Let's Get Physical

December 13, 2004

As most Internet readers are well aware, I have not published at any consistent frequency these past several months. Most of our time and energy has been for our paid readership but certainly it is our duty to continue our work in the Free Market of Ideas. One of the most significant silver gatherings just took place at the Northwest Mining Association Conference in Spokane, Washington state last week.

The CFTC senior economist Mr. David Kass did a presentation overview of the CFTC and then went into specifics on the silver market. First, his presentation was excellent and certainly the job of the CFTC is a difficult one. As has been pointed out in other articles the silver market is such a tiny market making up perhaps three tenths of one percent of all futures trading it hardly seems worth bothering with, unless you understand why the Silver Institute calls silver the INDISPENSABLE Metal. Without silver our modern way of life would not exist, certainly this would be true of most metals, however silver is the standout as far as technology is concerned. As stated quite some time ago "silver is one of the best technology investments you can make." Silver truly is indispensable to the modern way of life.

When Mr. Kass finished his presentation there was time for a couple of questions, and in fact one of the questions raised was addressed previously in the August issue of the Silver Investor report. This was sent to our paid subscribers and several asked that we post this excerpt to the web, but since it was primarily written to stimulate thinking and was never formally sent to the CFTC it becomes hypothetical.

Now that the essence has been addressed in the public forum, it was decided to issue this imaginary letter into the Free Market of Ideas. The verbal question asked was, if a retail dealer were to stand for 1000 contracts of silver (approximately 5 million ounces) every month, would this cause a problem with the CFTC?

Mr. Kass replied that this would not be done because a retail metal dealer would go into the cash market and not into the cumbersome time consuming practice of taking silver delivery off the exchange. Good point perhaps, but in theory can one stand for delivery each month?

Mr. Kass then stated that were that to occur the price of silver would go up. Interesting.. Please draw your own conclusions. To remain consistent, it has been our contention that the physical market would dominate the paper markets at some point. Did Mr. Kass himself verify our contention?

Before reading this blurb written this past summer a few changes have occurred, Michael Gorham is no longer with the CFTC, the amount of silver in Comex inventory is about 20 million ounces less and the registered category is about 6 million ounces less. Again, this letter is hypothetical and what ever your personal beliefs are about the silver market it might stimulate your thinking.

David Morgan

From the August Silver-Investor.com Newsletter

Let's get Physical with the CFTC

The official letter from the CFTC seemed to have a profound impact on most onlookers. The first impact on our thinking is the letter's author Mr. Michael Gorham is the fact he spent four years in the Federal Reserve System. This fact should factor into your thinking because all central banks throughout history have always favored their control over the money supply and avoided as much as possible a gold, silver or bimetallic standard. The discipline that precious metals puts on the money creators is normally shaken off at some point and then the issuing of worthless paper "notes" takes over, leading to either an inflationary depression or a debt liquidating depression.

To analyze the response to the satisfaction of all our readers will be impossible, but some of the major points that struck us will be discussed. First, the letter fails to address why the commercial interests are always net short, it all other commodity markets commercials will go long from time to time, especially when the given commodity is below the cost of production. This does not happen in silver ever, this fact does bring into question if there is any bias to the short side by the commercial interests.

Most important to us however is the link provided in the letter to the CFTC surveillance program. The obvious is stated clearly, the commission is very concerned with the physical delivery requirements and this is where the CFTC would be able to find "manipulation". The first question the commission asks is whether the position held long (buyer) is greater than the deliverable supplies?

This question is self evident, although Mr. Gorham alludes to a great deal of silver being available the exchange is very concerned of a Hunt repeat, meaning someone buys up the remaining or better yet more than the remaining amount of silver on the Exchange. This is primarily why the reporting requirements are in place. Positions must be reported if they are 1500 contracts or greater. This represents 7.5 million ounces of silver.

The real letter to the esteemed Mr. Gorham might read something to the effect:

Dear Mr. Gorham,

I have studied your recent reply to the silver manipulation in depth and have concluded that silver truly is undervalued in fact our firm believes strongly that by purchasing silver through the Comex and delivering to our mint, we would be able to mint one ounce rounds and sell to the retail market at a substantial profit.

I have taken notice that you are very concerned with the near month and physical delivery of silver, but really do not give a hoot about paper contracts trading in the back months. I am also aware of the fact that certain reporting requirements are issued by the CFTC. My question becomes the following, what is exactly the appropriate amount of silver bullion that can be purchased from the exchange on a monthly basis without the CFTC claiming manipulation by the "longs"?

I wish to take delivery of approximately 50 million ounces of silver bullion from the exchange over the next twelve-month period, which is less than 5 million ounces on a monthly basis. This is well under the current reporting requirements but just to be safe and to make certain the CFTC protects buyers of silver as well as sellers of silver I would like to know if my paying for and asking for what I purchased to be illegal in any way?

I have studied the silver market carefully these past several years and have noticed that only 50 million ounces or so are available in the registered category and therefore plan to stop my purchases at that amount.

Finally, I wish to inform you that all required contracts for the above outlined procedure are already in place for the next delivery month, again if there is any problem with buying silver off the Comex in the manner outlined please bring it to my immediate attention.

You outline and I quote: "Physical-delivery commodities. Futures contracts that require the delivery of a physical commodity are most susceptible to manipulation when the deliverable supply on such contracts is small relative to the size of positions held by traders, individually or in related groups, as the contract approaches expiration. The more difficult and costly it is to augment deliverable supplies within the time constraints of the expiring futures contract's delivery terms, the more susceptible to manipulation the contract becomes."

Although I understand the general idea the CFTC is set up mostly as a paper chase, I wish the real commodity and need to know how much would cause you a problem? Since 5 million ounces is approximately 4% of the total Comex inventory this would hardly cause a problem or would it?

One area that you outline is the question "Are the long traders likely to demand delivery?" As we both know the longs in any futures contract seldom take delivery but there is nothing at law that would prevent me from taking delivery. Therefore the question again becomes what is the allowed amount? The next question is whether taking delivery is the least costly means of taking delivery. The answer is yes, it is, I have researched this time and time again. However, that is of course unless the exchange starts to implement additional fees that they have never imposed prior to this letter.

Your next question baffles me completely "To what extent are the largest short traders capable of making delivery?" According to all the written correspondence with the CFTC the shorts are never the problem only the longs so why in the world would the exchange worry about them making good on a silver contract? They can throw paper better than the wallpaper hanger during the Weimar Republic, so I am sure they can come up with 5 million ounces of silver on a monthly basis, correct?

You also state and I quote "An excellent barometer for potential liquidation problems is the basis relationship (i.e., the cash and futures price difference). When the price of the liquidating future is abnormally higher than underlying cash prices or both the futures and underlying cash price are abnormally higher than comparable cash prices, there is ample reason to examine the causes and to assess the motives of traders holding long futures positions."

Again, I am a bit perplexed, it seems that if a commodity were in a tight supply condition the price would rise and if the shorts were having trouble delivering the silver I had purchased why should that become my problem? I bought on a contractual basis, paid the price obligated per contract and if the shorts have to bid up to deliver why would I be responsible, poor planning on their part does not constitute an emergency on my part or does it under CFTC rules?

Additionally I clearly stated my motive in the beginning of this letter to make a profit turning silver bullion in silver medallions with the inscription "The CFTC said I could Buy" on the obverse and "I stayed Long and Strong!!" on the reverse. My motive is profit; surely in your letter to us the Silver Investor you noted it would be hard to determine what motive the short interests could possibly have. Well, let me give you a clue the only reason the Futures markets exist is for profit - that my good sir is the motive.

Another area that concerned me was the statement made in your surveillance methods, which I quote: "Some of the information is highly confidential, including data from exchanges, intermediaries and large traders." I realize that confidence is required at some level but it seems by reading further that it is for protection of the large interests only because your ability to talk down position holders. Specifically, again quoting "relevant surveillance information is shared and, when appropriate, corrective actions are coordinated. Potential problem situations are jointly monitored and, if necessary, verbal contacts are made with the brokers or traders who are significant participants in the market in question. These contacts may be for the purpose of asking questions, confirming reported positions, alerting the brokers or traders as to the regulatory concern for the situation, or warning them to conduct their trading responsibly. This "jawboning" activity by the Commission and the exchanges has been quite effective in resolving most potential problems at an early stage."

If taking delivery of something one has paid for is going to subject me to "jawboning" let me know up front I will have my tape recorder ready, because I want to trade responsibly, in fact so responsibly that I will put up the cash required each month to take my silver off the Comex. Again however this specific amount has never been addressed by you Mr. Gorham or the CFTC. Is there an amount that will cause a problem? It seems from your most recent letter the only problem silver has is vast abundance (at least you implied this was a very probable reason for the low silver price) and therefore I conclude I am in a very small minority that thinks it still represents good value and it perhaps not as plentiful as the GFMS report you quoted states.

Finally we come near the end of my inquiry, and this paragraph simply scares me to death because it reads as if the Commission can do any darn thing they wish to prevent me from taking delivery of my silver even if paid for in full, is this true? Quoting and emphasizing certain parts of your statement…

The Commission customarily gives the exchange the first opportunity to resolve problems in its markets, either informally or through emergency action. If an exchange fails to take actions that the Commission deems appropriate, the Commission has broad emergency powers under which it can order the exchange to take actions specified by the Commission. Such actions could include limiting trading to liquidating transactions, imposing or reducing limits on positions, requiring the liquidation of positions, extending a delivery period, or closing a market. Fortunately, most issues are resolved without the need to use the CFTC's emergency powers. The fact that the CFTC has had to take emergency actions only four times in its history demonstrates its commitment to not intervene in markets unless all other efforts have been unsuccessful.

Now if I read this correctly the silver market could actually be closed down if I merely wanted to buy silver from the exchange and take delivery, well Mr. Gorham that scares the heck out of me, so please tell me what exactly is the precise amount of silver I can purchase off the exchange before it is closed down? If it were less than 50 million ounces I would need to know in advance, correct?

Finally, there has been a large shift in Comex silver the past several months. As this is being written there exists just over 120 million ounces of silver, divided as follows: 72.6 million in the eligible category and 47.8 million in the registered category. If this shift continues and more investors purchase silver from the Comex and decide to store it in approved Comex facilities and the shift continues at what point will the CFTC be concerned about liquidity in the spot month?

In other words, for example the total silver remained at 120 million ounces but 90% of it was held in the eligible (investor) category would this cause any concern to the CFTC? I suspect it would because this would leave a mere 12 million ounces of silver readily available to the registered (dealer) category, correct?

Yours for physical metal not paper promises,

Silver Investor

December 13, 2004

David Morgan
Stone Investment Group

David Morgan (Silver-Investor.com) is a widely recognized analyst in the precious metals industry; he consults for hedge funds, high net-worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report on precious metals, the author of Get the Skinny on Silver Investing, and a featured speaker at investment conferences in North America, Europe and Asia. You can receive a free 30 day trial subscription here http://www.silver-investor.com/joinfreelist.html

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