President, Gold Standard Institute USA
Oct 2, 2012
Re: Open Letter to Ted Butler
Dear Mr. Butler:
I read your article about silver manipulation at 24hgold.com (http://www.24hgold.com/english/news-gold-silver-the-arguments-against-silver-manipulation.aspx?article=4072424644G10020&redirect=false&contributor=Theodore+Butler&mk=1).
I am responding as someone who wants free markets. I want to make one thing clear before I proceed. We have no free markets anywhere today. Without constant government intrusions into the markets, the paper currencies would have collapsed already, and there would not be a “price” of money (i.e. gold and silver) quoted in terms of dollars. In this sense, all markets are manipulated by the central banks and their regime of falling interest rates.
I am compelled to respond to your allegation of “manipulation”, because I believe you mean it as the naked selling of silver futures (and others also include gold futures in the same scheme). This is not occurring, and I have data to prove it.
You express the central issue as follows:
“None of this makes much sense, as who would buy or hold such a giant physical position and super aggressively short it in a concentrated manner?”
Why indeed? Why would someone buy a bar of silver and then sell a future against it? I reframed the question in this way, to make it clear why someone would do it.
To make a profit.
To “carry” a commodity means to buy the physical good and simultaneously sell a future against it. The market is offering a profit to the warehouseman. It is giving him a signal in the form of a positive spread between the spot market and a futures contract. It is saying “please hold this good for a while, so consumption is even throughout the year.”
This is part of what I referred to earlier, when I said the whole system is manipulated. In a free market, there would be no such thing as a futures market in money itself. The high stocks to flows ratios (inventories divided by annual mine production) means there is no value added by a futures market in the monetary metals.
In any case, let’s look at this spread mechanically. To carry a good, one buys it in the physical, or spot, market. One must pay the ask. Simultaneously, one sells the futures contract, on the bid. This is the basis.
Basis = Future(bid) – Spot(ask)
If the basis is positive, then that means the market is offering an incentive to carry the good.
This is how the financial world operates today, whether we like it or not. So long as the basis is greater than one’s cost of capital, one would put on this position in very large size. I assume JP Morgan can borrow at near-zero interest rate.
Now, let’s get back to the basis. There is a simple mechanic here that will help us understand if the allegation is true, that JP Morgan is selling naked futures. To sell a future, one must sell on the bid. This will, of course, press down the bid. And this is indeed the whole point, according to the manipulation theory. They are trying to push down the price.
What happens to the basis if the bid on the future is pushed down? The basis falls. If they sold massive quantities of futures, the basis would go negative. To oversimplify slightly, this is called “backwardation”.
Gold has had no major backwardation, other than temporary backwardation of each expiring contract (http://keithweiner.posterous.com/temporary-backwardation-the-path-forward-from).
However, silver did have it. All long-dated futures were backwardated for a period of time. It was when the silver price rose from around $18 to over $40. This is the opposite of what the manipulation theory would predict, but it is what basis analysis predicted. Backwardation was not caused by naked selling of futures, which is supposed to drive down the prices. It was caused by scarcity of the good in the physical market, which relentlessly drove up the ask on spot.
Since then, backwardation in silver has been receding and it is all but gone today. The price fell sharply in April 2011, and since then it has moved down and sideways (and is now up recently around the QE3 announcement).
I watch the gold and silver basis constantly. I can assure you that there are no sharp backwardations to coincide with the many calls that a big player has just shorted futures that. It simply is not in the data. I reiterate that it would be impossible to sell enough futures to move the price down without forcing a large and growing backwardation.
I predict that backwardation is coming (http://keithweiner.posterous.com/when-gold-backwardation-becomes-permanent), but not due to futures market activity by banks. This will be the end of the regime of irredeemable paper money.
I will close with a now-infamous quote from President Bush during the depth of the financial crisis in 2008. “I abandoned free market principles to save the free market system.”
I think we both want the same thing: a free market in gold, silver, and credit. But we will not move forward to it by calling for more government regulators, more rules, and more picking winners and losers by government coercion. We can only move forward by revoking the legal privilege given to the “too big to fail” banks.
Mr. Butler, can we agree on repealing the legal tender laws that force all creditors to accept the government’s paper scrip for all debts? I think this would be a good start.