Price discovery in all commodities is an electronic paper affair. While the macro-economy and the geopolitical provide a distant framework, they do not wield significant direct influence. The “discovery issue” occurs across the board, but is nowhere more evident than in the precious metals futures markets and, most notably, silver. A look under the hood at the most recent rally confirms that we are nowhere close to the point of return to equilibrium price.
The set up for precious metals has been in place for years. In silver, the trading structure has been this way for decades.
A short list of giant multi-national hedge funds disguised as banks manages huge, concentrated short (selling) positions, while the price moves within a range far outside of reality.
It is the poster child example of how disconnected the macro economy is from the reality of fundamentals. Money supply, in addition to monetary policy, is so far from being priced that the potential for explosive return is a constant yet barely palpable presence in the precious metals pits.
It is these shorts that act as the lynch pin, or the tiny plug that holds the massive edifice together. If they were gone, we would be trading in a range that reflects present value based on purchasing power and not at a level that is barely a representation of potential future value.
Events in the geopolitical realm – especially those that are unraveling before us now that are mere off-gassing from tensions that were built long ago – bear no real effect on the actual future value of assets across the board.
At present it continues to be a game where the derivative tale wags the physical dog. A game played not just in the computerized pits of the COMEX, but all across the spectrum in truly bizarre manifestations.
Take the warehouse re-hypothecation issues in China we’ve commented on recently.
In order to maintain liquidity in China’s shadow financing sector (a version of our own credit facility), collateral is demanded as pledge for the paper arbitrage and lending deals.
Much of this demand is centered on the base metals, especially copper. Whether it is copper or any other metal – including gold – makes little difference. The metal is taken out of supply and stored in a warehouse where it is famously pledged over and over again in an array of transactions that seemingly create a web of shadows.
This is a classic example of re-hypothecation.
But the methods and madness are simply the results of years of pioneering financiers in the West who do essentially the same.
The COMEX futures market is no exception. In practically every commodity there is an overwhelming presence of speculators in relation to the number of true producers and users.
Nowhere is the more egregious than in the gold and silver pits, where futures are almost completely dominated by commercial banks and the hedge funds.
What we see play out over and over is a simple game that goes unchecked and largely unquestioned.
The bullion banks use their dominate positions to move speculators – literally tricking them into buying or selling on a whim, which may or may not appear to be economically sound. The moves are facilitated by the use of technologies or the so-called high frequency trading where compute-run algorithms are able to lean in to the market and paint a character (dumping huge, impossible to fill positions) but not following through.
In the wake of the most recent rally, where silver prices moved up nearly 10%, the big banks have once again capped each rally by adding in a record way to their selling positions.
We may move up, down or sideways from here, but is really just a matter of time before they harvest a new set of weak longs again.
How long can it go on?
It can go on for as long as the major market participants, those with a voice and the power, allow it. At some point, the large banks may decide that they’ve accumulated enough metal to let the price return to equilibrium.
But most likely, real values will return when the current pricing mechanism is finally broken beyond repair. Sadly, it will be too late for most.
And this, of course, is what passes for reality in financial discourse and commentary.
The dominant forces in the price discovery remain entrenched. These bullion banks have a nearly undefeated record when it comes to profiting from whatever positions they hold; despite the moral, ethical, or legal implications and sheer lack of regulator oversight. But the dominance of these positions can only paper over reality for so long. As belief or lack of confidence trickles up toward the now opaque trading structure, it slowly chips away at the entire house of cards until it dissolves all at once. And it is then the intrinsic value of real assets, especially those which are rare and precious, are once again laid bare for all to see. The key is being positioned for the day when value reasserts itself, because once it does, the race will be on.