Reddit has jumped head first into the silver market. Have they bitten off more than they can chew? Here are our thoughts and perspectives on the hot issue of Jan/Feb 2021.
The Reddit Rampage of 2021 has now set its sights on something higher than hedge funds running overly short books – the Man himself.
Not the Wall Street man, the Man. As in, the Man who prints the USD, Man.
Hyped up on, (take your pick) talk/rumors/conspiracy theories/undeniable fact, r/ Wallstreetbets has, at time of writing, poured into the silver market, caused a brief spike in prices, and then seen most of the gains given back.
Their rationale here seems to be twofold.
Firstly to replicate the success of their stampeding into GME and the stock of other small, heavily shorted companies.
Secondly, to make a longer term bet on sound, physical money over the fiat USD.
The fuel driving the first of their reasons is their belief that silver is primed for a short squeeze because the Wall Street banks, that is, the sellside, have been manipulating the price of silver lower for years.
That seems to be the connection the Redditors are drawing – sellside heavily short because of their manipulation, let’s squeeze them like we did GME!
Unfortunately for them, given silver’s refusal to skyrocket like GME, it turns out that the silver market either wasn’t manipulated the way they thought it was; the dark manipulative forces were far too strong, or some combination of the two.
At this point, it should have been apparent to at least some of the crowd that piled into the silver long play that they grossly underestimated the silver market’s size and complexity.
Simply put, the silver market is too big to manipulate in the same way one would go about manipulating stock prices.
That is not to say that silver cannot, and has not been manipulated, because it can. It just does not happen in the way the Reddit crowd thinks it does.
Most people seem to think that silver is manipulated lower by shorts pushing the price of the metal down in the same way equity short sellers sell stock and push share prices down.
This simply is not the case because silver is a truly international market that trades easily and smoothly across multiple time zones, and also over a variety of market types.
These include, broadly, physical spot silver, physical forwards and swaps, futures, options on futures, options on spot, leasing (combination of forward and spot transactions), ETFs, and equities in the form of silver miners and ETFs.
Most of these markets trade over the counter (OTC), and in very large volumes. This makes consistently suppressing the price of silver over the time scale alleged by Redditors championing the long silver trade very, very difficult.
It would be an undertaking that would require a magnitude of resources and consistent, coordinated collusion that is just impractical.
Instead, silver is manipulated in a different way.
Market makers manipulate short term prices by spoofing orders. This means that they place bids/offers that they do not intend to honor, and then proceed to very quickly cancel them. Spoofing is manipulative because, if a trader (or the algorithm) is quick enough, other market participants will look at the spoofed order and adjust their own bids/offers accordingly.
This allows traders, if they so choose, to execute their real orders against higher or lower bids/offers that they tricked someone else into placing.
Current regulation classifies spoofing as an illegal activity, but clearly such manipulation cannot result in large scale suppression of silver prices – it is simply too ad hoc and small scale.
To be continued…
Another way that silver could have been manipulated is by traders hammering the fix.
Could have because the fixing methodology has been revamped and is now auditable and based on transactions.
Before this revamp, traders simply had to say how much demand/supply they had from clients at a certain price.
The price would adjust based on what traders reported, which left ample room for traders to report numbers that were false. That is, instead of giving numbers that reflected what their clients were saying, traders would report numbers that would move the fixing price in a way favorable to their own positions.
Again, not an activity that can result in the manipulation of metals prices over the long term (before it was revamped).
While the first two examples related to how silver prices could possibly be directly manipulated, this last example applies more to industrial metals like aluminium. The same thing could possibly be done in the silver markets, but if it has, or is being done, it isn’t at levels bad enough to capture widespread attention.
This method pertains to London Metal Exchange (LME) regulations, which allow for metal warehousing operations to release only a small percentage of their total inventory each day. This creates an immediate bottleneck in the supply chain, which in turn creates a short squeeze since purchasers of the metal cannot get enough metal out of the warehouses to meet their levels of demand.
This causes purchasers of the metal to bid up prices in order to secure enough for their own use. Other purchasers do the same, and it quickly descends into a free for all.
The only parties making out handsomely in this situation are the owner of the inventory who benefits from higher prices, and the owner of the warehouse who keeps earning rental revenues on renting space to owners of the inventory.
Now… what if the owner of the metal and the owner of the warehouse are the same person?
Therein lies the heart of the manipulation, but again, this method cannot be used to support Reddit’s allegations of manipulation, simply because it pushes prices upwards, not downwards!
As such, it is highly unlikely that silver prices are being manipulated in the way Redditors think they are; the size and scope of the market simply precludes it.
While manipulation is possible and has happened in the past, they are confined to being short term and small scale, affecting individual transactions on an intraday basis rather than a multi-year or decade (depending on who you ask) basis.
This also means that the overcrowding on the short side of the silver market due to manipulation does not exist… So what is there to squeeze?
To be continued…
The second factor driving Reddit interest in silver is a more interesting discussion, which is their adoption of the “precious metals are real money” perspective – their attempt to really stick it to the Man.
Like our discussion on silver price manipulation, this one begins at the same point, the OTC market.
This is a financial space which is relatively loosely regulated, and extremely opaque in terms of transactional reporting. This naturally puts the most power in the hands of those with the most information, which are the largest market making banks in the space.
It is this group of banks that have been accused of colluding to manipulate the price of silver lower. Why lower?
The theory runs that the price of silver should be much higher than what it has traded for, and obviously higher than current levels. It should be much higher because of a host of factors, all of which hold the common theme of being extremely anti-fiat.
In a very interesting reversal of the metal-as-money crowd’s thinking, silver (and gold) are used as collateral for USD repo.
What does this mean?
It means that when parties such as financial institutions, governments, producers, and institutional investors require dollars to meet collateral requirements, fund foreign business operations, or simply to be able to pay their dollar denominated liabilities, they can choose to use silver to borrow dollars.
This happens because precious metals markets are very liquid, and very international.
Put another way, if you had USDs and were looking to lend them out for some yield, would you rather take silver as collateral, or something like Emerging Market corporate debt?
Most people would answer silver.
Why? Because if the person you lent your USDs to cannot pay you back, it is a lot quicker, simpler, and easier to sell off silver than it is EM corporate paper and recover some amount close to the fair value of the now defaulted loan.
This is due to the depth and breadth of the silver market, with buyers and sellers from all over the world willing to trade the metal at all hours. There simply aren’t many markets which offer the same amount of liquidity and international availability.
Even so, silver is still used as collateral for US dollars.
Not the other way round.
This means that the US dollar, as the world’s reserve currency, is even more liquid and international. In times of financial stress, like the Great Financial Crisis of ‘08 and March of Pandemic 2020, people were selling, and/or pledging their silver in order to get USD liquidity.
While it is true that fiat has a very poor historical track record, the reality is that neither silver nor gold are used as currencies these days. In fact, they are clearly subordinate to fiat currencies within the financial system, since they are among the first assets liquidated or pledged to raise fiat currency liquidity.
The metal-as-money crowd, and now the Redditors too, will come along and say that how today’s system works does not matter, because they are buying silver (and gold) in anticipation of, or as a hedge against, the failure of the current USD based system.
The leading reason they give for this will be the Fed’s QE led debasement, but that thinking does not hold, because none of the Reserves printed by the Fed make it out of the banking system.
Regardless of one’s view on the soundness of money and which fiat replacements are best, one cannot avoid the reality that the market for silver is very, very large; and the market for USD even bigger.
If all of Reddit’s efforts could only bring about a short-lived spike in silver, perhaps they should really pause and think about what they really do and do not understand about the global financial system before taking a bet whose success is contingent on supplanting the USD.
To be continued…
The biggest difference between stocks and silver is that silver is a market with producers. Stocks are not really produced, they are issued as needed (or wanted) by corporations. That means that most of the time, the supply of a company’s stock in the public market stays the same.
This is not the case in the silver market, where supply and demand are far more dynamic. Supply reacts to changes in demand, and demand reacts to changes in supply, with price acting as the arbiter.
Producers, in this competitive, free market environment, are natural longs, that is they, by the nature of their business operations, always have to deliver metal to buyers.
This is, if you think about it for a second, obviously true since producers exist to deliver supply to buyers.
More importantly, this means that producers are always exposed to falls in the metal’s price. Just like being long a stock means one loses money when its price falls, producers of silver, that is silver miners (and more generally, commodities), earn less when prices fall.
They guard against this by hedging their production in the market.
They can do this in a myriad ways across different markets, but regardless of which financial product they choose to use, they have to hedge by selling. If they sell in the forward or futures markets, they commit to sell at a price fixed at the time they enter the hedging transaction.
This necessarily means that silver miners are almost always sellers in the financial markets.
Why is this important? Because for the “silver is manipulated and suppressed” story to be true, someone or someones must be consistently selling the metal in the market.
The truth is that there have always been consistent sellers of silver in the financial markets, and those are the producers of the metal. Does this mean that the miners are colluding to keep metal prices low in order to boost fiat?
After all, if a global conspiracy existed to manipulate silver prices lower for decades, the producers must be involved, simply because they control supply.
Obviously, the answer to the question is no, because producers would bankrupt themselves if they consistently kept prices low. As explained above, they are natural longs, who lose money when the price of silver falls.
The Reddit Silver Salvo of 2021 is admirable from the standpoint of the “little guy” deciding to make their numbers count and stand up for what they believe in; fighting to regain their monetary sovereignty from what they view as the evil oppression of fiat currency.
But what if, the stories that they have been fed of collusive manipulation by nefarious forces are just that, stories?
Is it not ultimately possible that nobody is manipulating the metal(s) at all, and they, like all currencies in history, have simply come and gone?
To be continued…
It seems that Reddit’s vehicle of choice for their Silver Salvo is SLV, a silver ETF. This makes sense for them, since most do not have accounts (or brokers) that allow them to trade silver futures, leaving them with ETFs as the only way to gain exposure to silver prices.
Moreover, ETFs are cheap to trade, and trade just like stocks. This means that Redditors do not have to learn about new concepts like initial margin, maintenance margin, or open interest before jumping into their positions.
Unfortunately, that’s where the advantages of trading silver via the SLV end, and the potential nightmare begins.
SLV is a trust that owns actual physical silver, which makes it attractive to a lot of investors who want easy exposure to silver’s price.
However, an ETF is, at the end of the day, a structured financial product. As with all structured products, their ability to faithfully track the prices of what they’re supposed to track is severely hampered in times of stress.
Having a horde of retail investors stampeding into an ETF definitely counts as a “time of stress”. But what actually happens?
Without getting into too much detail, ETFs work well in normal trading environments because a group of designated broker dealers called authorized participants (APs) can arbitrage away any price differences that arise between the ETF and its underlying asset(s).
For SLV, this means that units of ETF can be exchanged for physical silver, and vice versa. This results in SLV being able to track the price of silver reliably and consistently, in normal times.
In times like these, massive demand leads to APs buying the required amount of silver and swapping these for shares of SLV. This is normal business behavior over the course of a trading day.
However, what isn’t normal is the enormous strain the demand for silver places on the physical market; where actual silver bars are traded.
Precious metal ETFs like SLV already hold in their vaults a good chunk of physical metal supply, which means that a huge spike in demand like the one we are witnessing now has the potential to create a squeeze in the physical market.
If this happens, physical prices would surge higher, creating a situation where APs can no longer arbitrage away the price differential between SLV and physical silver – which is when the nightmare begins.
To be concluded…
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