculators when they back their purchases with the full cash value of the contracts and hold for the long term. Now is it fair to cast the short speculators, who are out for a quick buck, as innocent victims? If the regulators want to change the rules against the index funds, don’t pretend these funds are evil and the shorts are blameless. If we get shortages in oil or grain or any other commodity, prices will go higher, with or without the index funds.
There is no index fund participation in COMEX gold and silver futures (the index funds buy gold and silver through the ETFs and directly). So, any arbitrary edict to limit index fund positions will not involve liquidation of gold and silver futures. In fact, any liquidation of index fund futures contracts may limit the choice of where large participants can invest, causing additional buying of precious metals. Lately, I have been struck with the thought of just how few alternatives are available other than silver.
THE REAL ISSUE
The real, but unspoken, motivation in the current index fund debate is the existence of a large number of shorts who are trapped and can’t easily fulfill the contract delivery requirements, nor extricate themselves from their short obligations by buying back their contracts. How can the shorts be secretly rescued from the folly of their own creation that threatens to send many prices explosively higher? Nowhere is the problem of the trapped shorts more extreme than in COMEX silver (and secondarily, gold). Precisely because there is no index fund long presence in COMEX silver futures, the problem for the shorts is worse. The long position is relatively diverse and not subject to an arbitrary edict of forced liquidation. The big shorts in COMEX silver and gold probably wish there was an index fund, or some other big concentrated long position, that they could attack and lobby against to get the shorts off the hook. But the real situation, to the shorts’ dismay, is as opposite as it can get.
While it is my contention that there is a large contingent of short positions trapped in many commodities, only in COMEX silver and gold is that trapped position held in a super-concentrated form. This elevates and intensifies the problem to the highest level. Whereas there is much debate about too much speculation in our markets, such as oil, there is no talk of concentration or the intent to manipulate, two vital components in manipulation. That’s because there is no concentration or intent to manipulate in most markets. Except, of course, in silver (and gold). I don’t think the shorts intentionally manipulated oil or grain prices upward, or that they held a concentrated position. But, public data confirms the opposite in silver and gold, namely, an intentional and documented short-side manipulation.
In the most recent COT for positions held as of June 3, the percentage of the entire NYMEX crude oil futures market held net by the 8 largest shorts was 12.8%. This concentration percentage is generally low compared to most other futures markets, mainly because the crude oil market is one of the largest futures markets. But it is striking compared to the concentrations in silver and gold. The reported concentration of the 8 largest short traders in silver is 53.8% and 57.2% in gold, each more than 4 times the reported short concentration in oil.
These reported figures grossly understate the real concentrations in these markets. When you remove the spread transactions, [long and short at the same time in different months] that makes the comparisons more stark. Removing all the spreads in crude oil raises the true net concentration of the 8 largest short traders to around 19% of the entire market, while the silver percentage jumps to 79% and gold jumps to a new record of 84%, How 8 traders controlling 79% and 84% of an entire market can not be a manipulation, in and of itself, is beyond me.
In terms of equivalent days of world production, the comparisons are off the charts. In crude oil, the 8 largest short traders represent 2 days of world oil production (174 million barrels held short vs. 85 million barrels daily production). In gold, the 8 traders hold short 103 days of world mine production (22.8 million ounces vs. 220,000 daily world mine production). In silver, the 8 largest traders hold short 183 days of world mine production (330 million ounces vs. 1.8 million ounces daily mine production). Under this comparison, gold has a concentrated short position more than 50 times the concentration in oil, while silver is 90 times more concentrated than oil. This is simply astounding.
Now here comes the most important message of this piece. If you think I’m just complaining about the super short concentration in silver and gold in terms of proving they are manipulated in price, you are only partially correct. I want to convey something else. If you agree with my premise that the most plausible explanation for the sudden sharp jump in crude oil prices was due to some panicky short covering, then I ask you to contemplate just what is likely to be the price result when the big shorts try to buy back silver?
I rant and rave about the manipulative and depressing impact of the concentrated short position in silver, but there are big benefits in this manipulation. The price-support this short position places below the market and the explosive effect it will have on future prices must be appreciated. If a small amount of short covering in oil can have a big impact on price, it is hard to imagine what the impact might be from short covering in the much smaller silver market.
This is the beauty of the short concentration in silver (and gold). Because the concentrated position is so large (on both a percentage and real world basis) and held by so few participants, any short covering by any of these short traders is virtually guaranteed to profoundly impact prices. In fact, it is this growing extreme concentration that should tell everyone that the game is coming to an end. That fewer and fewer traders want anything to do with the short side in silver (and gold) means that the manipulators are having to increase their short position and are growing more isolated and desperate. If silver and gold were such good short candidates, more and more participants would be shorting them, not less.
To those who think these short traders are in control and can extend the manipulation in silver indefinitely, please think again. What assures that the short manipulators will fail at some point, are the realities of the physical realm. The shorts can play all the paper games in the world, but the moment a wholesale physical shortage becomes evident, the shorts are toast. I intend to publish information in the near future, which should provide such evidence.
In the meantime, we must try to decipher the events of the day as they occur. I think oil prices recently shot up, just as did wheat and cotton not so long ago, because a number of shorts decided to buy back short positions in a hurry. I know that the short position in silver is held by very few participants, so when they cover, it will not be an event measured at the margin. It will be an event characterized by a change at the core of the market. The short covering in oil, wheat and cotton are just a hint of what’s to come when the shorts cover in silver.
INFLATION NATION
By James R. Cook
Last week the Wall Street Journal started a front-page article on worsening inflation with these words: "Inflation worries are heating up around the world and jolting financial markets in the process." Also last week the government advised that the U.S. inflation rate for the past 12 months was 3.8%. In the face of much higher prices for oil, food and services, the governments figures seem far fetched.
According to the great free-market economist, Ludwig von Mises, inflation is not an accident, it’s a deliberate government policy. Nor is inflation a policy that can last. It must either run away or it must end, thus leading to contraction and a bust. Our monetary authorities don’t want a recession, they intend to inflate at all costs. Mises taught that once the people begin to believe that inflating is a policy that will not end, the currency faces the likelihood of hyperinflation.
The greatest danger to American prosperity would come from the world rejecting the dollar as its reserve currency. If inflation erodes the dollar’s value too quickly, this possibility exists. Then we’d be like any other country, subject to fierce devaluations for our budgetary sins. Balance of payments deficits would be out of the question. Government spending for social programs, subsidies and military adventures would be cut to the bone.
It may sound implausible to you, but runaway inflation has become a distinct possibility. You can see that inflation is worsening and the monetary authorities are continuing to ease aggressively. In this environment, holding all your money in stocks, bond, annuities and savings accounts becomes more risky. If inflation explodes, you can be wiped out. The purchasing power of your money can wither away. That’s why putting 10% of your net worth into tangible silver seems more prudent than ever.
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