The 800 Pound Gorilla

I really hadn't planned on writing another gold/silver lease scam piece for awhile, but I happened to read Martin Armstrong's article of 1/28/98, and I got the feeling he was taking issue with my contention that the silver lease con was over, or that it ever existed. If you haven't read his piece (located at the bottom of this article), please do so, because it is an extremely important statement on the current predicament that the large industrial silver users and derivatives shorts face. It very clearly telegraphs the exit strategy planned by the big users/shorts. That planned strategy is the single biggest threat to the workings of the free market in recent history.

Armstrong's agenda is clear - the only hope for the big users/shorts in silver is for the government, any government, to come in and confiscate all available physical silver and arbitrarily terminate all paper contracts of silver. They are obviously disturbed by the prospect of resolution by the forces of the free market. If you were in their shoes, you would also be disturbed. For the sake of the markets, let's hope they don't succeed in their exit plans.

In classic double-speak, Armstrong rants about the upward manipulation in silver, while cleverly ignoring that at $6/oz, silver is cheap. What's also ignored is that whatever amounts of silver the buyers may own, either in physical or paper contract form, the sellers of that silver were not coerced into those transactions. Now, it is clear that the sellers are having second thoughts. Yes, there has been a manipulation in silver, but it has not been of the upside variety. The real manipulation has been the fifteen year downward rigging of silver prices through the leasing scam and the 800 pound gorilla in the room that everybody is doing their best to ignore and speak around. But the gorilla is getting tired of sitting still and is starting to throw his weight around. He will be ignored no more. You see, the gorilla is the largest naked short position the world has ever seen, and its resolution is going to be a monster. Funny, Armstrong didn't mention that.

You might want to get out a pencil and paper, or calculator, while I attempt to validate what is a pretty strong statement, that silver has the largest naked short position ever witnessed in the world's history. Don't worry, this will be simple math, as I'm no rocket scientist. The latest available data from the COMEX (Jan 29), indicates a total open interest in futures and call options (the two classes of contracts that can result in the ultimate liability of having to deliver physical silver) of over 170,000 contracts. Convert that into ounces by multiplying by 5,000 ounces (the contract unit of trade), and you'll come up with 850 million ounces. That's the total amount held long and held short on the COMEX. (Of course, there is an unlisted derivative and lease market, which could bring the total real short position to 2 or 3 times the listed exposure, but since the Central Banks or the bullion banks don't disclose their real books, let's stick with the published statistics.) Against that 850 million ounces, now measure available total inventories and world production. Even if you assume all visible inventories (around 100-200 million ounces) and total world production (around 500 million ounces) were somehow available to the COMEX shorts (admittedly ridiculous as the inventories are owned by someone not necessarily the shorts and world production can't even satisfy world consumption, so by axiom isn't available to the shorts), there is no way the shorts could get their hands on anywhere near enough material to cover their potential obligations. Are you starting to get an idea of the dimensions of the silver short position? We're not quite done yet, because if this were the normal configuration of open (short) interest to inventory and world production in all, or other, commodities, my claim of biggest ever short position would be bogus.

So take out the newspaper again, and test me by going through the same exercise with other commodities. Let’s do two or three together, and then I’ll challenge you to prove me wrong by finding any commodity that even comes close to the silver short to inventory/production ratio. Let's start with corn. Total open interest in corn futures and call options is 540,000 contracts, or 2.7 billion bushels. Forget inventories and world production, US production alone runs 9 billion bushels. How about oil? Total open interest for futures and call options runs a whopping 715,000 contracts, but that translates into 715 million barrels of oil, or only about 10-15 days of world production. Gold has a combined futures and call option open interest of 435,000 contracts on the COMEX, which translates into 43.5 million ounces or more than 50% of world production, but that's a very small fraction compared to known stocks. (I'm aware of the large off exchange and lease exposure in gold, but remember we are only comparing known statistics). No, silver is in a class by itself for having such a lopsided short position to real stuff ratio, and has for the past fifteen years. And don't think that this skewered ratio exists only in comparison to other commodities. While in extreme cases an individual stock may sport a short position equal to 10 or 15% of shares outstanding, the total short position for all stocks runs something like a half of 1% compared to all shares outstanding.

The point of all this is not just to demonstrate that when it comes to the short position, silver is off the charts when compared to anything else, but to stimulate your thinking as to what this means. What it means to me is that we have the bizarre situation where the size of the derivatives position of silver towers over the size of the real market. In silver, not only does the tail wag the dog, the tail is larger than the dog! How can that be? How can a derivative market be larger than the host market from which it is derived? Now here comes the tricky part. If the paper market in silver is much bigger than the physical market, guess which market determines the price? As you answer that question, remember that the paper market setting the price (not discovering, but dictating) is against every principal of commodity law.Forget commodity law, how about common sense? It is impossible to have a short position larger than what exists or could be produced, yet that's the condition in the silver market. And if someone sold short more of something than existed, don't you think that would have a price-depressive influence?

To those who would say, so what - there are just as many longs as shorts (I have gotten that response), please consider this; all it takes for a long to complete his contract obligation (aside from selling out) is to fill out a check. A short (who doesn't buy back) must round up and deliver material that doesn't appear to be available. Besides, the longs aren't the ones wailing.

Now do you have a sense of the real problem in silver? Now do you understand the screams of alarm at $6 silver, and the lawsuits and the cries for government intervention? After crushing this market for 15 years with massive paper shorts, the deficit balancing supplies from the lease market have dried up, leaving only a literal paper tiger. The only question is whether the government says to hell with the free market and bails out the big users/shorts, and rewards them for manipulating the silver market for 15 years with their massive and uneconomic short positions by mandating an artificial settlement. For the sake of free markets, let's pray they don't.

Ted Butler

1 February 1998

Martin Armstrong's Silver Essay: "Metals Scandal of 1998?" http://www.pei-intl.com/Research/SILVER.HTM