EJ: Thanks for an outstanding piece! I'm also honored to have been quoted.
It appears to me that there is still some confusion on a couple of points, so I'll try to at least clarify my own view on four subjects: Ron Kirby, the JPM short Ted Butler has written extensively about, then perhaps most importantly, the "100:1 leverage" allegation and surrounding confusion about Jeff Christian's comments, and then finally, Andrew Maguire and why I find his story suspicious.
Ron Kirby:
Someone described my comments about Ron Kirby as an inappropriate character attack, and I understand and respect that sentiment. Please understand, however, that I had no idea EJ would be quoting me in this piece. When I wrote those comments in a comment post, I prefixed them with an apology for not having the time to substantiate my arguments. I'll now elaborate below.
Ron Kirby is the "analyst" who broke the
Anyone who understands the futures market would immediately recognize this nonsense for what it is. "Illegal Naked Short Selling" is a real issue, but the phrase relates to the stock market, not the futures market. Futures are a derivative market, and the seller isn't expected to own the underlying. There is nothing illegal about that whatsoever, and it is most often the case in most commodities. So Kirby either has no clue what the futures market actually is or how it operates, or else he's engaged in an intentional disinformation campaign designed to put fear, uncertainty and doubt into the metals markets. I can't decide which, but either way I have zero respect for this character.
In his original piece breaking the
Of course Kirby never bothers to mention that although gold and tungsten have nearly identical density, they have completely different ultrasonic response frequencies, and that a tungsten fake would be spotted instantly if assayed by any sophisticated buyer using ultrasonic verification. That's a rather odd detail to leave out. Unless you're writing conspiracy drivel for the intentional purpose of scaring people.
The JP Morgan Silver Short:
BlackVoid suggested that I had contradicted EJ by implying that I was convinced JPM is manipulating the silver market. That does appear to be the case in the text I wrote that EJ quoted, but please keep in mind that what I wrote was done in haste and not knowing it would be quoted. I now realize that what I said ("very real") was a little stronger than I intended.
What I meant to say pertains to the body of evidence assembled by Ted Butler alleging that Bear Sterns was engaged in a massive concentrated short position that was taken over by JP Morgan and was still being used to manipulate the market right up to just before the CFTC hearing. My choice of the words "very real downward manipulation" was unfortunate. What I should have said is that I find Butler's analysis of the COT reports revealing this highly concentrated short to be highly credible, hence "very real". Whether that very large short is truly being used to manipulate the market to the downside is something I can neither prove nor disprove, but I think the evidence Butler has assembled certainly warrants a closer look by regulators. Perhaps I should have said "GATA has very real evidence of a large concentrated short and a plausible allegation that it exists purely for downside market manipulation. Those claims certainly warrant thorough investigation."
The reason I was saying "very real" was to contrast this business of the JPM short with the utter nonsense being thrown around by GATA relative to the 100:1 "leverage" (sic) business. More on that below.
100:1 Leverage and Jeff Christian's "Admission":
This is the really important one, and it's the area where I think GATA is being outright incompetent. I'm afraid that for everyone to understand this will require a short tutorial on the futures market. I'll try to be as brief and concise as I can...
The futures markets are used for two purposes. First, they are actually used to buy and sell real stuff, including crude oil, wheat, soy beans, precious metals, and (as made famous by Eddie Murphy's film Trading Places), even pork bellies and orange juice. Second, the futures markets are used for speculation. When someone buys or sells a crude oil contract, for example, they are often not intending to deliver any oil if they sold or take delivery of any oil if they bought. Rather, they bought or sold the contract on speculation of a price change, intending to close out the position prior to contract expiration and settle any profit or loss in cash. Some contracts are cash-settled meaning it's not even possible to take delivery. Example: Dollar Index futures. You can't deliver an index. By buying or selling a DX contract, you are just making an economic bet on which way the index will move between the time you open and close the position. Because speculators are the bulk of the market, most brokers won't even allow you to take or make delivery! My broker, for example, will automatically close any open position 24 hours before its notice date, just to make sure they don't get involved in a "delivery situation" they don't specialize in.
This is the normal operation of the futures market. It is not special or unique to gold or silver. It's true of all commodities. Jeff Christian's comment about there being 99 speculative contracts for every contract that will actually be delivered against with physical metal was accurate, but it didn't reveal anything new or particularly siginficant. The same thing is true of crude oil contracts, copper contracts or a any number of other commodities.
GATA's assertions that buyers of paper gold are being defrauded are nothing short of ludicrous. Anyone who has the most cursory understanding of futures trading knows that it's a derivative market, not a physical market. GATA goes a step further and really flaunts their ignorance with the asinine allegation that selling a gold future contract without first owning the physical metal is "fraud" and that by settling in cash rather than delivery, this amounts to "default".
This is utter hogwash. Just as most buyers and sellers of puts and calls in the equity markets will close the position rather than take it through to exercise, the same is true in futures. The futures markets are very organized. The buyer or seller of any contract has two options: They can either close the position and settle in cash (there's a deadline for doing this called the first notice date), or they can keep the position open past that date in which case they have to deliver or accept delivery. GATA alleged that anyone who sells a contract without metal to deliver is committing fraud and default. That's utter nonsense. Anyone who holds an open position past the notice date without ability to deliver is indeed in a default situation. But that's not what we're talking about. GATA went on to say that the buyer of a gold futures contract thinks they are buying real gold. Considering that 90% (my guesstimate) of futures brokers won't even allow that transaction, this claim is outright ludicrous! GATA's principals appear to be shockingly ignorant about how commodities markets function.
I do think the market needs a watchdog - someone to seriously investigate real issues like the question of whether the big JPM short Ted Butler has written about is really being used to manipulate the market. But we can't afford to have the organization chartered with this important job (GATA) to be run by leadership that is categorically ignorant about the most basic aspects of futures trading. That seems to be the case, unfortunately.
There's another aspect of this that's really important to understand: Leverage. Not the 100:1 thing - that wasn't even an accurate use of the term leverage. I mean the fact that the buyer of a commodity contract doesn't pay the full price of the commodity when they open a position. They only put up a down-payment of about 10%. This gets really confusing for equity traders because it's called margin. Please understand it has nothing to do with "borrowing on margin" in the stock market sense. Same word, completely different meaning. In the futures context, it means putting up a down-payment, with the balance due only if and when physical delivery occurs. Remember that's a rare case, so most often the transaction involves margin and profit or loss, and the balance of the actual commodity price is never paid.
The fear mongering hype machine we know as GATA is prone to saying things like "What if all the buyers of gold contracts wanted their gold? If as Jeff Christian admits (sic) there is only 1 seller out of 100 with real gold, doesn't that mean 99 buyers would get screwed?" To really understand this you have to realize that the whole reason most buyers bought futures rather than physical gold in the first place was the "low down payment" aspect of the market. You can control a million dollars worth of gold or silver derivatives with just $100k of margin (down-payment).
So what if all those longs (buyers of gold and silver contracts) said "We want our gold! Give us delivery of physical metal!"? Well, the way they would do that would be to pay their broker the remaining 90% of the purchase price - money the vast majority of buyers just don't have! So this simply isn't a realistic scenario. Even if it was, most brokers don't even allow physical delivery. GATA clearly doesn't understand how the market works.
Now there is a legitimate issue here: If the futures market was originally conceived for sale of actual commodities, does it really make sense to allow speculators to participate in the market in the first place? After all, if some bizarre situation resulted in all those buyers coming up with the money and demanding delivery, it could lead to a failure to deliver! That's actually an entirely legitimate question, so let's consider it carefully.
The first part of the answer is that nothing about this is unique to precious metals in any way shape or form. The same question applies to all commodities - the ratios may vary, but there are far less barrels of oil than there are oil contracts, far fewer tons of bulk copper than there are copper contracts, and so forth. So this is a question about commodity markets in general, not about gold and silver.
But more importantly, the second part of the answer is that this issue of whether speculators should be in the market has been well known and hotly debated in commodities circles for decades! There is nothing new here. All Jeff Christian did was to state some obvious and well known facts about commodities markets. GATA has taken them completely out of context, which I can only attribute to either gross incompetence and ignorance about how the markets really work, or as an indication that they are engaged in an intentional disinformation campaign.
GATA claims that the physical metals markets have now been exposed to be a fraud, to the tune of 100:1 "leverage" (sic), where poor unsuspecting buyers of gold are being duped by a criminal fraud in which there's only 1 ounce of real gold backing every 100 that are traded! That's great sounding rhetoric, but it's fatally flawed logic. We're not talking about the physcial market, which is known in the industry as the spot market. We're talking about the futures market, which is a derivative market. Everyone buying or selling futures contracts knows going in that there is a lot more paper in the system than there is physical commodity. If they don't know that basic, well known fact, then they have no business trading futures! (Or running a watchdog organization, for that matter!) The futures exchange mechanism does a good job of insulating traders from isolated cases of counterparty risk, because if the guy on the other side of a futures contract defaults on delivery after keeping his short position open past the notice date, the exchange has some gold set aside to give the buyer to cover for the delinquent seller. But if a systemic crisis errupts, which is looking more and more possible, then the exchange itself could default and you could be screwed. Again, all competent futures traders understand these risks going in. If you don't like these risks, buy physical metal on the spot market and don't mess with futures!
Andrew Maguire:
I've never met this man and know nothing about him, so I want to preface my comments by saying that I have no proof of any wrongdoing on his part. My issue is simply that the whole blogopshere seems to be on fire with the very one-sided sentiment that "The assasination attempt proves Maguire was right and JPM tried to have him killed to shut him up".
Ok, I guess that's plausible. But I think astute investors would do well to also question whether there is any possibility that Maguire could have a financial motive of his own associated with hyping up this story. I'm not accusing him of staging his own assassination attempt - I have no proof of any such thing. All I'm saying is that such a scenario is no more outlandish than the popular belief that the bankers are trying to have him killed for spilling the beans on their silver manipulation.
I'm willing to believe that the GATA people are actually ignorant enough to truly believe the nonsense they have been saying about Jeff Christian's comments amounting to an admission of a conspiracy in the metals markets. But as a professional metals trader, Maguire clearly has to know better. I have immense respect for Eric King's interviewing style, but frankly I was disappointed in him for not calling Maguire out on several statements he made that just don't jibe with the reality of how the market actually works.
What really caught my attention in the interview was Maguire's off-handed comments about how rich Asians are supposedly beating a path to his door because they are waiting for the green light from him to throw zillions of dollars into the silver market, to squeeze the evil shorts for once and for all. Really? How would all these rich Asians have known Maguire was the guy to call for this before he recently got famous with this whole assassination attempt thing? Could it instead be possible that Maguire wants to know a bunch of rich investors who will invest with him? He certainly has a financial incentive to attract new business, and even if he knew perfectly well that no manipulation existed in the first place, using the blogosphere to market his services to a bunch of wealthy investors would be a pretty slick racket. If he were so inclined, he could even orchestrate a massive pump & dump scheme where he uses a bunch of client money to run the market up, then short it himself knowing the boost was temporary and created by his own trading. So Maguire could actually be the market manipulator here, not JPM!
Now that I've said the above, I want to be perfectly clear: I have no evidence to suggest Maguire has done anything wrong, and it's entirely possible that there is veracity to his boy scout do-gooder story about being able to make money from the manipulation but instead choosing to do the right thing for society and expose it. Maybe. He might also be up to something shady. If the story about him providing clear advance information to SEC of what would happen on certain dates at certain times could be verified conclusively, that would certainly allay some of my skepticism. But so far as I can tell the people writing about him (Eric King, Tyler Durden, etc.) seem not to be grasping the real issues here themselves, so I don't trust them to have credibly checked their facts. Maguire supposedly had a bunch of MSM interviews cancelled at the last minute, which could have resulted from due diligence on the part of the MSM, but frankly I don't give the MSM that much credit. Bottom line, I don't know what to think. All I'm saying is that this is anything but clear.
I'd be inclined to give Maguire the benefit of the doubt and assume he's the good guy he appears at first to be, but the 100:1 nonsense is just too hard to swallow. As a professional futures trader, there's no way he could possibly be stupid enough to believe the nonsensical meaning GATA is trying to ascribe to Jeff Christian's comments. No way. So something is rotten in Denmark. I just can't figure out what.
I hope this was helpful. Again, please don't take my comments as an accusation of Mr. Maguire. He could very well be the hero he first appears to be. All I'm saying is that this is a cloudy picture and caution is warranted.
-xPat
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