Thursday, April 1, 2010

Real v. Paper: Will the CFTC stand up for reality?

What a headline on this March 23 article: Manipulation Standard Needs to Change--CTFC Commissioner tells KITCO News. CFTC Commissioner Bart Chilton said something to KITCO last week that I thought I'd never, ever, ever hear from anyone at the CFTC. In reference the position limits on metals in the futures and spot markets, Chilton said:

“We currently only have limits on the amount of contracts you can have; position limits in the spot month when the futures are being sold," said Chilton. "There are no limits other than that. People are concerned and I am concerned about excessive concentrations of positions that could lead to manipulation of the metals market."

Wait a minute--you mean we actually have a CFTC commissioner who is concerned about "excessive concentrations of positions that could lead to manipulation"? Wow, didn’t see that one coming. Of course, not that I believe he’s actually concerned, and not that I think that what he says actually means anything, but hey, at least he's placating those of us with the term "free market" still in our vocabularies. Chilton is a mixed bag--which is to be expected at that madhouse called the Commodities Futures Trading Commission.

Here’s the background. Back in February, the CFTC, ostensibly with Chilton's cooperation, said it planned to meet with various likewise "concerned" individuals as the commission began reviewing the speculative position limits in metals, as well as manipulation in general as part of its multi-year, never-ending “investigation” into the metals markets, especially silver. Speculative positions are those positions which are not held by players who have an actual need to be involved in the market for the commodity, for example producers (ie, a silver or copper mine) and consumers (ie, a mint or a copper wire company). Speculative positions are usually held, therefore, by banks, including (for silver and gold) the so-called “bullion banks,” and to a lesser extent, financial groups/pools whose only involvement in the metals market is, well, speculative. The CFTC, however, currently defers to the metals exchanges themselves to set the speculative position limits on these commodities, and even lets the exchanges regulate the level of enforcement. (Oh, no, I can’t see any possible problem with this, nope, none whatsoever.) According
to the CFTC:

To protect futures markets from excessive speculation that can cause unreasonable or unwarranted price fluctuations, the Commodity Exchange Act (CEA) authorizes the Commission to impose limits on the size of speculative positions in futures markets. Core Principle 5, of Section 5(d) of the CEA, requires designated contract markets to adopt speculative position limits or position accountability for speculators, where necessary and appropriate, to reduce the potential threat of market manipulation or congestion, especially during trading in the delivery month.”

While that might sound nice at first glance, the fact that the CEA “requires” exchanges (“designated contract markets”) “to adopt speculative position limits” on metals doesn’t mean the exchanges are actually going to enforce them. Perhaps what Chilton and the other commissioners at the CFTC finally noticed is what many other have noticed for years: these exchanges aren’t exactly interested in enforcing their own “speculative position limits” if in doing so they would have to constrict and reduce the number of contracts purchased on their exchanges, and thus eliminating the nice profits they collect from the spread (bid-ask) and fees (for hosting the trades). I know, I know--it’s the shocker of the year, but it turns out the exchanges like money better rules. The CFTC can, of course, change this and enforce the limits themselves, as is clearly stated on their own “
Speculative limits” page:

“Section 4a(a) of the CEA,
7 USC 6a(a), specifically holds that excessive speculation in a commodity traded for future delivery may cause "sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity." Section 4a(a) provides that, for the purpose of diminishing, eliminating, or preventing such problems, the Commission may impose limits on the amount of speculative trading that may be done or speculative positions that may be held in contracts for future delivery.”

…they just don’t. Another possible tool of enforcement from the CFTC’s perspective is the 90% cover rule, which is supposed to prevent naked shorting of commodities. But given that the exchanges themselves allow for cash and other paper (remember that COMEX rule on GLD shares for the cash leg of delivery?) to “cover” for contracts on commodities instead of, oh, I don’t know, actual commodities(!), the CFTC also really can’t do anything with the 90% cover rule, either, and doesn’t much seem to care about it. As recent as February 2010, the
CFTC fined UBS $130,000 for exceeding the position limits on the NYMEX in gas, heating oil, platinum on “more than one occasion,” and in December 2008, the CFTC fined Dairy Farmers of America over $12 million for exceeding the positions limits and conspiring to manipulate the market price of milk and cheddar cheese through contracts on the Chicago Mercantile Exchange (CME). In 2003, the CME had to request permission from the CFTC to increase the contract size on live cattle by 25 pounds, and change a rule regarding how long cattle would be restricted from drinking water before official weight checks. If we must have a futures market, the Commodities Futures Trading Commission should at least be in the position of regulating it. They seem interested enough in heating oil on the NYMEX, and cheddar cheese and beef on the CME, so what about metals on the COMEX? Well, considering that the CFTC knows that two banks hold short positions on as much as 32% of all COMEX silver contracts and 33% of the all COMEX gold contracts, it doesn’t seem like the CFTC shares the same enthusiasm for regulating the drinking patterns of cattle as it does the integrity of metals prices!

So what, then, is the CFTC now talking about with its newfound consideration of position limits on metals? Well, the new CFTC chairman and commissioners (okay, actually one of the five commissioners) are at least giving lip-service to the idea implementing actual CFTC-declared position limits on speculative traders in the energy and COMEX metals markets. Other markets do have such
position limits: corn, oats, soybeans, wheat, cotton and other agricultural commodities have federally-imposed limits that pre-date the CFTC itself by decades (and, please note, refer to a period of time when the banks’ leverage levels were a fraction of what they are today), as do pork-bellies, frozen concentrated orange juice, milk, and cheese. But there are currently no CFTC-imposed limits on futures for gold or silver, crude, gasoline, heating oil, or natural gas, and none whatsoever (spot or future) for copper. The only limits on these commodities are whatever the exchanges set, and, of course, whether they even decide to enforce them. The abovementioned $135,000 fine issued against UBS for exceeding the position limits on heating oil, gas, and platinum only happened because the NYMEX bothered to turn the bank in after several violations.

“Concerned” statements like Chilton’s are only part of what swinging a spotlight over towards the limit-free metals and energy markets, low wattage though it may be. Last Thursday, March 25, the commission held a hearing for the metals side that included both those for and against the CFTC stepping in. A Reuters report this week indicated that it wasn’t looking too likely that the metals position limits would come to fruition, but it is too early to tell, as the CFTC has not made an official statement yet and probably will not for some time. Many will be eagerly awaiting the king’s decisions, but for now let’s review exactly what went down on Thursday.

Thursday was about the speculative traders—in other words, the banks. You know about the suggested new “Volker Rule” that might (if we are lucky) see a return to the post-Glass-Steagall Act, pre-Gramm-Leach-Biley Act, wherein bank holding companies were banned from proprietary trading ("prop trading") due to the prohibition against thier owning other financial institutions. Prop trading refers to when banks trade in speculative markets including equities and commodities markets using bank’s capital under a bank-owned account (through another financial instituion which the bank owns) and which generates bank-owned profits and losses. Such practices were illegal for bank holding companies to partake--until the 1999 changes, and these practices then only became more popular in 2000 with other rule changes, until finally effectively being amplified by mid-2004 under the Fed's loose money policy that seems to have encouraged massive leverage, including through "investments," to compensate for the then-flattening yield curve. Investment banks were never prohibited from prop trading because that’s just what they do, but the change in the rule allowed for commercial bank holding companies—including all the big players like JPMorgan, Citi, BofA, Wells Fargo, etc—to engage in market-making and trading in nearly any kind of asset, from commodities to equities to, of course, derivatives (illegal narcotics is just about the only restricted group, so the banks just do the laundering for that!). Thus, if the Volker rule is implemented, bank holding companies would once again be prohibited from trading for their own accounts and the position limits would likely be a much smaller issue.

Goldman Sachs, which as you know was sprinkled with Fed fairy dust and magically declared a “bank holding company” in late 2008 granting, it eligibility for TARP funds and FDIC-backed paper issue, has already stated that it will autocratically convert back to an investment bank if prop trading is restricted. JPMorgan, Citi, BoA and the other biggies are “real” bank holding companies (who actually have ATM’s) and cannot, obviously, do that, so they would have to cease their prop trading, thought they might be allowed to establish independent and independently-capitalized investment operations to trade “separate” from the bank-holding company if the Volker Rule occurs (however that would work; this has been suggest but not settled). As we stand today, all the big bank holding companies are acting like investment banks anyway, and it is really the last decade of trillions of dollars of leveraged prop trading that has made position limits a new focus in commodities markets. Perhaps a decade too late, the CFTC is finally taking note--at least symbolically—of the massive speculative bank-owned positions in these markets.

Ironically, it was the same massive speculative bank positions in the agricultural commodities during the 1920’s that sparked the first federal position limits (those listed above) to keep the banks from cornering the agricultural markets without ever having actually dragged a plow or planting a seed. The focus today is metals and energy. Just last fall, after investigating the 2008 commodities bubble that pushed crude to $148/barrel, the CME Group (which runs several exchanges including the COMEX and NYMEX), determined that somehow that “bubble” was not caused by excessive speculation, and yet simultaneously begged the CFTC to impose unilateral position limits so it wouldn’t have to enforce its own “limits” and it could prevent “
excessive speculation in energy markets.” As you would guess, the CME Group wanted the CFTC to impose the restrictions because then all exchanges would be subject to enforcing the positions limits, thus greatly reducing the likelihood that the CME Group exchange would lose contracts to other domestic exchanges. Of course, unless the BIS lurks into the shadows and instructs its puppet European and Asian CFTC-counterparts to declare the same position limits, the CME Group could very well lose activity to foreign markets. This is, in fact, the common tune from the CME Group and other exchanges whenever the CFTC starts to think about positions limits: “you can’t do that--we’ll lose players to foreign exchanges that have no position limits!” Its not specious argument: producers and consumers are already exempt (or can get exemptions) from the position limits if they are legitimately hedging, and so the only players these exchanges must be talking about are the speculative financial firms, the investment banks, and the bank holding companies with their prop accounts.

It might be true that the CME Group could lose contracts to other exchanges if position limits were imposed, but given that the CME Group is already the single largest derivative exchange group on the planet, its not likely (more on the CME Group later). As I mentioned above, the CME Group itself was the one asking for position limits on energy as recently as 2009, and just this February we had the abovementioned quote from a CFTC commissioner claim he is “concerned about excessive concentrations of positions that could lead to manipulation of the metals market.” It seems as though if ever there might be a chance for sanity in the futures contracts on energy and metals—if ever there was a chance to bring some reality to the derivative contracts on “real” commodities—this appears to be the moment. The other federally-limited are fairly well protected from speculative players (at least prop), and producers/consumers can be granted exemptions to the limits, as they are non-speculative. Energy and metals remain the vast, sprawling trillion-dollar derivatives frontier—but is the CFTC ready to take that on?

Indeed, Commissioner Chilton’s recent statement acknowledging concern about the concentrated positions and their possible role in manipulation sounded very encouraging: too bad such encouragement only lasted for about a microsecond! Later that same week in February, after just stating it was ready to meet with other "concerned" individuals in regards to the concentrated positions on the COMEX and in the metals market generally, the CFTC showed its real personality in a response to a very relevant inquiry from the Gold Anti-Trust Action Committee. Basically, the response came in such a fashion as to, again, cast a heavy doubt on the commission's interest in market transparency of any kind. And, it relates directly to position limits.

GATA's inquiry was to request an explanation from the CFTC as to why the commission was suddenly, as of December 2009, simply refusing to publish, or in CFTC-speak, "suppressing," the Bank Participation Reports on silver positions in options (the BPR Options Reports). This is a very important question: the CFTC had been publishing the BPR's for both futures and options for well over a decade on many commodities, including silver, yet suddenly last December, someone somewhere in the CFTC curtailed the release of this important information. GATA noticed this immediately, as suddenly the word “SILVER” was outright missing from the options reports, and requested of the CFTC an explanation for this apparent pivot in policy. The CFTC's response was that (and again, please remember that they are saying this the same week during which Chilton made his "concerned" comment!): the CFTC declared that continuing to publish the proper numbers on the options-BPRs in silver would possibly compromise the banks and reveal their identities because those bank(s) are such huge player(s) that the total options position for all commercial banks involved in the COMEX silver market is held by “less than four banks,” and possibly one.

Now, are you thinking what I’m thinking: What?! This is the "reason" for not releasing the information? Shouldn’t this be exactly why you'd want to state the "bank participation" in a commodity market in the first place--to demonstrate the massive concentrated speculative positions of banks?!

Oh boy. Let me elaborate on this, because it directly relates to the position limits about which I am writing. The CFTC has been publishing the
Bank Participation Reports for over a decade. The reports are statements of the positions--futures and options, including calls and puts in options--of the speculative involvement of various banks in various commodities exchanges. The BPRs include bank involvement numbers on everything from different types of oil, to soybeans, to cotton, to sugar, to precious metals, and they cover exchanges like the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBT or CBOT), the New York Mercantile Exchange (NYME or NYMEX), and, of course, the Commodities Market Exchange (the CMX or COMEX), all three of which are owned and operated by a single company, the abovementioned, world’s largest derivative exchange group, the CME Group. The BPR’s also note US sugar contracts from the Intercontinental Exchange (ICE or ICUS, who you’ll remember from the emissions trading scheme). Bank involvement needs to be reported in these commodities exchanges because these exchanges are where prices are set, and banks are, by definition, speculators. Banks aren't producers who are hedging by selling a short futures contract so they know someone is going to buy their goods, and banks aren't consumers who are buying that contract to meet their needs; the only reason banks are playing in the commodities game is for speculation.

Yet, though they are unessential speculators, the CFTC has suddenly decided that is must slip on its red cape, leap into the air, and nose-dive to the rescue to “protect the identities” of these banks by suppressing the data of their involvement by omitting it from the BPRs. This means that the non-speculative players, like the producers and consumers, no longer have access to the same information about the banks as the banks have about them. And what’s so totally insane is that the BPRs do not even release the names or identities of the reporting banks: the document simply states how many positions are held by how many unidentified commercial banks. That’s it. You won’t find a single bank name on any BPR. The only possibly insightful breakdown offered is that they are categorized as either "US banks" or "Non-US banks,” and as you would probably guess, it is no other than the
Bank for International Settlements which helps provide the CFTC with the non-US bank data. You can click here to see the current options BPR in which the word “SILVER” is missing, or just look below to the September report, as I have pasted what a BPR looks like when you convert it to a table. “O.I” stands for “open interest” (total number of outstanding, unsettled contracts on the exchange listed), and the numbers are in contracts, the sizes of which vary by commodity. Below is the information from one of the pre-suppressed reports, the September 2009 BPR on Options for “CMX SILVER” (that’s COMEX silver; each contract is 5,000 oz):

And here is the
September 2009 BPR on Futures, also the CMX silver, 5,000 oz contracts:

Again, as you can see, no mention of the banks’ identities is published. So, given that only the number, the US/non-US status, and the total positions for all the banks without any individual per-bank breakdown is published, what, dear CFTC, exactly is the harm in releasing this information? If the CFTC honestly wants to provide even a modicum of transparency as to the presence of speculative players in these price-setting commodities exchanges, shouldn't it be tripping over itself to release this relevant data? And especially when the CFTC has already been doing it for a decade-plus, with the “help” of the BIS, and on the back of statements of "concern" about manipulation? Shouldn’t this be a no-brainer? Well, apparently, not: the CFTC's detailed response as to why they are "suppressing" the information is blatant. Below are words from the CFTC's own legal department in
response to GATA’s inquiry as to why the information was being suppressed:

"The (CFTC) decision to suppress the (bank) trader counts was made as part of an ongoing review of the methodology of the BPR. As part of that review, the commission determined that where the number of banks in each reporting category is particularly small, fewer than four banks, there exists the potential to extrapolate both the identity of individual banks and the bank's positions. Under section 8(a) of the Commodity Exchange Act, the commission, among other things, is generally prohibited from publishing data and information that would separately disclose the business transactions or market positions of any person/entity."
"Accordingly, in order to protect the confidentiality of market participants' positions, the commission determined to suppress the individual category breakdown when that number is less than four."

Please excuse me again: WHAT?! Is it not the precise purpose of the "BANK PARTICIPATION Report" to indicate the PARTICIPATION of BANKS, regardless of the number of players? What an insulting, ridiculous, and arbitrary decision to make--to defer to suppression for the purpose of “protecting the confidentiality” of banks that the CFTC isn't even naming! There are no names on the reports! As Adrian Douglas at GATA rightly notes, the CFTC obviously is not “separately disclosing” the identity, positions, or transactions of the banks if we still have to “extrapolate.” That the potential to extrapolate would be the same to the CFTC as outright identification is just absurd.

Now, of course, I readily admit that I am not saying that we (and GATA) can't indeed do exactly what the CFTC is afraid that we (and GATA) might just do, and extrapolate the identities of the banks (cough--ah, eh, JPMorgan and HSBC--cough) from the data on the BPR. Of course we can do that: last time I checked, it not illegal to “extrapolate,” and our “extrapolations” would have zero legal weight anyway. But we're all crazy who think that speculative banks might be manipulating short positions on metals because we’re just “conspiracy theorists.” Banks don’t ever conspire to do bad things in the markets---oh wait, you know what, let me take that back, because it was just this weekend that Bloomberg reported that JPMorgan, UBS, Citi, Bank of America, Lehman Brothers, Bear Stearns, GE's financial arms, and another half dozen banks have actually been identified in federal court documents by the US government as "
unindicted co-conspirators" (yeah, that’s right, co-conspirators, as in “conspiracy”) in a bid-rigging scheme in the $4 Trillion municipal bond market that extracted billions from local and state governments through a sophisticated muni-swap conspiracy to manipulate and fake trade to produce profits at the expense of the taxpayers! But I’m sure that’s just an isolated, dozen-plus bank, multi-billion dollar, interstate conspiracy. Such a thing could never happen in commodities markets, especially under the watchful eye of the CME Group who doesn’t even enforce their own position limits. Nah, so, whatever we, Ted Butler, and GATA extrapolate or don’t extrapolate is our business, and the CFTC would never confirm us if we were right anyway. It is just a joke that in the same week as expressing "concern" about the concentrated positions in precious metals the CFTC decides to suppress the BPR in a way that inherently impacts metals—and in particular, silver—information-gathering the most.

Furthermore, this new policy actually contradicts the CFTC's own "explanatory notes" on the BPR, the very notes which the legal advisor cites in the CFTC's response to GATA. The CFTC, in its
Explanatory Notes on BPR, says that (emphasis mine):

“For purposes of protecting the confidentiality of participants’ market positions (as required under §8(a) of the Commodity Exchange Act), when the number of banks in either category (U.S. Banks or Non-U.S. Banks) is less than four, the number of banks in each of the two categories is omitted and only the total number of banks is shown for that market.”

The "total number," even if there is only one bank participating to report, should be an actual number, like “1”, not an outright suppression of the data! We must accept that the new “explanatory notes” apparently do allow the CFTC to omit “the number of banks in each of the two categories,” but these notes say nothing about omitting the “total number of banks...for that market” altogether! To the contrary, the notes explain that “only the total number of banks is shown for that market.” Key word: shown. The CFTC is not only not showing the "total number of banks...for that market"--they aren't even reporting the market! Check out the latest
March 2010 Options BPR: the word “SILVER” is not even on it, and is not mentioned on any of the options BPRs that have been published since this arbitrary change in reporting policy late last year. No mention of any bank activity for options on the COMEX in silver, whatsoever. None. As far as the CFTC is concerned, banks aren’t even involved in options on the silver. So what are we left with to “extrapolate” from the outright refusal to release any information on bank participation on silver options? Well, all we know is that there are less than four banks involved in the silver options market--but we really have to just guess that a silver options “market” even exists, because, again, the CFTC is not even reporting it. They certainly aren’t reporting the positions of the banks, either. We now have no access to that data. According to the last four BPRs on silver options, there is no market. What an outrage.

Why am I making such a big deal of this options BPR omission? Simple: because there is a market on silver options, and there is massive speculative, paper silver bank participation in this market on silver options, and the bank(s) are hugely important, particularly when you look at the market on silver futures. I said above that this suppression impacts silver greatly, and I say this simply because of the fact that one bank has been dominating the options market--especially the put options--on silver for quite some time, and that bank happens to be the almighty, trillion-dollar JPMorgan. JPMorgan’s partner in crime is HSBC, who happens to be one of two banks involved in the official
London Bullion Market Association (LBMA) daily silver-fixing, as well as shorting gold on the COMEX while acting as the “custodian” of the 36,324,951 oz of gold in the SPRD Gold GLD ETF. (Conflict of interest? Nah, I don’t see it.) Perhaps I should mention that the custodian of iShares Silver Trust and its shareholders’ 298 million ounces of silver is the no other than the London branch of JPMorgan. That’s right: these are the massive shorters who are the “custodians” of millions of ounces of gold and silver—and I mean massive shorters. You have to see these positions to believe it—and thankfully, the CFTC has not suppressed that data yet. Of course, they haven’t done anything about the massive manipulation either, but at least we can watch it happen.

At least for now, the CFTC is still graciously blessing us serfs with the release of silver futures information that is only partially suppressed. Yeah, even the futures BPRs have now been censored: citing their newfound interpretation of their own “explanatory notes” again, the CFTC has also been leaving blank the “US/non-US” categories in the BPRs on futures, and not just for silver, but for all commodities with “less than 4 banks” in the US category. Case in point, CMX Silver on the
December 2009 Futures BPR. It looks like this:

There are two nice big blanks where there used to be data. Compare it to the September 2009 report, before the newfound decision to “suppress:”

Again, no banks named, and now, no numbers specified. By the way, both of the above tables should have gotten your attention—specifically if you caught the data in the “% O.I” column. O.I, again, is open interest, or all the unsettled contracts on the exchange, which is in this case the COMEX. That in mind, look at the column again, and when you pick your jaw up off your keyboard, continuing reading this.

Translation: what the “% O.I.” column of the Sept 2009 BPR is telling us is that in that month, two US banks held a short position equal to 28% of all the open contracts on the COMEX. Repeat: 28% of all open COMEX silver contracts were being shorted by two banks, one of which is the 300 million oz SLV “custodian.” But, if you can believe your eyes, that’s actually not the worse its been: I went though futures BPRs all the way back to Feb 2008, and the most amazingly massive concentrated silver short position on the COMEX was a whopping 31.9% in June 2009—a stat which was written about extensively at the time, including by myself (this is at the same time as mysterious Duetsche Bank COMEX gold cover). That staggering position compares to a measly 3.4% the June before (2008). How is it even allowed that two banks can short nearly a third of the COMEX silver? Answer: it isn’t—but no one is stopping them, and they are doing it completely naked…unless you count their “custodianship.”

The CME Group claims to have position limits on silver and gold of 6,000 contracts each (Rule Book,
pdf page 57, Position Limits book pg 10), or expressed in ounces, those limits would be 30 million oz for silver and 600,000 oz for gold. Only under special exemptions can metals producers and consumers occasionally get waivers that allow for larger positions. At recent spot prices ($1110 gold and $17.38 silver), these positions limits would equate to total liabilities of $666,000,000 on gold and $521,400,000 on silver. This should be the maximum position that any one market player can take.

Looking back the September 2009 short position on silver, the BPR revealed an amazing 29,888 short contracts on the books of two banks, which would have had a minimum market liability (liability because they’re shorts) of $2,645,000,000 (Billion, nearly five times the “maximum”) at the month’s lowest $14.75/oz price, and $3,313,824,000 price tag at silver mid-month peak at $17.50, a possible loss of $493,240,000 on the contracts’ values. If these were 30-day contracts (we’ll never know) and JPM and HSBS didn’t cover them quickly that second week of September when silver started to move up right after the reporting (we’ll also never know), and if they just stuck it out until month’s end to see if silver moved back under $14.75, these two massive short banks would be very disappointed--and would be holding a $313,824,000 loss when silver settled 30 days later at $16.50.

Let's compare these positions to the maximum “deliverable” silver registered on the COMEX. Adrian Douglas of GATA recently wrote a short report, "
COMEX Inventory Data Reveal an Alarming Trend" examining the inventory versus contracts on COMEX bullion from mid-2009 through February 2010. In it, Douglas notes and explains the two categories of gold/silver on deposit at COMEX: 1.) registered bullion, and 2.) eligible bullion. Registered bullion is that metal which is owned by dealers and deposited with the COMEX as bullion available for delivery to settle contracts. Conversely, eligible bullion is the property of customers who have deposited metal with COMEX but have not made it available for delivery against futures contracts. So what is the actual, physical, deliverable silver available on the COMEX, where two banks are shorting an average of 180 million oz a month (30,000 six-thousand oz contracts)? Stunningly, it is just 60 million oz. Yes: the short position alone of two banks is equal to 3 times the total available silver of the entire exchange. Read another way, if these two banks had to physically cover just one third of their short position, they would have to buy the entire COMEX silver inventory!

Closer examination of the numbers is, indeed, more revealing: since August 2009, registered (deliverable) silver available on the COMEX fell from 62.5 million oz (Moz) to 47.4Moz--or over 24%, with just 1.15Moz of new silver added. It fell because people are taking delivery: 33.5 Moz worth of delivery notices were issued, and a little more half of those were settled in cash or cash equivalents, and the remainder (about 15 Moz) was delivered. This has reduced the inventory from 62.5 Moz in August 2009 to 47.4 Moz in February 2010. The same story appears in gold, though even more dramatic: registered deliverable gold dropped from 2.81 Moz in August to 1.64 Moz by February, or over 41%. For both metals, customer ("eligible") inventory increased, but customer metal is not available for delivery. Despite these numbers, the massive short positions by two banks remain for both silver and gold, as you'll see below in the March 2010 futures BPR table.

Before we get there though, and while the above data on severe bullion drawdown sinks in, I should tell you that the CFTC recently gained a whistleblower last November—who they quickly blew off. His name is Andrew Maguire. Maguire, a metals trader in London, was “told first-hand by traders working for JPMorganChase that JPMorganChase manipulates the precious metals markets, and they have bragged to how they make money doing so.” Maguire contacted the CFTC, and even provided them with forecasts of when the market takedowns would occur.
GATA has contacted him also, and they posted him emails to the CFTC as a recent manipulation (a short which Maguire called and informed the CFTC of in advance) unfolded live. Maguire claims that JPM traders “invited” him and others in on the information so they too could profit from the movement. In an email to the CFTC, Maguire explained:

“I brought to your attention during our meeting how we traders look for the "signals" they (JPMorgan) send just prior to a big move. I saw the first signals early in Asia in thin volume. As traders we profited from this information but that is not the point as I do not like to operate in a rigged market and what is in reality a crime in progress."

"As an example, if you look at the trades just before the pit open today you will see around 1,500 contracts sell all at once where the bids were tiny by comparison in the fives and tens. This has the immediate effect of gaining $2,500 per contract on the short positions against the long holders, who lost that in moments and likely were stopped out. Perhaps look for yourselves into who was behind the trades at that time and note that within that 10-minute period 2,800 contracts hit all the bids to overcome them. This is hardly how a normal trader gets the best price when selling a commodity. Note silver instigated a rapid move lower in both precious metals."

"This kind of trading can occur only when a market is being controlled by a single trading entity.”

He followed up with more emails as the “manipulation” unfolded:

“A final e-mail to confirm that the silver manipulation was a great success and played out EXACTLY to plan as predicted yesterday. How would this be possible if the silver market was not in the full control of the parties we discussed in our phone interview? I have honored my commitment not to publicize our discussions."

"I hope you took note of how and who added the short sales (I certainly have a copy) and I am certain you will find it is the same concentrated shorts who have been in full control since JPM took over the Bear Stearns position. It is common knowledge here in London among the metals traders that it is JPM's intent to flush out and cover as many shorts as possible prior to any discussion in March about position limits. I feel sorry for all those not in this loop. A serious amount of money was made and lost today and in my opinion as a result of the CFTC's allowing by your own definition an illegal concentrated and manipulative position to continue.”

Here, here. The above emails excerpts were from February 5, 2010. Maguire mentions the position limits as a motivation for JPMorgan to cover its huge short position, and above I mentioned that despite the 24% and 41% drawdowns in gold and silver bullion available on the COMEX, the short positions continue. See for yourself on the
March 2010 Futures BPR report on COMEX positions:

You are reading that correctly: four banks are shorting 19% of the total contracts on gold, and a “suppressed” number (read: 2 banks, JPM and HSBC) are still shorting over 28% of all open contracts on silver on the COMEX. The last time I checked, 6,000 contracts each times 4 banks equals 24,000 contracts maximum, not 92,635. Same for silver: 6,000 x 2 = 12,000, not 30,431. As you can see, the CME Group is outright refusing to enforce its own “rules’” on position limits, and the CFTC doesn’t much seem to care either. Understand that all of this information is coming directly from the CFTC’s website, from the CFTC’s own reports—so it is not like they don’t know. Additionally, they have fellow trader telling them his side and calling takedowns in advance. The March position is still huge, but it is a bit lower than the February position of 30.6%, which was also down from December’s over 32%, but it is really not much. It doesn’t appear to me that JPM is too worried about the CFTC slappin' them around. Nah, they’re the ones that usually do the slappin'.

So the CFTC defers to the exchanges for enforcement of position limits, and the exchanges simply decline. The
CFTC’s own definition of a position limit correctly states that the limit terms apply to contract position whether long or short, as does the CME Group’s own rule book. So, the CME just doesn’t enforce them. And the CFTC doesn’t care. This is why I stated at the beginning that I didn’t much believe Commissioner Chilton’s statement that he was “concerned about excessive concentrations of positions that could lead to manipulation of the metals market.” Given the last two years of BPR data published by the CFTC itself, I’m less than convinced that they would want to upset the applecart anyways.

But what if they did, what would that mean? The current idea would be to restrict metals along the same lines as energy. The CFTC would
restrict speculative positions to 10% of the first 25,000 open interest contracts, and then 2.5% beyond that. In other words, if o.i. was 100,000 contracts, then the position limit would be 12,500 contracts. If we take the March o.i. numbers, the limit would be 12,903—a far cry from the current 29,888 position. JPMorgan just doesn’t seem to concerned.

And now, finally, I must add this fabulous synopsis/analysis of the Thursday (March 25, 2009) hearing posted on Zero Hedge: “
Former Goldman Commodities Research Analyst confirms LBMA OTC gold market is “Paper Gold” Ponzi.” It is long, but it is worth reading slowly, and it’s worth reading twice. There are videos of the CFTC hearing embedded in the article, as well as transcriptions of the most revealing testimony. Be forewarned—the only thing more outrageous than the content of the “testimony” is the fact that both the chairman and commissioner of the CFTC were there to hear it, and apparently found little problem with what was revealed. This is perhaps most dramatically demonstrated by the fact that both of the “regulators” heard the following statement from one of the “experts” called, Jeffery Christian, and didn’t leap out of their seats screaming bloody murder! Christian is a former Goldman Sachs Commodities Research Group “metals expert” who is now the head and founder of the CPM Group. Christian thinks that positions limits are “a bad idea,” and was at the hearing to discourage the CFTC was further involvement in the metals markets. You can judge his “expertise” yourself by his own statement below which he gave as testimony during the CFTC hearing last week. All emphasis and (brackets) are mine: the words of Jeffery Christian:

“One of the things that the people who criticize the bullion banks and talk about this undue large (short) position don’t understand what is the nature of the long positions of the physical market, and we (traders) don’t help it; the CFTC, when it did its most recent report on silver, used the term that we (traders) use, “the physical market”. We (traders) use that term, as did the CFTC in that report, to talk about the OTC market--in other words, forwards, OTC options, physical metal, and everything else. People say, and you heard it today, there is not that much physical metal out there, and there isn’t. But in the “physical market” as the market uses that term, there is much more metal than that…there is a hundred times what there is.”

Do you want to fire our “regulators” at the CFTC yet? Perhaps this isn’t the time to tell you the CFTC’s slogan, which they print on every press release and
display on every page of their website:Insuring the Integrity of the Options and Futures Markets.” Okay, right, got it. These defenders of integrity just heard a former Goldman Sachs metals “expert” declare that the “physical” market is “a hundred times what” the physical market actually is. Let me re-quote what our regulators heard:

“People say, and you heard it today, there is not that much physical metal out there, and there isn’t. But in the “physical market” as the market uses that term, there is much more metal than that…there is a hundred times what there is.”

No, Mr Christian, it is not about “how the market” uses the term “physical”—it is about how the CFTC does, and it is about what contracts can actually be covered in compliance with the regulations on commodities. Physical commodities—not your paper derivative non-sense. This is just ridiculous. That statement alone should have been reason enough for the CFTC to say, “That’s it! We’re setting position limits, you rascals!” But unfortunately, we’ve known about this for some time, direct from the Bank for International Settlements. Here’s a one-page table from the BIS, “
Amounts Outstanding of OTC equity-linked and commodity derivatives.” It demonstrates what Mr Christian said in so far as the fact that “there isn’t” that much metal out there. Check out the June 2009 numbers: it lists the “notional” (paper) value of gold derivates as nearly 10 times the “gross market value” (actual metal)--$425 Billion versus $43 Billion.

It’s nearly that bad for “other precious metals,” and unfortunately silver is not separately listed from the other metals in this category, which are presumably platinum, palladium, and maybe rhodium. The OTC paper and derivatives on “other precious metals” is listed with a notional value of $203 Billion against a gross market value of $32, or over six-fold multiplier (the silver market is only about $10 Billion actual, or about 600 million oz per year, most of which is consumed in industry). If those paper holders ever needed or decided to take delivery, Mr Christian and his “hundred times” pocket full of paper would have the alchemists working like mad.

I wish that were it, but the above-linked Zero Hedge article includes only more outrageous comments from Christian. This next one is just total non-sense—and happily, a commissioner actually caught it. In attempting, in all his “expertise”, to explain why the above-mentioned short positions for the two banks skyrocketed from 4.8% in June 2008 to 25.4 in August 2008, Christian offers this silly analysis:

“Well, actually let’s go back to a concrete example of Mr. Organ when he was talking about August of 2008 when there was an explosion in the short positions in gold and silver held by the bullion banks on the futures market and he seemed to imply that that was somehow driving the price down. If you understand how those bullion banks run their books the reason they had an explosion in their short positions was because they were selling bullion hand over fist in the forward market, in the physical market, and in the OTC options market. Everyone was buying gold everywhere in the world so the bullion banks who stand as market makers were selling or making commitments to sell them material and so they had to hedge themselves and they were using the futures market to do that (by buying short positions).”

Oh my gosh! Uh, no Mr Christian, we aren’t the ones who "don’t understand” the OTC paper gold market—you’re the one who doesn’t even seem to understand the purpose of shorting! Re-read what Christian, a former Goldman Sachs Commodities Research analyst and “expert”, just said: the bullion banks (commercial banks with positions in metals) had an “explosion in the short positions” because they were just selling soooo much gold “hand over fist in the forward market, in the physical market, and in the OTC options market” as “everyone was buying gold everywhere in the world,” that they just couldn’t handle all the good news for selling so much gold, so these banks, which were, again “selling bullion hand over fist” decided that buy short positions to “hedge” their sales? What?!

Quick market review: you buy a short position when you think the price will fall. You don’t do this—short something—to cover a sale. Thank goodness the chairman, Mr Gensler, caught this and actually called Christian out on it. Gensler said:

“I would like to follow up on Commissioner Dunn’s question for Mr. Christian, if I might, because I didn’t quite follow your answer on the bullion banks. You said that the bullion banks had large shorts to hedge themselves selling elsewhere, and I didn’t understand; I might just not have followed it and you’re closer to the metals markets than me on this, but how do you short something to cover a sale, I didn’t quite follow that?”

What is Mr Christian’s response? Well, whoops, that he “misspoke:”

“Well, actually I misspoke. Basically what you were seeing in August of 2008 was the liquidation of leveraged precious metals positions from a number of places and the bullion banks were coming back to buy it, and they were hedging those positions by going short on the COMEX and that is really what it was.”

Hmm. Too bad that one doesn’t make sense either: if a “liquidation of leveraged positions in precious metals positions” was occurring when the banks were selling “hand over fist,” this liquidation would have meant bu-ku bucks for the “leveraged” holders of the positions who could sell them to “everyone everywhere in the world” as gold moved higher. There still would be no reason to “hedge those positions by going short on the COMEX.” Why would you go short on what you were selling if it was going up? Short sellers lose money when what they are shorting goes up, and since shorts are derivative contracts whose value is derived from an asset borrowed from a third party, the short seller would also be subject to having to front more money to cover the margin as the price increased. You just don’t do this.

And an even better question: who on Earth would sell you a short position of an asset they had when they could sell the asset for the higher spot price point blank? If something is going up and up, and you think it’s going to fall, you wait for it to stop going up before you short it! This is totally insane; in fact, it is double-insane, because in order for this to work, you’d need two equally insane people. The first insane person (JPMorgan) would sell a 6,000 oz gold contract for $1000/oz to a jewelry maker, and then simultaneously purchase a short for $950/oz from the second insane person who just so happens to have an extra 6,000 oz of gold laying around his basement and, whoops, he doesn’t realize that the current market price is $1000! Or maybe the second insane person just kisses off a $300,000 profit out of the kindness of his heart? Get outta here! Meanwhile, the first insane guy (JPMorgan) is instantly losing money because there is no way he’s gonna get that short position covered as gold continues to move up (nevermind the premium he paid to get the short, and then the margin calls as his risk increases, holy smokes!). This is the madness we’re dealing with!

I’ll end this report with a long cut-and-paste from GATA’s Andrew Douglas, as his March 27 analysis of this CFTC conference cannot be topped. The
Zero Hedge article includes it, and here it is:

This is a stunning revelation. Mr. Christian confirms that the “physical market” is not in fact a physical market at all. It is a loose description of all the paper trading and ledger entries and some physical metal movements that occur each day on behalf of people who believe they own bullion in LBMA vaults but in fact they don’t. They are told they have “unallocated gold” or “unallocated silver” but that does not mean the LBMA has physical metal set aside for those customers and has just not given specific bar numbers to the customers. No, it is the most cynical and corrupt definition of “unallocated”…the customer has NO bullion allocated to him. NONE! The LBMA defines the owners of “unallocated accounts” quite clearly as “unsecured creditors”. That means they have NO collateral. NONE. Can it be any clearer? It is a giant Ponzi scheme.

“Mr. Christian confirms what many analysts and GATA have been alleging that there is not much REAL physical metal, but testifies that there is actually one hundred times the REAL Physical metal being sold based on the much more “loose” definition of what “physical” means to the bullion banks.

The last sentence of his statement is mind-blowing. He says the “physical” positions of the bullion banks are so huge that they are much bigger than the COMEX short position. He says the “physicals” are hedged on the OTC market in London! Did you get that? Let me walk you through it. The bullion banks are selling what is supposed to be vault gold but it is just a ledger entry if the customer never asks for delivery. They must balance their exposure with a ledger deposit entry. This has to be some paper promise of gold from a third party, or some derivative, or even some real gold bullion. If all the ledger entries balance out then the bullion bank has no net exposure in exactly the same way the futures market works with a short offsetting a long. A futures market can never default if no one asks for delivery as only paper contracts are traded. The loosely defined “physical” London market is an identical scheme. As long as everyone is prepared to buy and sell “ledger entries” for imaginary gold in the vault no one will ever discover the fraud.

“The LBMA does, however, buy and sell some real physical metal as well. But we now know form Mr. Christian’s testimony that this is one one-hundredth the size of the paper gold trading. The LBMA states on its website that it trades 20 million ozs of gold each day on a net basis. We can calculate the net trade of REAL physical gold should be about 200,000 ozs each day; that is 6.25 tonnes per day or 1625 tonnes per year. This is very much in line with the size of total global mining output of approximately 2200 tonnes per year.

“So the giant Ponzi trading of gold ledger entries can be sustained only if there is never a liquidity crisis in the REAL physical market. If someone asks for gold and there isn’t any the default would trigger the biggest “bank run” and default in history. This is, of course, why the Central Banks lease their gold or sell it outright to the bullion banks when they are squeezed by high demand for REAL physical gold that can not be met from their own stocks.

“Almost every day we hear of a new financial fraud that has been exposed. The gold and silver market fraud is likely to be bigger than all of them. Investors in their droves, who have purchased gold in good faith in “unallocated accounts”, are going to demand delivery of their metal. They will then discover that there is only one ounce for every one hundred ounces claimed. They will find out they are “unsecured creditors”.

“GATA has long advocated the ownership of real physical bullion. The “bombshells” dropped in the CFTC Public Hearing have only served to reinforce that view. We believe we have made significant new inroads into exposing the fraud, and the suppression of precious metals prices and it is documented in the CFTC’s own hearing.”

Well said. And Douglas is not kidding around with that “unsecured creditors” line. I mentioned the iShares Silver Trust (SLV) ETF above, and the fact that JPMorgan in London is the custodian of nearly 300 million oz of silver at the same time it’s shorting 30% of more of the COMEX silver. Here’s
the prospectus for iShares SLV, and here’s the answer to the question on it regarding creation and redemption of shares:

“The Trust issues and redeems baskets of shares on a continuous basis (a basket equals 50,000 shares). Baskets of shares will only be issued or redeemed in exchange for an amount of silver having a value equal to the aggregate NAV of the number of shares in the baskets being created or redeemed. No shares will be issued until the custodian (JPMorgan) has allocated the corresponding amount of silver to the Trust’s account (except for an unallocated amount of silver not in excess of 1,100 ounces—see “iShares Silver Trust assets” for more detail). Baskets may be created or redeemed only by authorized participants, who pay the trustee a transaction fee for each order to create or redeem baskets.”

I can’t even believe that people “invest” in this. You’ll notice the term “allocated” and “unallocated” silver accounts, and the Trust claims to have both, though it also claims to limit the unallocated accounts to 1,100 oz. What do these terms mean? Simple: silver we claim we have (allocated) and other silver we claim we have that we don’t even really have a serial number for, and we don’t even really know where it is, so maybe, you know, we don’t have it after all, but we’re not sure (unallocated). Okay, that’s my definition—but the prospectus’ definition is even more blatant:

“Unallocated account: Silver is held in unallocated form at a custodian when the person in whose name silver is held is entitled to receive delivery of silver, but that person has no ownership interest in any particular silver that the custodian maintaining the account owns or holds. Ownership of unallocated silver may expose the investor to custodian credit exposure.”

And only, as Douglas states, an “unsecured creditor” with a bundle of paper silver may be “exposed to custodian (JPMorgan) credit exposure,” folks—an unsecured creditor. Could the risk of the custodian’s, JPMorgan’s, credit exposure be exactly the reason the bank is shorting silver? Could it be as simple as the fact that they don’t have the silver they are guaranteeing, so they are trying to keep the price in a range that reduces the likelihood of demanding delivery? Is that what this is all about?

I don’t know—I have no clue. The
March 2010 futures BPR reveals that JPMorgan and HSBC are currently shorting 30,431 contacts. This equates to 152,155,000 oz, which is 327% of the total available deliverable COMEX silver (47.4 Moz). The total holdings of the SLV currently is 298,300,326. The position is equal to 28.1% of the COMEX and 51% of SLV.

Gold, of course, is no different. The custodian of the SPDR Gold ETF (GLD) is our friend HSBC: check out
the prospectus. Highlights include the following duesy:

Shareholders’ recourse against the Trust, the Trustee and the Sponsor, under New York law, the Custodian (HSBC), under English law, and any subcustodians under the law governing their custody operations is limited. The Trust does not insure its gold. The Custodian maintains insurance with regard to its business on such terms and conditions as it considers appropriate. The Trust is not a beneficiary of any such insurance and does not have the ability to dictate the existence, nature or amount of coverage. Therefore, the Custodian may not maintain adequate insurance or any insurance with respect to the gold held by the Custodian on behalf of the Trust. In addition, the Custodian and the Trustee do not require any direct or indirect subcustodians to be insured or bonded with respect to their custodial activities or in respect of the gold held by them on behalf of the Trust. Consequently, a loss may be suffered with respect to the Trust’s gold which is not covered by insurance and for which no person is liable in damages.”

Oh, sounds nice and safe! More:

“The liability of the Custodian is limited under the agreements between the Trustee and the Custodian which establish the Trust’s custody arrangements, or the Custody Agreements. Under the Custody Agreements, the Custodian is only liable for losses that are the direct result of its own negligence, fraud or willful default in the performance of its duties. Any such liability is further limited, in the case of the Allocated Bullion Account Agreement, to the market value of the gold bars held in the Trust’s allocated gold account with the Custodian, or the Trust Allocated Account, at the time such negligence, fraud or willful default is discovered by the Custodian in the case of the Unallocated Bullion Account Agreement, to the amount of gold credited to the Trust’s unallocated gold account with the Custodian, or the Trust Unallocated Gold Account, at the time such negligence, fraud or willful default is discovered by the Custodian. Under each Participant Unallocated Bullion Account Agreement (between the Custodian and an Authorized Participant), the Custodian is not contractually or otherwise liable for any losses suffered by any Authorized Participant or Shareholder that are not the direct result of its own gross negligence, fraud or willful default in the performance of its duties under such agreement, and in no event will its liability exceed the market value of the balance in the Authorized Participant Unallocated Account at the time such gross negligence, fraud or willful default is discovered by the Custodian.”

Wait! It gets better:

“In addition, the Custodian will not be liable for any delay in performance or any non performance of any of its obligations under the Allocated Bullion Account Agreement, the Unallocated Bullion Account Agreement or the Participant Unallocated Bullion Account Agreement by reason of any cause beyond its reasonable control, including acts of God, war or terrorism. As a result, the recourse of the Trustee or the investor, under English law, is limited. Furthermore, under English common law, the Custodian or any subcustodian will not be liable for any delay in the performance or any non-performance of its custodial obligations by reason of any cause beyond its reasonable control. Gold bars may be held by one or more subcustodians appointed by the Custodian, or employed by the subcustodians appointed by the Custodian, until it is transported to the Custodian’s London vault premises. Under the Allocated Bullion Account Agreement, except for an obligation on the part of the Custodian to use commercially reasonable efforts to obtain delivery of the Trust’s gold bars from any subcustodians appointed by the Custodian, the Custodian is not liable for the acts or omissions of its subcustodians unless the selection of such subcustodians was made negligently or in bad faith. There are expected to be no written contractual arrangements between subcustodians that hold the Trust’s gold bars and the Trustee or the Custodian, because traditionally such arrangements are based on the LBMA’s rules and on the customs and practices of the London bullion market. In the event of a legal dispute with respect to or arising from such arrangements, it may be difficult to define such customs and practices….Trust may not be able to recover damages from the Custodian or the subcustodian.”

“It may be difficult or impossible for the Trust to sue a subcustodian in a United States, New York or other court situated in the United States. In addition, it may be difficult, time consuming and/or expensive for the Trust to enforce in a foreign court a judgment rendered by a United States, New York or other court situated in the United States. If the Trust’s gold bars are lost, damaged, stolen or destroyed under circumstances rendering a party liable to the Trust, the responsible party may not have the financial resources sufficient to satisfy the Trust’s claim.”

Of course, all that extensive legalese above assumed that the gold is even there to lose and then be totally indemnified against. You might be thinking about an audit? Sure, sure:

“The Custodian is required under the Allocated Bullion Account Agreement to use reasonable care in appointing its subcustodians but otherwise has no other responsibility in relation to the subcustodians appointed by it. These subcustodians may in turn appoint further subcustodians, but the Custodian is not responsible for the appointment of these further subcustodians. The Custodian does not undertake to monitor the performance by subcustodians of their custody functions or their selection of further subcustodians. The Trustee does not undertake to monitor the performance of any subcustodian. Furthermore, the Trustee may have no right to visit the premises of any subcustodian for the purposes of examining the Trust’s gold bars or any records maintained by the subcustodian, and no subcustodian will be obligated to cooperate in any review the Trustee may wish to conduct of the facilities, procedures, records or creditworthiness of such subcustodian.”

“In addition, the ability of the Trustee to monitor the performance of the Custodian may be limited because under the Custody Agreements the Trustee has only limited rights to visit the premises of the Custodian for the purpose of examining the Trust’s gold bars and certain related records maintained by the Custodian.”

Wow, this is your “gold” and “silver?” Can I volunteer to be the "Custodian," hire some subcustodians, and watch over GLD's 36,324,951 oz of gold--that seems like the sweetest job in the world, and totally indemnified! You can see why the CFTC is so apparently weak on position limits, now, can’t you? How are they going to tell all these people they don’t have what they think they have?

Take delivery.

No comments:

Post a Comment