SILVERAXIS - TODAY IN SILVER

If I get enough interest, I’ll be putting up a post like this periodically to provide a place for SILVERAXIS readers to report their recent success or lack thereof in finding reasonably-priced silver and gold bullion. I also invite dealers themselves (anonymously if they wish) to post what they are seeing in the market as well as what they currently have in inventory. So, if you are out talking to dealers, you might want to mention this website to them as I believe these postings could be useful to both buyers and sellers. I would prefer at this point not to see glowing recommendations but simply objective information about retail bullion market conditions and inventory. These posts will be placed under the Category and Tag “Retail Survey” so historical postings can be easily found. Once our subscription service is up and running, we’ll have a more sophisticated way of doing this. For now, however, please comment as appropriate and don’t forget that you can always do so anonymously (well not totally, as I will know the IP address of your ISP, but that is about as anonymous as it gets on the Internet).

I said before that the 2 or 3 “U.S. Banks” that have reported, per the Bank Participation report published by the CFTC, a huge short position in COMEX silver and gold were not “money center banks” or “dealers”. Well, after an exhaustive review of the bank quarterly Call Reports filed by each U.S. commercial bank with the Federal Financial Institutions Examination Council (FFIEC), it seems that I’ve established that in fact the primary U.S. banks involved in the futures market are the usual suspects after all. The specific banking entities reported by the CFTC are not “dealers” per se in the sense of being futures brokers but they most definitely have “swap desks” and they are “money center banks”.

Before getting to my findings, I will discuss the process I used so you can try to recreate, if you wish, what I did. First, I took the Quarterly Banking Profile as of 6/30/08 issued by the FDIC and noted the total “Commodity & Other” derivatives were $1.137 trillion in notional value across all FDIC insured commercial banks and state-chartered savings banks. See Table VI-A on page 11 of the report. Also, I noted that “Futures & Forwards” were $23.6 trillion. In addition, I noted that more than 99.9% of derivatives were held by banks with assets greater than $10 billion. Then I ran an “FDIC - Statistics on Depository Institutions” report that matched and reconciled the derivatives totals to the Quarterly Banking Profile. This statistical report indicated that the top 84 commercial banks over $10 billion in assets held the vast majority of commodity derivatives and all futures and forward contracts, while the top 48 savings institutions held almost none. Note that savings institutions file quarterly Thrift Financial Reports, not Call Reports, and the TFR does not provide notional amount information on derivative positions (only market value or credit risk equivalents are reported). Still, we can safely assume that savings and loans are not involved in commodities or futures and forward contracts to any large extent on a notional basis (this is probably why they don’t report the notional amount of derivative positions in the TFR).

Next, I ran the Call Report for each of the 84 commercial banks with assets over $10 billion as of June 30, 2008 and came up with the following (Schedule RC-L, Page 29).

Total Commodity and Equity Futures & Forwards Notional Amount: $308.1 billion (from FDIC Statistics report — this is the closest breakdown for commodities)

COMMODITIES (including off-exchange forward contracts):
(1) JP Morgan Chase Bank, National Association: $126.3 billion (futures only: $74.5 billion)
(2) HSBC Bank USA, National Association: $36.2 billion (futures only: $4.5 billion)
(3) Citibank, N.A.: $16.8 billion (futures only: $15.1 billion)
(4) Bank of America, National Association: $12.6 billion (futures only: $12.2 billion)
(5) Wachovia Bank, National Association: $12.2 billion (futures only: $12.2 billion)
(6) Bank of Oklahoma, National Association: $0.3 billion (futures only: $0.3 billion)
(7) Other: $0.1 billion
TOTAL COMMODITIES: $204.5 billion (futures only: $118.8 billion)

EQUITIES ((including off-exchange forward contracts):
(1) JP Morgan Chase Bank, National Association: $82.3 billion
(2) Citibank, N.A.: $15.0 billion
(3) Bank of America, National Association: $4.0 billion
(4) Wachovia Bank, National Association: $1.1 billion
(5) Suntrust Bank: $0.3 billion
(6) Other: $0.9 billion
TOTAL EQUITIES: $103.6 billion

Not a lot to be surprised about except I didn’t think Wachovia would have that much in commodity futures ($12.2 billion). What does come as a bit of a surprise is that more than 99% of commodity (and equity) futures and forward contracts held by U.S. banks are concentrated in just 5 institutions. Yet if we look back at the Bank Participation report for July 1, 2008 (which corresponds very closely timewise with the 6/30/08 Call Reports), we indeed can see that no commodity futures were held by more than 5 U.S. banks. And now we know the names of those 5 banks: JPMorgan, BofA, Citibank, HSBC and Wachovia.

Let me note at this point that even though the Bank Participation report showing the huge increase in COMEX gold and silver short is dated August 5 (more than a month after the June 30 Call Reports), there is little reason to believe that the top 5 banks have changed. Indeed, I’ve looked at a selection of historical Call Reports and did not see a lot of change in the composition of the top futures-holding (or should we say wielding) banks.

So, which of the 5 are the actual 2 big shorts in COMEX silver and 3 big shorts in COMEX gold? Well, the Call Reports seem to reveal that as well (Schedule RC-R, Page 40):

JPMorgan
Gold Contracts: $85.2 billion
Other PM Contracts: $10.9 billion

HSBC
Gold Contracts: $27.5 billion
Other PM Contracts: $6.9 billion

Citibank
Gold Contracts: $0.5 billion
Other PM Contracts: $3.0 billion

Bank of America
Gold Contracts: $0.4 billion
Other PM Contracts: $0.2 billion

Wachovia
Gold Contracts: $0.0 billion
Other PM Contracts: $0.0 billion

Bank of Oklahoma
Gold Contracts: $0.0 billion
Other PM Contracts: $0.0 billion

Note that it makes sense that 2 of the 3 are JPMorgan and HSBC simply because these two have the largest commodities forward contract books of business ($83 billion out of $85 billion or so). The third (in COMEX gold) is likely to be Citibank, which has a $1.7 billion commodities forward book of business, although it could very well be Bank of America. We should know when the 3rd quarter Call Reports come out later this year assuming one or more of these banks made a killing shorting gold and silver (gains and losses on derivatives are reported in the Call Reports, although without breaking out commodities separately).

You can draw your own conclusions at this point but I would like to make a couple of observations before I’m done. First, the very large commodities forward contract book of business run by JPMorgan and HSBC could very well mean that the huge COMEX short futures positions that showed up in the August Bank Participation report are hedges or offsets against the forward contracts. The 33,805 COMEX silver contracts have a notional value around $2.5 billion, and the 90,568 (I’m counting both long and short) COMEX gold contracts have a notional value around $7.7 billion. JPMorgan and HSBC’s commodities forward contract books of business are almost an order of magnitude larger than this.

Second, based on some of the incongruities between the Bank Participation and COT reports that I’ve already pointed out, I believe it is somewhat likely that the huge COMEX silver and gold short positions of the 2 or 3 U.S. banks (I am no longer placing “U.S. banks” in quotes because I have now determined they are in fact just plain old U.S. banks in the generic sense of the word) represent an intercompany transfer between the futures dealer subsidiaries and the banking subsidiaries of JPMorgan and HSBC. Such a transfer could be accomplished by having the banking entity enter into a swap with the dealer entity. What would remain on the dealer’s book is just the forward contract.

Now, I understand if you are scratching your head in bewilderment as to why the dealer and bank subsidiaries of a bank holding company would bother to do such a swap. Well, I have an answer for that as well. Take a look at the CFTC Financial Data for Futures Commission Merchants reports. Do you notice anything interesting? Hint: HSBC Securities and JP Morgan Futures (I’m talking about the futures dealer subsidiaries otherwise known as Futures Commission Merchants) have relatively little “Adjusted Net Capital” compared to a number of other futures dealers. In fact, their reported capital (HSBC Securities: $829 million; JPMorgan Futures: $1.7 billion) does not come anywhere near to being able to support the total notional amount of commodities futures contracts (HSBC Bank USA commodities: $36.2 billion; JPMorgan Chase Bank: $126.3 billion) and futures contracts in other markets (for example, JPMorgan Chase Bank has $1.2 trillion–trillion with a “T”–in interest rate futures contracts alone) held at the bank level, as reported in the respective Call Reports.

Thus, it appears that the swap of forward contracts for futures contracts is being driven by the need of the JPMorgan and HSBC banking subsidiaries to hold most of the consolidated capital reserves. And that, in turn, could be the result of the massive loan write-offs on subprime mortgages and collateralized securities, which apparently have required JPMorgan and HSBC to boost banking reserves at the expense of the reserves held at the futures dealer subsidiaries. You can see what I’m talking about by reviewing some of the historical Futures Commission Merchant reports, noting that most other large futures dealers have increased their reserves by a multiple in the past couple of years whereas JPMorgan and HSBC have remained near historic levels despite a large increase in their futures trading activities.

One final note. JPMorgan and HSBC are obviously huge individual players in the gold and silver markets and that includes the COMEX. The Call Reports prove, I believe, without a shadow of a doubt that these two U.S. banks constitute a significant portion, and probably the outright majority, of commercial short positions (both gross and net) in COMEX gold and silver futures. That might get the conspiracy-minded among us to start hootin’ and hollerin’, but I do want to point out that JPMorgan and HSBC have a much larger book of forward gold and silver contracts than they do COMEX gold and silver contracts. As a result, it is impossible to conclude with any degree of certainty that the COMEX gold and silver short positions are not in fact hedges of forward gold and silver long positions. Unless, of course, we have an agenda and a propensity to jump to conclusions.

Silver and gold did not hit new lows yesterday even though the U.S. dollar made a fresh high before falling back. No doubt crude oil had something to do with this as hurricane worries in the Gulf of Mexico put a weather premium back into black gold. But, crude oil didn’t seem to have a lot to do with the gorgeous bottoming pattern that au/ag exhibited after Asian markets closed yesterday. Even if yesterday doesn’t mark the actual final bottom (yesterday’s rally started from $13.00 silver and $807 gold) — something I suspect might be true based on the dollar and oil not having reached exhaustion — this is the type of pattern to look for when we suspect one might be forming.

Speaking of Asian markets, I am hearing more and more chatter that indeed the Far East was a major source of the recent U.S. dollar buying binge. I’ve already speculated about this but I see more confirmation each day. If I get a chance, I’ll try to put together some references. In the meantime, if any of you have already gathered evidence to support this contention, please post links in the comments section below.

Please note that any post with more than 2 links requires manual moderation on my part (which can take a day or two). This is an automatic spam filter (I guess spam comments often have more than 2 links). Oh yeah, please don’t post any spam as I will block your IP if the spamming starts to get bad (only a couple so far). In any case, you can always post several comments back to back if you have more than 2 links.

Here is why I think it is important to know from where the U.S. dollar buying is coming. One, it can give us a hint as to how long it will last. Two, it can give us a signal when it is over. Three, it can put things into perspective (are au/ag headed for a bear market?)

If the U.S. dollar buying is coming primarily out of Asia, it could be the result of Chinese currency intervention. Assuming Chinese exports are starting to fall as the global economy slows down, Chinese domestic production is also starting to slow, and Chinese inflation is soaring, the Chinese have good reason to buy the U.S. dollar in an attempt to devalue the Renminbi. At the same time, they also have good reason to dump commodities (especially those they might have accumulated in excess during the past few years). Many have wondered how U.S. Treasuries have been able to hold up in this fiscal environment: Chinese buying provides the answer. Finally, I will even give a nod to the conspiratorial angle by pointing out that China has often been suspected of playing a much larger role in the silver markets than it has admitted. There is simply no way to tell how much silver China has in stockpiles. It could be millions of ounces. It could be none. Or it could be a billion ounces or more. Thus, it cannot be ruled out if China is dumping commodities that it might be dumping a relatively larger portion of the one commodity in which it has a relatively larger stake. While I don’t view this as likely, it could certainly explain why silver has sold off so dramatically.

Should the above Chinese theory prove to be the case, it is actually quite positive for gold and silver since there is always a finite limit to currency intervention. For one, it gets more and more expensive. Moreover, it usually proves itself to be futile rather quickly. We might, however, see it appear and disappear a few times over the next several months as each intervention phase is given a chance to work before a new one is embarked upon. What would constitute an intervention “working” and thus being complete? Simply that the Chinese are hitting growth and inflation targets. Conversely, the alleged intervention could be abandoned as useless if the targets are being badly missed. I suppose a gold and silver optimist might look at that as a coin with two heads.

The Great Gold, Silver Conspiracy Explained
Mike Shedlock
August 27, 2008

Mike “Mish” Shedlock takes no prisoners in his blast at conspiracy theorizing in the gold and silver camp. While much of his logic is dead on, he does flippantly dismiss several factors that deserve more analysis. For example, the large short position by the two “U.S. Banks” constituting Ted Butler’s “naked gun” does not appear merely to be a matter of longs and shorts doing their thing in the futures markets (it could turn out to be that but right now it does not appear that way).

Similarly, what we recently saw in the silver market, where the price traded down dollars at a time in illiquid electronic markets yet market orders were filled with almost no slippage, does not appear to be merely a matter of longs and shorts doing their thing.

Furthermore, Mish states the following: “When a long sells his position, a short automatically covers.” This is either ignorance or gross oversimplification. A long, of course, may sell his position to another long. In fact, the only way to determine whether a long is selling to another long who is establishing a new position or to a short who is covering a short position is by looking at open interest. But since the open interest figure is only available on a daily basis, as an analysis tool it is more often a sledgehammer than a scalpel. Still, that doesn’t mean we should ignore it.

Also, Mish has no answer for why silver “lease” rates are negative, which clearly means he does not understand that these “lease” rates have nothing to do with actual leases at all. As most of my readers know by now, the gold and silver “lease” rates are simply the arithmetic difference between LIBOR (London Interbank Offered Rate) and the LBMA forward rate (the price at which metal can be purchased for delivery on the LBMA in 1, 2, 3, 6 or 12 months). The main reason the silver “lease” rate is negative today is because LIBOR has decreased faster than the forward rate on silver. This has several implications but perhaps the most obvious is that the balance between forward demand and supply of silver has shifted toward the demand side. In other words, there is currently less forward supply of silver to meet forward demand then there was a couple of years ago. That makes the silver forward rate very close to that of gold (whose own low “lease” rate is partially a reflection of gold producers not wishing to sell production forward).

Is the negative “lease” rate due to fraud or manipulation? Not in my opinion. There are a number of reasons that account for the recent shift. One is the reduction in the volume (supply) of silver being “leased”. Another is the buying of “silver streams” by Silver Wheaton which means that a growing number of base metal or gold miners no longer have the “need” to sell forward their by-product silver production. Notice this is a similar situation to the lack of forward selling by gold producers in the past couple of years.

This is rich subject and I can discuss it ad nauseum, but I’ve already done that in the past (see my exposition [PDF] on “leasing”) so I would prefer to answer only specific questions, which I will do in response to any comments on this post.

Silver and gold meandered today along with oil and the U.S. dollar while it was the stock markets’ turn to get trounced.

The Barclays iShares SLV added another 2.2 million ounces last Friday. If you can’t find silver or gold bullion to buy at a reasonable premium, I would at least urge you to look into this or other ETFs (GLD) for a temporary trade. As always, easy does it with dollar-cost averaging will get you the best deal should silver go down marginally from here.

Tulving ( www.tulving.com ) and some other U.S. dealers now have some limited inventory although with steep premiums in silver. For example, $3 premium on silver Eagles and 40 cent premium on junk 90% U.S. silver coins. I wouldn’t recommend doing the bulk of one’s buying at a $3 premium to spot price, so the junk bags seem like the better deal. On the other hand, the $3 premium on the silver Eagles might make sense if this is one of a series of purchases. After all, you’d be paying just over $16 per silver Eagle, which is still the lowest price of the year. On the other hand, if silver prices persist near these lows for several months due to some strange reason (such as continuation of a temporary commodities bust like the one in 1974-76), bullion supplies could build back up a bit and these high premiums could ease.

A quick note on the Bank Participation Report which is purported to be a smoking gun of manipulation in COMEX gold and silver. First, I actually think the appropriate term is “naked gun”. Second, I am finding it impossible to reconcile this report with the COT data. Note the following (numbers refer to contracts not ounces):

July 1
Open Interest: 130,495
2 “U.S. Bank” COMEX silver short position: 6,199 (4.8%)
Gross commercial short position in COMEX silver: 92,817
Gross non-commercial short position in COMEX silver: 9,925
Gross short position concentration in COMEX silver, 4 or less largest traders: 47.1% (61,463)

August 5
Open Interest: 133,255 (+2,760)
2 “U.S. Bank” COMEX silver short position: 33,805 (25.4%) (+27,606)
Gross commercial short position in COMEX silver: 90,678 (-2,139)
Gross non-commercial short position in COMEX silver: 9,649 (-276)
Gross short position concentration in COMEX silver, 4 or less largest traders: 51.0% (67,960) (+6,497)

Note that both the commercial and non-commercial short position actually shrank between July 1 and August 5 when the 2 “U.S. Banks” (note that I am putting this in parentheses since these are not just any two U.S. banks but rather U.S. banks that are not futures dealers) apparently added 27,606 short contracts. This seems impossible especially since open interest increased by only 2,760 contracts during the same time frame. Where did these 2 “U.S. Banks” get all of these short positions? Even more puzzling, the gross short position concentration ratio increased by only 6,500 contracts (4% or so) while the two “U.S. Banks” supposedly increased their short positions by 20% of open interest. Things get even further away from reality when we look at the concentration ratios of the 8 or less largest traders.

In fact, if both the Commitments of Traders and the Bank Participation reports are correct, it would mean that a huge shift in the composition of the commercial category occurred during July. In particular, the large concentrated commercial dealers seem to have handed over to a couple of non-dealer “U.S. Banks” a huge COMEX short position right before silver had its biggest and fastest drop in three decades. How likely is that? If it isn’t that likely, I suggest this “naked gun” theory may yet turn out to have a few twists and turns.

Another 3,300 short contracts were covered between yesterday and today in COMEX silver and although silver actually fell during the session, the white monetary metal was very well behaved in doing so considering that the dollar took back most of its losses and crude oil gave back most of its gains of the past two days. The short covering should come as no surprise with first delivery notice for the September contract coming next week. Basically, what’s happening is that the commercial shorts are simply exiting their September positions without rolling all of them forward to December.

Speaking of which, here is something those of you who have followed my live au/ag basis presentations might appreciate. You might recall that we roll the calculation forward to the next active month when we are within 10 days of option expiration. The reason we do this is precisely because of what’s happening in the September COMEX contract right now: a disproportionate amount of buying by shorts looking to cover in the expiring contract as compared to buying in the next active month. Simply put, the short covering distorts the basis calculation because it represents distorted buying in the nearby contract that we use as a proxy for the spot price.

I’d like to wrap up this busy week with some hope that gold and silver will soon finally start to outperform the commodity markets (and most other markets as well). Sure, that out-performance may not always look pretty (as it was not today). I suppose it’s a good thing, then, that beauty is only skin deep. And I don’t mean that only in a figurative sense. What I mean is that it is too easy to fall under the spell of silver and gold as the savior from the world’s troubles at every twist and turn. Too many people give up on the monetary metals because they are not the answer to every ailment as some would have you think. Unfortunately, that decision is bound to be financially deadly for many, many people. The closest analogy I can think of would be the refusal to take a snake bite antivenom because it will not cure your cold, regardless of the fact that you have indeed been bitten by a snake.

I’m not obsessed with Mr. Butler, I promise, but I have to wonder if our recent debate didn’t sharpen his and his cohorts’ pencils. I still owe the final installment of my exchange with him in which I address the Central Fund of Canada. In the meantime, however, Mr. Butler has uncovered something that should give pause to even the most ardent manipulation denier. Between July 1, 2008 and August 5, 2008, two U.S. banks apparently went net short 28,000 COMEX contracts, or more than 20% of the entire open interest. COMEX gold saw similar short positioning by 3 U.S. banks. My quick review of these reports did not reveal any other commodity with such a significant buildup of short positions by the U.S. banks between July and August.

It’s no surprise Mr. Butler published his second article of the week (a real rarity) to proclaim this as the proverbial smoking gun that offers proof of downward manipulation of COMEX silver and gold by large dealers. I’m not ready to jump to such a conclusion because there are some key questions that must be answered first (see below for some). However, the facts simply look bad. Sort of like all those put options on airline stocks that were supposedly purchased right before 9-11.

In the past, I have often felt that the CFTC was being badgered with well-meaning but misinformed requests from silver investors to look into Mr. Butler’s claims. This time, however, I believe the CFTC owes the public an investigation that explains exactly what is going on here. Especially since the CFTC’s recent vigilance (I use that term lightly and in a relative sense) uncovered major speculative activity by a trader who was improperly designated as a commercial trader in the NYMEX crude oil market.

I would note that my Hung Brothers theory does not actually get skewered by this discovery. The two U.S. banks that show up on the CFTC reports may have been placing these trades as offsets to positions they entered into off-exchange (OTC). In other words, it is possible that the Hung Brothers had spread trades or other strategies that placed the long leg of their trades with these 2 U.S. banks whereas the short leg was traded through an entity not included on these “market participation” reports.

I should clarify at this point that the U.S. banks to which these reports refer are NOT the dealers with swap desks such as HSBC, JPMorgan, Chase, Scotia Mocatta, etc. In other words, they are not the usual suspects that Mr. Butler and others perennially accuse of manipulating gold and silver. These are regional, non-money center banks that don’t have their own futures clearing operations and whose futures and options trading is being done for internal reasons. These reasons could very well include the offsetting or hedging of over-the-counter derivatives positions, and therefore it is premature to conclude that the 2 U.S. bank in COMEX silver or 3 U.S. banks in COMEX gold have actually profited from these short positions.

Now, for a few questions. There are literally dozens more and I urge the CFTC to address this issue immediately to clear them up.

1) Were these U.S. banks trading for their own accounts or hedging in a commercial capacity?

2) Where do these large positions show up in the COT Reports?

3) Did the banks actually cause the decline by putting on these positions, or was it perhaps a “put options on airline stocks before 9-11″ scenario?

4) How did silver manage to remain within its trading range above $16.50 as of August 5 with so many contracts being sold by these U.S. banks?

5) Is there a connection with the very strange activity I saw where silver would fall 50-100 cents on 1-minute and 5-minute bars yet fills on stop market orders were still extremely tight (Hung Brothers)?

6) How did these banks manage to create such a large short position without a significant change in open interest?

Au/ag went on a vigorous rally today as crude oil had one of its best sessions ever and the dollar pulled back from its highs. At one point crude traded above $122, a full $10 higher than just 24 hours earlier. I’ve talked enough about short covering in the past few days, but now we’ve actually seen what it can look like (in NYMEX crude oil at least). Copper and corn both did almost as well, clobbering the impressive gains of au/ag.

So, where to from here? Well, it looks like there was some more short covering in COMEX silver too yesterday, with a reduction in open interest of 2,000 contracts based on preliminary NYMEX data. If confirmed, this would be a decline in open interest of 7,000 contracts from its recent high of 140,000. Should conditions remain aligned in silver’s favor, I would expect short covering to accelerate in the days ahead, feeding the present rally.

Now let’s quickly look at those conditions. The two main drivers in the ultra short term remain crude oil and the U.S. dollar. Personally, I have some doubts that crude will be able to leverage the rally of the past two days. There are still some strong technical (if not fundamental) reasons why the gooey stuff might need to visit the $102 level or so. On the other hand, these reasons will be invalidated should crude manage to climb above $128.50. We’ll have to see if the current war of words between the “West” and Russia will do it. Also, there was a report released today that claims a single trader held 11% of the long positions in NYMEX crude last month and may have been improperly classified in the commercial category. Man, talk about concentration! Why am I not surprised this was on the long side? In any case, a CFTC investigation of the NYMEX crude market may further cool off whatever overheated speculation might exist.

With respect to the dollar, it might be unwise to count it out completely just yet. The 77.50 level basis the Dollar Index did repel initial test attacks, but the pullback wasn’t as immediate or as strong as one might expect if in fact this was an exhaustion move. Moreover, the Euro still appears bound ultimately for the 1.430 level from the current 1.485 or so, which corresponds with the 80.00 level or so in the Dollar Index.

The above assessment may seem pessimistic in terms of au/ag prices, but due to the very strong physical buying and the vast improvement in market internals, I expect any forthcoming weakness to be of the “two steps forward, one step back” variety. I don’t believe the recent lows would be taken out by more than a marginal amount, if at all. I can’t rule out a final capitulation move that results in a seminal bottom as the vast majority of speculators get flushed out, especially if it turns out that speculative long positions are quickly built back up in the next few days and weeks. By contrast, if the dollar does continue to sink and oil rise. then the $3-4 rally in silver would still be in play (to the $15-16 level). My current approach is to attempt to cover both possibilities using the strangle, which is a pairing of a long call and put option designed to take advantage of significant price movements in either direction. Since September COMEX silver expires in just a few days and its options have failed to cooperate by falling below my maximum buy price, I will be looking at October and later COMEX gold as well as options on the gold ETF, GLD.

Some of us have speculated before about the reason Barclays split the silver iShares 10-to-1 (and some other ETFs by varying amounts) on July 21. Personally, I thought it had to do with added liquidity, an attempt to align the ETF’s price with the underlying (silver bullion) itself, attracting smaller investors, and/or a desire to move toward real-time NAV calculations like big-brother GLD. Well, I was wrong. What it had to do with was the reduction of the basket size, or the minimum ounces of silver that the Authorized Participant needs to deliver to/from the iShares Trust in exchange for receiving or redeeming a corresponding number of shares.

Before, an Authorized Participant who wished to profit from closing any gaps between the price of SLV and the price of spot silver would have to either (1) accumulate 50,000 shares before redeeming them for 500,000 oz. silver or (2) distribute 50,000 shares after delivering 500,000 oz. silver. This may not seem like a lot based on SLV’s average daily trading volume of over 500,000 (pre-split) shares per day, but considering that the price of SLV rarely meanders very far from par, a 50,000 share position may actually present some holding risk to some Authorized Participants. At a minimum, it might not be a very attractive proposition.

In fact, SLV appeared on the Reg SHO Threshold list for several days earlier this year, most likely due to Authorized Participants selling shares in advance of acquiring a basket. This is known as short selling and since ETF shares can be particularly difficult to borrow, it can easily result in fails to deliver (which some call “naked” short selling). Doing so allows the Authorized Participants to accumulate the 500,000 oz. of silver incrementally and therefore take advantage of even relatively small price gaps. Given all the tinfoil hat speculation in the gold and silver camp about the existence of metal backing, however, it’s a particularly undesirable thing for SLV (or GLD) to appear on a list of securities with delivery failures (”naked” shorts).

With the recent split, an Authorized Participant need only deliver 50,000 ounces of silver in each basket. That is obviously a much easier task and means that the spread, if any, between the price of SLV and the spot price of silver should be tighter than ever. When making your own comparisons, don’t forget that the net asset value per SLV share will decline over time as a result of the annual 0.5% administrative fee. For example, each SLV share currently represents not one ounce of silver but rather 0.9885 oz.

But judging by the large additions of silver to SLV in the past few days — a total of 9.2 million ounces or 286 tonnes since last Friday — the 10-fer-1 split has had another effect. Namely, it may have actually increased the pace at which silver is being added to the Trust. Think of it like the difference between water and sand flowing through a sieve. Since water particles are much smaller than sand particles, they travel through the openings faster. This is true even when the openings are much larger than the average sand particle. There is usually some sifting of sand required to keep the material moving at a decent pace.

With SLV baskets more like water now than sand, we may see the premier silver ETF go on an absolute gobbling spree in the months ahead. This on top of SLV being possibly one of the most strongly held investment vehicles out there with virtually no decline in its holdings after a 40%+ price drop. The future of SLV and silver could be quite interesting!

After the prior post about my recent exchanges with Ted Butler, this feels like slowly pulling a band-aid with the scab stuck to it off a flesh wound. In other words, it would be better at this point to just let this all go and allow whatever healing might take place to do so on its own. Unfortunately, Mr. Butler insists that a mutual misunderstanding is instead actually a sleazy attempt by me to discredit him. Most of you know that I’m not like that, but I’m going to put this on the record just in case, and then move on. I promise that I will never, ever, respond to an e-mail from Mr. Butler again. I’ve had people make death threats against me as I curiously (sometimes like a bull in a china shop) traipsed the silver market to and fro. Those episodes turned into mutual forgive and forget. This one will be forget and forget. But first, I gave my word and I’m not going to go back on it even if I have a good reason.

(1) I used the term “libeling” in my August 8 commentary to refer to Mr. Butler’s repeated statements alleging without proof that Barclays’ Silver iShares Trust does not hold one ounce of silver (less fees) for each issued SLV share. Mr. Butler has been stating this as fact based on his supposed findings that SLV fundholders have been the victims of rampant, unreported naked short selling by Barclays and the Authorized Participants. These findings are apparently the result of his analysis of SLV’s daily trading volume. Yet as I’ve pointed out before, unreported short selling does not show up in reported trading volume. Putting all that aside, Mr. Butler has asked me to retract the term “libeling” because he feels that his efforts are justified and his motives lack malice. Since I have no reason to comment on Mr. Butler’s motives, nor do I care a whit about them, I am making the following amendment to my August 8 statement: Yet apparently the detractors are not satisfied with libeling questioning Barclays and its silver ETF, SLV.

(2) Mr. Butler claimed in the same editorial that Central Fund of Canada (AMEX: CEF, TSX: CEF.A) had not yet received the 3.5 million ounces or so of silver it purchased in July because of a “delay”. To this, I responded on August 8 with the phrase: “This is truly sad”. My implication was clear: I believed Mr. Butler to be sadly wrong. Well, Mr. Butler called me on it, and I offered to check with his source. The source turned out to be none other than CEF itself. During my fact-checking phone call with CEF’s chairman Philip Spicer, I learned many things but two that are relevant to the matter at hand. One, that CEF indeed had not received the silver purchased in July as of August 13th. Two, that CEF, as of August 13th, did not expect to have already received the silver it purchased in July and therefore it was not considered a delay. The story doesn’t end there because I feel more has to be said about CEF. But for now this is sufficient to define the extent to which Mr. Butler and I were right or wrong.

(3) Mr. Butler claims that I pulled a dirty trick by only posting our e-mail exchange concerning the term “short covering”. Apparently he meant all of our recent e-mail exchanges. That’s not how I interpreted it especially since those other e-mails provide an incomplete view of what I learned about CEF’s internal process. That process, while not secret, is also not general knowledge. In fact, I could not find a description of it anywhere on the Internet. Given that Mr. Butler has already falsely characterized CEF’s silver deliveries as being delayed, my belief is that reprinting our e-mail exchange, which only partially addresses the issue, would be unfair to CEF. Mr. Butler has made it very clear to me that he does not care about CEF; he only wants me to live up to my end of the bargain he thought we had made. Well, he can win this pouty-kid game but I’m not going to help him spread misinformation. I’ll soon post the (O Lord, let this be it) final installment of this “Ted Butler series” including all of my other e-mail exchanges with him as well as a detailed explanation of CEF’s internal process.

Is this all very petty? Absolutely. This is not at all how I envisioned the outcome. It’s too bad that Mr. Butler and I managed to bury some important issues under a big pile of immaturity and petulance. Still, I walk away from this with some pride knowing that I can admit and learn from my mistakes.