Monday, July 25, 2011

Q&A With The Doc: How Can Paper Silver Affect the Price of Physical?

Ty writes:

Hi Doc,
I'm fairly new to silver buying and I guess you can say I've gotten bit by the silver bug because I've been converting the majority of my savings into silver.
Outside of my 401k this is my first foray into investing other than say real estate, etc.
Can you explain paper silver and the market manipulation. I don't understand how JP Morgan dumping a bunch of electronic paper onto a market should affect the price of the physical silver I have at home. How can the two even be compared? I'm new to this and this seems like one big scam so I guess where I am confused is why doesn't the rest of the world know it's a scam? Who is actually buying this paper silver? Is this mostly day traders? I could see day trading it but I cannot imagine holding something like a digital piece of paper that says I own silver when I can just buy the actual silver for the same price. Why wouldn't the two be priced differently? Are there good resources where I can learn about this manipulation and how it works?

First of all, great to hear you've been bitten by the silver bug! I hope you were thoroughly exposed to the venom!
Currently the LBMA and the COMEX are the major PRICE DETERMINATION markets for gold and silver (as well as other major commodities).  The action on the COMEX determines the spot price of gold and silver.
The COMEX trades gold and silver FUTURES, which in the case of silver, allow the long to obtain 5,000 oz of silver/contract at a future delivery date.
Now, the exchanges allow trading of gold and silver futures on MARGIN.  These means that you do not have to put up the cash for the full contract, allowing your capital to "control" exponentially more gold and silver than you could without the leverage of margin.
For example.  Lets say silver is at $30, and a single silver long contract is purchased as a $40 call.  To purchase 5,000oz of physical silver at $30 would require $150,000 in capital.  If silver rose from $30 to $40, that would result in a gain of $50,000 (the 5,000oz of silver would now be worth $200,000).  This would result in a percentage gain of 33%.  ($50,000 gain/$150,000 capital required) 
Futures markets through leverage allow traders to control that single contract with say $15,000 rather than $150,000. With the leverage involved, that same move that results in a gain of $50,000, = 333% gain. ($50,000 gain/ $15,000 capital)
Now typically, most traders use the COMEX for this leverage opportunity.  This means that when the contracts come due, most traders ROLL their contracts forward into the next delivery month.  They're not trading silver because they have a need or want for the metal, they are trading it for the LEVERAGE that the futures market offers.
Jeffery Christian of the CPM group testified to the CFTC that paper silver and gold trade in multiples greater than 100 TIMES the underlying physical silver representing those paper contracts.  As long as the majority of traders never stand for delivery of physical silver and continue rolling contracts, no problem results.
Clearly end users such as mints and refineries (or any trader who so desires) can stand for delivery, and acquire the actual physical bullion.  But yes, you are correct, 99% of the trading on the COMEX is high frequency trading (HFT) or day trading.
This affects the price of physical silver because again, the futures markets are the PRICE DISCOVERY mechanism for commodities.
During extreme paper manipulation sell-offs however, the price of silver bullion often decouples from the paper markets, which can be seen by rising PREMIUMS for coins and bullion. During the 2008 market collapse, spot silver traded down to nearly $8, yet premiums on Silver Eagles at the time rose to $5.99/oz over spot!  The futures market price of silver was nearly $8, yet PHYSICAL silver in 100oz and lower denominations could not be found ANYWHERE for anything near that price.
Expect the decoupling of the COMEX futures spot price of silver vs. physical bullion to increase as the silver manipulation end game nears.

Now that we have an explanation of the paper silver market vs. the physical bullion market, lets answer your questions of WHO and WHY.

I have previously written extensively on this subject here describing Treasury Secretary Robert Rubin's Strong Dollar Policy as the cause of the metals manipulation.  It is all about perception of the US dollar, the world's reserve currency.  Should gold and silver be allowed to freely rise they would reveal to the world the fundamental rottenness of the US dollar.

JP Morgan, HSBC, and the rest of the "cartel" at least initially were not concerned about losing money by shorting gold and silver, as ultimately the US government is behind the trade.  However, the potential losses particularly on OTC precious metals derivatives have become so monstrous that the banks and even the entire system is threatened should those losses be realized.
This is why the manipulation is becoming increasingly desperate and blatant, as the noose is literally tightening around the banksters necks in the form of dwindling physical silver supplies.  This is why you saw this week 250 million oz of paper silver dumped onto the market in 1 minute to knock silver back below $40.  250 million oz is 10 times the remaining deliverable silver supply at the COMEX of 26+ million oz, 5 times the 50 million oz mined in the US ANNUALLY, and 1/4 of the entire worlds annual silver supply.  The cartel now has no choice left but to double and triple down on the silver suppression.

You are correct, the COMEX paper silver market is ONE BIG SCAM. 
However, that big scam is rapidly coming to an end by the free market.
Buy as much silver at the discounted manipulated price as you can now, for when the scam ends, so will the discount, and silver will instantly be revalued MUCH HIGHER.

(A good animated over-view of the silver manipulation has been created by one of our readers as well, The Life of a Silver Hitman)