Today In Silver

Ted Butler is on a roll publishing a trifecta this week of his thinking about silver manipulation. The second installment is All Talk, No Action, a condemnation of the yet-unconcluded CFTC investigation of COMEX silver manipulation. I could spend a bunch of time debating many of Mr. Butler’s points but I will simply pick two as they are the foundations of much of his 20 years of futile argument. Despite their seniority, these arguments are surprisingly easy to prick and deflate.

From Mr. Butler:

As I wrote yesterday, all the evidence from the OTC market, as documented by the Office of the Comptroller of the Currency (OCC), indicates that the big U.S. banks, led by JPMorgan Chase, had been heavily short silver derivatives in the OTC as well. Since when do you hedge a short position with another short position?

As I explained earlier, the OCC reports do not indicate in which direction — short or long - that JPMorgan and other big banks hold their OTC and exchange-traded derivative positions. Instead, the OCC reports show total notionals and gross exposures. If anything, all the evidence points to bank positions being held in both directions in roughly equal proportions, which is exactly what one would expect from a dealer who is primarily intermediating (acting as a clearing party) between bids and offers from customers. Moreover, using total notionals to calculate underlying asset amounts results in double-counting. Also, JPMorgan’s own financial statements reveal a propensity to be net long in the relatively small amount of primary commodities-related trading that it does for its own account. In conclusion, please allow me to answer Mr. Butler’s question of “when do you hedge a [COMEX] short position with another [OTC] short position?” YOU DON’T. At least not in the real world although it seems almost anything is possible in his imagination. For example Mr. Butler see evidence of short positions in the OCC reports where no such evidence exists. Sadly that leaves him asking questions that are rhetorical solely in his own mind.

More Mr. Butler:

Commissioner Chilton characterizes my analysis in removing all spread transactions in order to calculate true net total open interest as a spin and he claims that there is no good economic reason to calculate on this basis. He further states that it is wrong to look at the aggregate position of the large traders, as it could include proprietary as well as customer positions. He (or Commission staff) sees no evidence of collusion among the large short traders.

I would counter that, as I explained in my original commentary, spread transactions are distinct from true outright positions and must be considered as separate and different from outright positions. In fact, the CFTC confirms this in their breaking out of non-commercial spread positions in every COT report. Look, I know Commissioner Chilton is relying on staff input in his message, but this must be embarrassing for him. Spreads must be removed to calculate true net open interest and concentration. Any representation to the contrary is plain dishonest.

As far as the aggregate position of the large traders, I would suggest that Commissioner Chilton and staff bone up on CFTC regulations. The Large Trader Reporting System (LTRS) outlines aggregation guidelines. http://www.cftc.gov/industryoversight/marketsurveillance/ltrp.html

What matters in determining aggregation is financial interest and control. Let me give you an example.

If a hedge fund, with a thousand individual investors, buys or sells commodity futures in its name on behalf of those investors, its position will be listed as a single trader in the COTs. That’s because the hedge fund is in control and decides when to buy and sell, not the investors in that fund. That’s the way it should be. The whole purpose is to monitor the market impact of the hedge fund and guard against manipulation.

Likewise, when JP Morgan controls the buying and selling of its customers, that trading is aggregated as one account, also as it should be. If certain customers of JP Morgan decide when to buy or sell independent from Morgan and are of large reporting size, those customers will be listed as separate traders in the COT. Therefore, this business that aggregation explains away the concentrated short position of JP Morgan in silver is bogus. If they control the trading, then they are considered a single trader.

Here Mr. Butler uses the classic parlor trick of distraction and sleight of hand. He buries the real issue — which is that the large commercial traders are primarily trading not for themselves but on behalf of customers by offsetting physical or swap trades on the COMEX — by going off on tangents about spread positions and financial interest/control. Forget control and consider that the commercial dealers have many customers who do not have futures accounts and that is why they are using the services of a dealer in the first place. When will Mr. Butler actually start debating this issue?

I have nothing more to say on the matter other than to provide the following excerpt from the CFTC’s May 2008 silver market investigation (emphasis mine). Based on this I’m not sure what else the CFTC still needs to investigate other than the large COMEX silver short position that the 2 U.S. banks, JPMorgan and HSBC USA, held last summer right before the big selloff in silver. Everything else is just beating an old horse to death.

An area that has drawn significant attention from silver commentators is the level of concentration among short traders in the silver futures market, as reported in the CFTC’s weekly Commitments of Traders (COT) reports. The COT report provides a breakdown of each Tuesday’s open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. The report shows open interest separately by reportable and non-reportable positions. For reportable positions, additional data is provided for commercial and non-commercial holdings, spreading, changes from the previous report, percent of open interest by category, number of traders, and the concentration of positions held by the largest four and eight traders.

Silver commentators have argued that the four-trader net short position reported in the COT reports is unusually high and imply that it is indicative of an effort by a specific group of four or fewer traders to maintain low prices indefinitely. The commentators also imply that the futures positions held by these traders are “naked” in that they are not legitimate hedge positions or otherwise entered into to offset positions in the physical silver market. To evaluate this claim, staff examined the specific traders comprising the top four shorts and their overall futures positions, their motives for holding these positions, how the levels of concentration in the silver futures market compare to those in similar futures markets (i.e., gold, platinum, palladium, and copper), and the relationship between open interest concentration and the level of open interest held by these futures traders to changes in silver futures prices.

The analysis of open interest, collected daily from June 6, 2005 through January 16, 2008—a total of 659 days in the sample—indicates that the composition of market participants among the top four net traders is not static, though certain traders do appear in the top four significantly more often than others. For the period as a whole, there were a total of 10 different traders who at some point were counted among the top four in terms of their net short futures position.(10) Of those 10, three were present in the top four more than 50 percent of the time. The trader most often in the top four was usually ranked number two in terms of net position size among traders, when present. The trader present second most often was typically ranked fourth among the top four traders, and was never ranked first. Finally, the trader showing up third most often was usually the number one ranked trader, holding that position on 356 days of the 475 days in which they were present in the top four. Thus, the Commission’s large trader data shows that, as opposed to the allegation that four traders dominate the market by consistently holding a large concentrated short position, the top four traders at any point in time may involve any of 10 different market participants. Notably, these large traders are not always net short; of these 10 traders, four at times were among the top four net long silver futures traders. These data show that any scheme to manipulate the silver futures market would require involvement of up to 10 traders as opposed to the four that silver commentators suggest. This renders the allegation more implausible, as such a large diverse group would increase the difficulty and complexity of effecting concerted actions while ensuring discipline within the group.(11)

In addition, the top 10 traders are not monolithic and represent a wide diversity of business interests with diverse customer bases. In this regard, staff interviewed five of the largest traders that are included among the group of 10.(12) Based on these interviews and from the Commission’s records, the staff has determined that the entities in this group are involved in the silver markets as dealer/merchants, index traders, swaps/derivatives dealers, money managers, banks and silver depositories. Two of the five traders interviewed indicated the futures positions they entered into were to offset activity that they engaged in with customers situated in the physical silver markets. This activity included buying silver from producers and selling silver to consumers in various manufacturing industries. Few of the futures positions of these two traders represented proprietary trading of the firms. The remaining three traders were less active in the physical markets, but, nonetheless, they primarily established futures positions to offset other obligations, such as over-the-counter swap trades and other financially settled contracts, that they had entered into with their customers. For each firm interviewed, their futures trading activities are driven primarily by the desires and needs of the firms’ customers to either buy or sell silver or to assume or hedge financial exposure to silver prices.

The interviews also revealed that the customer base of these firms is large and broad. The customer base of the firms was estimated to range from 50 to hundreds of individual traders or firms. Those firms that tended to cater to clients in the physical markets tended to have smaller customer bases than those dealing in financially settled contracts. Of the traders dealing primarily in financially settled contracts, the largest customers of these traders tended to be hedge funds, who, depending on market conditions and trading strategies, take long or short positions against the trader.

The silver commentators tend to rely on the Commitments of Traders reports to portray silver shorts as a group of four—possibly eight traders—intent on suppressing prices. Underlying these allegations is an implicit assumption that those traders listed among the top four net short futures traders are always the same traders and that their futures trading activity represents proprietary decisions. The reality, however, is that there is a larger, more varied group of individual traders that constitute the top four net short traders over time. Moreover, as noted above, the positions of the large futures traders are, for the most part, driven by their customer base. These customers may be involved in buying or selling physical silver, or seeking a long or short financial exposure to silver prices. Little of the overall futures trading done by the five firms interviewed appears to be as a result of proprietary trading decisions of the firms. Thus, with respect to the traders’ overall positions across all silver markets, the firms holding the largest net short futures positions are more-or-less market neutral.

The understanding that the largest net short silver futures traders have an overall neutral position in the silver market is confirmed by information collected by NYMEX relating to several of these large traders. In August 2007, NYMEX contacted several of the largest short silver futures traders requesting specific information regarding their activity in the silver cash and OTC markets.(13) The exchange found that these firms generally held significant forward purchase and sales agreements that, overall, left the firms with a net long silver exposure. The short futures positions on NYMEX were approximately offset by their long cash exposure. This means that, contrary to the silver commentators’ allegations, the largest net short traders in the NYMEX silver futures markets are not “naked” shorts, as the firms’ overall exposure in the silver markets (considering their futures, cash and OTC positions) is approximately neutral.

(10) By comparison, there were 14 traders in the gold futures market who at one time were counted among the top four net short traders. Of these 14, five traders also were in the list of the top four net short traders in the silver market.

(11) It should be noted that allegations regarding violations of the CEA or Commission regulations often come from parties within the industry, be they company insiders, disgruntled employees or competitors. In the more than 20-year period over which the silver commentators maintain that prices have been manipulated, the Division has not received a single tip or allegation from any of these sources that a conspiracy to manipulate prices downward has been taking place.

(12) Largeness was determined by both the frequency with which a trader appeared among the top four net short futures traders and by the average size of their position when they were in the top four.

(13) Four of the firms contacted by NYMEX were among the five firms interviewed by Commission staff.

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