SILVER PAPER`S PROBLEM / MACLEOD FINANCE

Silver paper's problem

Paper derivatives are fine when there is liquidity. But when liquidity dries up, derivative liquidity does as well. Silver is pointing the way, with no one wanting to take the short side.

ALASDAIR MACLEOD

This is illustrated in silver’s chart, with open interest on Comex falling to the lowest level for some time. 

Speculators are being deterred by wide spreads and high volatility. 

Furthermore, banks and other traders can only hold less physical and paper silver because of its higher value, further impacting contract liquidity.

There is no silver

Other than raiding ETFs and leasing it at whatever the rate, there’s no liquidity in physical silver. 

And since derivatives are encashable at maturity for silver, it also means there’s no liquidity in silver paper either. 

These are the simple facts behind a price which exploded from under $50 to $120 virtually in a straight line in only two months. 

And it was the lack of liquidity which led to exceptional volatility, seeing silver virtually halving from $120 in only six trading sessions.

This is not an orderly market. 

It is a market failure, inevitable because of “the system”.

The Western derivative system cannot manage its own failure. 

In silver’s case, its price is rising relative to the fiat dollars we price it in because the world’s private sector and some governments don’t want dollars. 

This is a story usually debated in the context of gold, but it also extends to all commodities because gold’s value represents them. 

And over decades, centuries, and millennia gold’s value measured in commodity baskets is relatively stable.

Take copper, regarded as the base metal bellweather. 

The chart below shows that while its price in dollars rose 11.5 times since 1972, in gold it has fallen 84%. 

This distortion is due to everyone accopunting in fiat dollars. 

A return to long-term normality suggests that even priced in gold it will rise over 500%. 

The outcome in depreciating fiat dollars doesn’t bear thinking about.

From the covid-related dollar debt explosion to today, silver and other metals have embarked on a renewed bull market, which properly explained is an accelerating decline in the purchasing power of the dollar in respect of base metals. 

Nowhere is this more acute than in critical metals and minerals, especially silver.

Silver has been controlled for decades by China. 

She is the second largest nation by mine output, and she has been importing silver doré and processing other non-ferrous ores containing silver: some 60% of mined silver is a byproduct of other ores. 

Until the end of last September when a spat over US tariffs led to China restricting rare earths exports, she also pulled the plug on silver suppression. 

The result was immediate, with a delivery crisis in London leading to lease rates spiking to 40% in early October, and backwardations between London and New York.

China letting the price of physical silver float has exposed the contradictions in paper silver. 

These contradictions are the long-term consequence of US and UK government intervention in markets for gold by letting the banking system dominate trading. 

Banks only deal in paper, making them unsuited for commodity trading. 

In gold’s case, the expansion of forward and futures contracts absorbed demand which would otherwise have driven physical prices higher. 

It was the intention to suppress the value of real legal money while the dollar was established substituting gold.

So successful was this 1980s scheme that it extended to silver and platinum group metals on the LBMA, while Chicago also extended it to other metals and energy. 

The flaw in the case of silver was the lack of liquidity, not too much of a problem so long as China put a lid on prices.

We are now seeing the consequences of government endorsed gold and commodity price suppression through the expansion of paper equivalents unravel dramatically. 

As the relative pricing of copper in the chart above demonstrates, significant upward price momentum is likely to develop in the majority of physical commodity prices measured in gold, and even more so in declining purchasing powers for fiat dollars.

Silver is leading the charge, a catalyst warning of a widespread commodity derivative crisis in paper markets dominated by banks which are dealers in credit, not physical commodities. 

Pricing has now moved to Shanghai, where there is genuine demand, leaving London and New York in the lurch. 

And so long as Western derivatives are priced at a discount to Shanghai, liquidity in physical silver will continue to be drained from them.

And this is against a background where physical liquidity is even being drained from Shanghai’s markets to critical levels at prices exceeding those in the West by over 10%.

Silver forward and futures are contracts in which market makers are finding impossible to deal. 

Their struggle to extricate themselves will reverse the original state-sponsored intention to absorb demand by expanding paper equivalents. 

True price discovery now has a long way to go in a relatively short period of time.