IS SILVER ENDING THE PAPER GAME? / MACLEOD FINANCE

Is silver ending the paper game?

Events in recent weeks culminated with a crisis for silver derivatives in New York, London, and even Shanghai. Could it be the beginning of the end for the entire derivative complex?

ALASDAIR MACLEOD

Introduction

Either it was a deliberate plug-pull, or just awful timing for the CME’s database to go offline coinciding with the most dramatic silver squeeze seen so far following weeks of backwardation between London spot and the Comex December contract. 

Rumours abounded, including one in Shanghai that there was going to be a very large stand for delivery.

It turned out that there was one, or several together amounting to 7,330 contracts, which is for 36,650,000 ounces (1,139.93 tonnes) valued at over $2 billion. 

This is not a record, which was 11,692 contracts on 30 April valued at $1.9 billion at the time. 

The difference is that back in April the threat of tariffs unlocked global liquidity which flowed to New York in large quantities and were readily available. 

This time there is no liquidity. 

This is evidenced in the chart below, which shows how the squeeze on silver has developed on Comex:

What the bear squeeze tells us

It is unusual to see a price rising while interest contracts, a situation which only occurs when there is a squeeze on the shorts. 

But there is another conclusion to be drawn. 

Open interest in both silver and gold futures has declined to low levels while prices rise, indicating a shift away from these contracts. 

It is almost certainly being mirrored in London’s forward market. 

The idea behind encouraging the expansion of these derivatives over forty years ago was to divert demand away from the metals by creating artificial paper supply and thereby suppress their prices. 

It is that concept which appears to have ended.

In the wider context, not only did the expansion of derivative markets from the 1980s onwards put a lid on prices, but it gave the authorities the ability to do so without having to deliver physical metal. 

If we are seeing this function of derivatives ending for silver and gold, then the replacement of physical by derivatives goes into reverse, withdrawing artificial supply and leading to higher prices. 

This is what appears to be behind banks and market makers refusing to extend their commitments. 

In the past, agencies such as exchange stabilisation funds have stepped in. 

There is little sign of it now, raising the question as to whether they have simply given up.

These developments are consistent with a failing fiat currency system, whose smoke and mirrors no longer deceive. 

Derivatives help stabilise markets so long as there are no significant challenges to their validity. 

Bullion banks will hedge price-risk using derivatives, and derivatives to hedge derivatives. 

Meanwhile, the physical required to keep this circus maximus going is leased, swapped, hypothecated, and rehypothecated as many times as necessary.

After leased gold was dramatically withdrawn from the Bank of England earlier this year, depositing central banks would be foolish to renew lease obligations as they fall due. 

It is a development that undermines the most important derivative market of them all, coupled with China’s move to incorporate gold into trade settlements for the entire SCO, BRICS, and global south. 

And in silver, persistent supply deficits in recent years are no longer being met by the investor category in the Silver Institute’s supply and demand calculations.

But according to the Bank for International’s statistics, silver is a minor market, with over-the-counter (OTC) derivatives for silver and platinum group metals having notional amounts outstanding of only $101 billion at end-2024. 

Note that these figures do not include regulated exchange-traded derivatives, with Comex alone adding a further $43 billion. 

OTC Gold is significantly larger at $1,025 billion, and other commodities add a further $1,028 billion making a total of $2,154 billion.

OTC derivatives are peer-to-peer, and if a counterparty fails, it threatens to spark a chain of events across other derivative categories. 

If silver derivatives are the first domino to fall, gold will almost certainly follow. 

That being the case, counterparty risk will spread to other commodity derivatives, and from there to credit derivatives including interest rate swaps, and so on. 

The point is that the Fed, the US Treasury, and bank regulators must stop the rot from problems in silver spreading to other contracts.

This realisation supports suspicions that the Comex shutdown last week was deliberate to nip a very dangerous situation in the bud. 

We cannot know if this is true. 

But the important point to understand from this debacle is that paper markets can no longer be used to absorb physical demand. 

Instead, they are becoming a significant source of demand as banks and hedge funds seek to reduce their exposure, turning buyers themselves. 

The situation is already out of control so far as silver is concerned and is going that way for gold.

It also explains why their prices are rising with barely a pause. 

The end of derivatives is the loss of a crucial support for fiat currencies, particularly the dollar. 

Erode and remove that support and its relationship with gold and silver fundamentally alters. 

Unwinding four decades of price suppression will see far higher gold, silver, and other commodity prices, exposing the true value of the fiat dollar and the other major G7 currencies for the ephemera they truly are.