What will the Reddit Retail Rampage of 2021 turn out to be? Will it, like most things that abruptly enter the mainstream’s consciousness, slide out of time and memory? Will it turn out to be something more than what currently resembles nothing but the final gasp of speculative fervor that so commonly marks the end of bull markets?
While attention and headlines were focused on the herd behavior of a select group of Reddit users and the hapless retail brokerages caught in the crossfire of the whole “Retail vs Wall St Bankers”narrative, little was said about the rampant speculation that the episode ignited in the broader retail investing world. How will this play out for the bank accounts of all involved?
Also, in what might be a first in such situations, regulators have so far managed to avoid coming under heavy fire. Unfortunately for them, regardless of whether they choose to admit it, they have a major role to play in this saga not just in terms of their current policies but also in how they choose to change them when the fallout inevitably comes. Can they remain onside of prevailing (very fickle) political winds, while helping retail investors? Of course that would depend on how they define helping…
Stick it to the Man is a collection of writings that encapsulates our thoughts on the Reddit Rampage; our attempt at adding some perspective to the miasma of fear, greed, anger, and hyperbolic accusation swirling around this runaway train as it heads all the way to Capitol Hill.
Unfortunately for retail brokers, the situation does not get any better even if they were to argue for placing trading restrictions out of fiduciary duty, because regardless of intent or how presumptuous such arguments are, retail will still lose money when this blows up.
And when that happens en masse and unfortunate individual investors find out that they have lost more money than they deposited – What?! How?! Because of leverage! – retail brokers will become public enemy number one with a massive target on their back. Regulators will hound them, and retail investors will vilify them on social media. Also, since it has been in vogue over the past few years, it wouldn’t be surprising if politicians decide to haul CEOs of these brokerages up to Capitol Hill for a very public and international dressing down.
Adding to the frustration for retail brokers is the fact that the Reddit rampage of 2021 is actually very good for their businesses! If they didn’t have regulators breathing down their necks, it is likely that these firms will give retail exactly what they want; continued access to normal levels of leverage and continued unrestricted trading in the most volatile names. After all, they make money on volume, and for them nothing is higher volume than retail fueled BubbleMania.
Of course, prudent retail brokerage CEOs would not run their businesses in such a way even if they could, simply because doing so puts the reputation of their firms on the line, while also running the substantial risk of bankruptcy. But unfortunately in financial markets there are always people and/or firms willing to risk it all for a larger bonus check, consequences to themselves and everybody else be damned.
Finally, let’s consider the socioeconomic circumstances that serve as the backdrop for this entire saga. There has, to date, been a decade of QE in the USA, which has gotten the market high on pure belief, and Covid lockdowns which have destroyed the labor market, rendering retail investors unable to earn an income. All of this while the richer equity owning folk earned even fatter returns from the stock market, contributing to even higher levels of inequality.
In this environment, it doesn’t matter that the vast majority of retail investors do not understand the risks of their own actions. Current or future trading restrictions, as well as possible future regulatory action to prevent a repeat of this saga will be seen by retail investors as being told that they can’t get rich because only rich people can get richer. Considering their already seething sense of injustice…How could they not get mad?
Pity the retail brokers, they really are damned if they do and damned if they don’t.
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…
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