Silver: Do we want to have a free market or do we want shortages?

I am back with my tinfoil hat to write a bit more on the silver market. Doombergs recent article on the copper and oil markets have put things into a bigger perspective for me. In addition I have relied on the work of Nate Fisher and Ronan Manly on the silver market.

Oil

I will start with referencing Doombergs 25. October 2021 article “Doctor Copper Is Sick“ where they started with explaining what happened in April 2020 when the oil price traded negative $37.63 a barrel:

 «The front-month May 2020 West Texas Intermediate (WTI) for delivery in Cushing, Oklahoma is the contract that traded negative and – critically – the Chicago Mercantile Exchange (CME) allowed it to happen.»  

«Whatever you might think about the CME’s decision, few doubt the sanctity of that market now. Participants understood the rules, the rules didn’t change, a clearing price was found, and life went on. Production of oil was curtailed, creative storage solutions were implemented, prices recovered, and excess inventory was worked off in an orderly fashion as the economy rebounded.»

Doomberg

In this case long traders were punished because they did not have a place to take delivery of the oil they had purchased. For anyone who believes in capitalism, this is how you do it. You do not interfere with the price or change the rules. Price is the market clearing mechanism. Everyone in the market knows the rules already, and you do not change them when some of the participants are in trouble. The market was allowed to find a market clearing price at negative $37.63 a barrel, and this was reached without outside interference. 

Copper

On the The London Metal Exchange (LME) however, the price was not allowed to find a clearing price in the copper market:

«somebody was caught naked short and could not make delivery. They collected money from another trader at some point in the past on the promise that they would have copper to give them, but when the time came, they couldn’t make good on their contractual obligations.»

Doomberg

Market participants have to know the rules in the market they operate in. If a naked short sees the price of copper goes up, they have to run around to sellers of physical copper to buy from them. If they can’t find anyone to sell them copper, they can’t deliver on their obligations. (To use GameStop as an example: the short sellers were forced to buy back the shares they were short at prices way above what they had already sold). Those are the rules, and they have not changed. This led the copper price at the short end of the curve to go vertical.

LME interfered and allowed participants with short positions to avoid delivery. The rules were changed. People who have followed the commodities markets have expected copper going up with increased demand, and have taken long positions in anticipation of this. (As we saw in the oil market, being long is not without its risks). Interference to protect short sellers does damage to the market. Inventories of copper were low because supply could not keep up with demand. Increased demand for a product is not manipulation.

«the LME damaged its credibility in the marketplace. It either facilitates price discovery and thereby serves a useful purpose, or it doesn’t. Apparently, it doesn’t.»

Doomberg

The positive take away from the oil and copper market is at least that it is communicated to the market. Many find it is a lot worse in the silver market.

Silver

Moving on to silver I will follow the example of Nate Fisher and make the disclaimer that everything I write about the silver market are allegations only. 

I am using the articles “The Great Silver Conspiracy – should we have hit $50 silver in February? Yup.” by Nate Fisher and “LBMA misleads Silver Market with False Claims about Record Silver Stocks” by Ronan Manly as my reference.

They are very thorough articles so I hope you will read them for reference. I am doing the cliff notes version here:

Starting at $24.85 on 28. January, the price of silver spiked up. Silver was going into the weekend 30. and 31. January at about $27.00. Over the weekend there were massive retail raids of physical silver all over the world, and several sellers sold out their inventory. This had the effect that retail sellers would have to source new inventory. Into Monday 1. February the price of silver went up even more, and hit $30 before ending the day at about $29. A massive move in a short amount of time. The next day on 2. February the paper price on silver was smashed down over $3.50. – This was at a time where there was massive physical interest with retail silver selling out, and money was pouring into vehicles like the SLV and PSLV.

The reason for people buying SLV and PSLV was simple: 

(this) “led many of us to buy SLV or SLV call options expecting the float in the LBMA warehouses to be exhausted and force SLV to go to the open spot market to buy silver at increasing prices. Potentially hundreds of millions of ounces would need to be sourced, and it led investors to believe that the price of SLV would thus go sky high.“

“Now, with SLV, investors at the time were led to believe that if they bought shares in SLV, that SLV would then add the appropriate ounces to the trust.“

Nate Fisher

Over a three trading days period between 29. February and 3. February SLV claimed to have sourced a massive 118 Moz, and barely moved the paper prize of silver in the process. (With a yearly consumption of 1,000 Moz, a three day shock of more than 10% of this is huge). People who did not believe this were asked to take off our tinfoil hats.

Silver investors

“However, it appears that somewhere around February 1st, SLV changed their prospectus to suggest that “not all of the silver is there.”

Nate Fisher

What a coincidence. A fund that at one time had in their prospectus that they had fully allocated to silver, suddenly changed to say it might not be all there.

Later, in April when they closed the books for March, someone found a 110 Moz accounting error in “one of the LBMA vaults”. (Tinfoil hat back on).

«In short, instead of silver holdings in LBMA vaults having risen by 3,863 tonnes (or 11%) in March, the new LBMA claim is that the silver inventories rose by 561 tonnes (or 1.6%). Which is 6.88 times less.

Instead of a 124.2 million oz increase, the increase was 18 million, a difference of a massive 106.1 million ozs. Instead of record silver holdings in London, there was no record. Therefore, the folks at the Guinness Book of Records are not needed. The record still belongs to March 2020, when 1.175 million ozs of silver was claimed by the LBMA to be stored in London.»

Ronan Manly

There are a lot more factors in play here, but I suggest you read the two articles I have linked on the subject. In short what happened was the following:

SLV misled investors to think they had added 118 Moz of silver, and they did not. (If they had gone out into the spot market to buy these 118 Moz, the silver price would have moved significantly, and sharply higher. In turn, this much higher price would have attracted even more buyers and speculators – driving the price even higher. Silver and many commodities act like a Giffen good: A good that people consume more of as the price rises). Furthermore, SLV changed their prospectus during this time, before they months later discovered the accounting error.

I can attest to, as a person who works in accounting, and has reporting every month, that in even smaller companies you will have some quality control over what you report. If there is a big change month over month in a reported number, it will always be investigated, verified and commented on. «I see we have a 10% increase in inventory this month. What is the reason for this?» Is something that will be asked in situations like this. Especially if holding bullion is your main business. The responsible for purchasing and logistics then have to confirm it. People make the entries, and we always have to double check for human error.

The only thing I am unsure of in this case is what price we could have seen in February. Could it have hit $50? One can never know how things would have played out without interference. I am sure that when price was not allowed to spike up, and find willing sellers, we have just kicked the can down the road. The market has not been given price signals to increase production, and companies like First Majestic are holding back part of their production. People around the world are seeing rising prices. Those who have read up on history are buying real assets, cryptocurrencies, commodities and precious metals. I am sure we will see situations later where we will have a similar run on silver, and there will not be enough to go around. The playing card with “accounting error” will not be possible to use again. Silver investors have also learned not to use vehicles like SLV, and will only buy physical or use PSLV that actually stack silver for their customers.

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