Is Silver Being Manipulated?

The voices are getting louder about the manipulation of silver prices, and a vast number of websites can provide a forum for these claims. I don’t have proof of manipulative tactics either way, but what I find fascinating is that the same accusation is made with relation to oil – except that the oil price is being manipulated up! Was silver being manipulated while rising, or was it supply and demand from an investment perspective? The large silver price drop took place during Asian trading. Interestingly, and the last time I looked, China and Australia are 3rd and 5th in terms of global production! Food for thought!

Meanwhile, oil executives were summoned to testify before Congress on why gasoline prices are eating the common citizen alive. Rex Tillerson, Exxon’s (XOM) CEO, responded that oil prices, in his opinion, should be in the range of $60 to $70 per barrel, as reported by Reuters. One may view his answer as less than candid, and interpret it as a way to blame speculators for the price increase. That’s fair. But he may be telling the truth and that’s also fair.

It appears to me that every time someone doesn’t like the price action of any asset, especially if that someone has the other side of the trade, manipulation is always the answer. The ease with which one could conjure the same theory for just about anything is frightening, and certainly investors with larger purses can influence prices either way. But there are position limits to deal with, strategies designed to “corner the markets”, and, according to Reuters, Goldfinch Capital Management was recently fined $50,000, plus $17, 287 in profit in natural gas, by the CME Group – not a government agency.

The NYMEX Business Conduct Committee found the firm "sold (December 2010) futures contracts and extended its short position to 1,053 contracts, 53 contracts (5.3%) over the expiring speculative spot month position limit, before buying (December) futures contracts and reducing the position back under the limit.

But let’s look at the silver futures contract as it has become a different beast over time. The contract size is 5,000 troy ounces, or $250,000 at $50 per ounce. By comparison, one oil contract is 1,000 barrels, or $100,000 at $100 per barrel, and gold is 100 troy ounces, or $150,000 at $1,500 per ounce. Are we starting to see the difference?

When oil drops $1, the contract loses $1,000 in value, and if gold drops $1, the contract loses $100. But when silver drops $1, the contract loses $5,000. If we look back to May 2, it is obvious that as silver dropped the first $2, investors faced a loss of $10,000 per contract, and a vicious cycle ensued. Even a meager 25 cent move either way – long or short -- leaves an investor with a $1,250 gain or loss in the time it takes to get a cup of coffee. For example, on May 13 between 11:40 am and 11:45 am CST, the silver contract had a range of 42.5 cents, or $2,125, and even to some professionals that is a large amount to absorb in a single trade.

I don’t know what triggered the drop, but that is the risk associated with leveraged positions -- especially silver due to the contract size – and large declines sometimes occur due to a lack of buyers. My take is that plenty of individuals piled on the trade without a good grasp of the risk involved. In addition, margin increases are designed to protect the brokers from ending up with accounts that cannot fulfill their obligations. Between April 13 and April 25, silver rose virtually non-stop from $40.17 to $47.17 – interim high was $49.84 -- for a whopping $48,350 gain or loss per contract at the extremes.

Furthermore, and on a weekly basis, silver had been in overbought territory since the beginning of March. On a daily basis, the same was true since April 5, yet the metal kept reaching for the sky.

Maybe producers sold a few bars forward because they felt pretty good about delivering inventory in July at that price, having realized that demand was easing. Meanwhile, Reuters reported that “Big hedge funds had actually begun paring positions weeks before prices reached an all-time high of nearly $50 an ounce. At about 19,000 contracts, speculative net length is at its second-lowest since early 2010.”

In addition, and to bring additional perspective to the subject, the magnitude of the market was covered by the CME Group with a press release on April 26, 2011.

Yesterday, trading of Silver futures reached 319,204 contracts, surpassing the prior record of 201,216 contracts set on November 9, 2010. At the same time, open interest in Silver options reached a new record of 240,344 contracts. The prior record of 235,992 contracts was set on April 21, 2011. Silver futures have demonstrated rapid growth during the month of April. Month-to-date average daily volume (ADV) for Silver futures has increased 218 percent from this point last year. During 2011 year-to-date, ADV for Silver futures have grown 110 percent versus the same period last year.

As reported by Reuters, CME’s last margin increase effective May 9 required $16,000 per contract – or a $3.20 increase or decrease per ounce. What is not being addressed is that margin affects both sides, and if the price increases by that much short sellers are also affected.

Yet another important point in light of the leverage provided by one silver futures contract is that the reward is tremendous when the price is climbing and more often than not when everyone is dancing everyone forgets about the downside – until it happens, that is. Then conspiracy theories abound and are plastered all over the web. And if one is pursuing the physical metal approach without a complete understanding of the futures markets, it becomes distressing and downright infuriating when prices sink.

With respect to oil, the same story applies, and the fact that one oil contract provides less leverage, the sudden shift in mood as witnessed over the last two weeks can flush the small players in a similar fashion. Last week the West Texas Intermediate oil contract had a trading range of $9.35, translating into a $9,350 profit or loss per contract between the high and the low, and exceeding the current initial margin of $8,438. One again, increased volatility will increase margins.

Lastly, the futures markets are just that: The future! So when individuals refer to dealers’ silver coin and bar shortages, the point is irrelevant, because the market is stating that as of the close on May 13, silver is worth $35.01 on July 27, 2011 – the last trading day for the July contract -- not on Friday.

Certainly the mood can change tomorrow – up or down -- and that is why one should watch the futures, including the S&P 500, like we watch today’s weather forecast for the week, not for today's or yesterday’s temperature.

source:http://seekingalpha.com/article/270272-is-silver-being-manipulated#comments_header