Submitted Vincent Lanci, as posted originally on Marketslant
The Mechanics of Silver Manipulation
JPMorgan Chase on Wednesday won the dismissal of three private antitrust lawsuits, including from hedge fund manager Daniel Shak, accusing the largest U.S. bank of rigging a market for silver futures contracts traded on COMEX. The lawsuits accused JPMorgan of having in late 2010 and early 2011 placed artificial bids (i.e., spoofing) onto the trading floor, harassed employees at metals market COMEX to obtain prices it wanted (i.e., intimidation) and made misrepresentations to a committee that set settlement prices. (i.e., manipulating settlements).
What follows is how JPM manipulated the silver markets by selling the Silver contango during illiquid hours, then used their deep pockets to push settlements, then waited until margin calls made the large locals puke their positions. JPM in effect stretched the relationship between forward rates and futures spreads until they made no sense anymore. Not unlike a company trading at 50x earnings. It cannot last long. But it only has to last long enough until the guy with the position opposite you has to liquidate. That guy does not have access to cheap money, political influence or the most physical silver in the world in a single vault at his disposal to create a squeeze.
U.S. District Judge Paul Engelmayer in Manhattan, however, said the plaintiffs, who also included traders Mark Grumet and Thomas Wacker, did not show that JPMorgan made “uneconomic” bids, or intended to rig the market at counterparties’ expense. He also questioned the plaintiffs’ use of Silver Indicative Forward Mid Rates (“SIFO”) as a benchmark for determining proper levels for the spreads in their lawsuits.
Analysis: The demand was fabricated
The market was only partially backwardated. Spot was below the next 6 expirations. Translation: there was no massive demand for immediate delivery. There was only demand in months where the last remaining MEN who took risk trading their own money had positions. JPM’s own book was likely short and had to get liquidity to cover their positions. We knew Shak from our floor days, and were trading spreads off-floor when this happened. They should not have lost this case. Comex traders do not trade physical spot. Spot was under the backwardation. Smoking gun? No, but damning circumstantial evidence in the least.
Given the (lawsuits’) failure both to explain why SIFO should track silver futures spreads, and to concretely plead that it did so consistently, a mere general correlation between these two is not sufficient to make SIFO a reliable benchmark such that deviations from it support a claim of irrational pricing animated by anticompetitive aims,” Engelmayer wrote.
Analysis: a poor job was done explaining the role of SIFO in spread pricing.
SIFO represents the spread between expirations of FORWARD physical contracts in silver. The futures spread markets are derivative of the SIFO spreads. SIFO represents the cost-of-carry for physical silver and is used in determining lease/borrow rates over periods of time. These are in-turn extrapolated and the dominant factor in determining futures spreads on COMEX. Comex spreads are a direct function of SIFO. Without SIFO there are no spreads. And since SIFO was a much bigger market than the Comex spread market. The pricing mechanism was not fully transparent. It was in the hands of a few dominant cartel-like players, as it had been for 30 years.and every time JPM sold 1 year silver and bt 4 month silver it was using their deeper pockets to push the locals to liquidate. Add that they probably asked clients with silver in storage to pull it off the lease market, and you have a “tail wags dog short squeeze.”
If Shak and the other traders had ability to take delivery: warehouse, cash&carry liquidity, etc., they wouldn’t have had a problem. They would have taken delivery in spot and then made delivery on the short contracts in the next months they were short. But due to inability to play in the spot market, they could not “butterfly” their positions. Another reason they could not do this: FCMs only give 50% cash value for physical silver as hedge vs. futures shorts. Think about that next time you hear EU banks guaranteed 100% face on their Greek bonds. The physical is worth only 50% collateral to the futures. Banks like JPM have no issue with that. They borrow from the Fed window at 1%. Guys like Shak would have had to use their credit cards and sell their homes to carry that position.
Silver was being taken delivery from the warehouse.
Rebuttal: Define “Take Delivery”
During the time Phibro cornered the silver market in 1995 (likely for Soros), and in 1997 for Warren Buffet they employed “taking Delivery” as a catalyst to get the market moving. How does one take delivery?
- You physically remove silver from the warehouse and say you took more than you did- because of the physical work involved a receiver can take ayt most 6MM oz of Silver daily. Why? Because it’s just not that easy to move silver out of the vault and onto a receiver’s vehicles. So when you see “30MM oz removed” it’s not physically possible. That is 375,000 lbs.
- You take delivery, store it nearby and bring it back when you are out of your long futures position
- Be long 30MM oz of silver in futures.
- Take delivery of 20 MM in physical using borrowed money
- Store the metal in a warehouse in RedHook Brooklyn and wait for the news to spook the market.
- Tell your pals with long positions to make their own silver unavailable for delivery. as prices will go up soon
- You throw a sheet over the silver still in the warehouse and say, “this is mine, it is no longer here. I’ll pick it up tomorrow- – Phibro was to have employed all 3 methods in 1997 after filling Warren on his buys.- Andy Hall was a genius when he had order flow to front run
- Buy the last 1,000 contracts for the customer as sloppily as you can.
- Tell the customer you beat the VWAP, i.e. last price on the board is higher than the average price you bought for client.
There is a word for that. It is called Racketeering
In 1994, Phibro played this game except for the spreads. They exercised out of the money calls on a 4 day weekend. But that squeeze was short lived. Warren Buffet just rescued Solly and didn’t want any more DOJ problems.
But in 1997 Warren was the instigator.In 1997 Warren Buffet, actually stood for delivery. Yet the market did not rally until AFTER the spreads backwardated all the way to spot.
This trader also remembers that in 1997, Buffet was then asked by the Gov’t to defer his request for delivery a year. . They pleaded with him, “The integrity of the market was at stake (Hunt Brother’s anyone?); and The whole Silver mining industry was in jeopardy. (TBTF).” Buffet happily complied by selling spot at approx. $7.40 and buying a 1 year future at around $4.50. He netted an ROR of 40% due to negative carry without selling. Effectively, he lent the producers their silver back to them 40% higher than his cost.
In 2011Blythe Master did a mini-Buffet.
The difference being, the market had ALREADY rallied without backwardation, and all of a sudden spreads (literally overnight during Asian and London hours) went into backwardation.
In a real market, the spread activity predicts the physical demand before the flat price does. You see the spot price start to act squirrelly to the front month future in the EFP. Immediate demand drives deferred month pricing.There are exceptions to this. But it is rare.
I’m sure each one of my arguments for manipulation can be taken apart by some lawyer or “expert”. But that is what lawyers do.
- Facts against them? Argue the Law.
- Law against them? Argue the facts.
- Both against them? Use ad hominum attacks to shoot the messenger. So for the sake of transparency, here is the messenger.
Author’s Background and Caveat:
For the record- I was suspended from NYMEX 12+ years ago for manipulating a settlement without a client complaint. I learned that behavior from watching the pros do it and get away with it. I was arrogant enough to think I could. I was a street kid form Philly who had to drop out of college and learn to survive. Got lucky and had 15 Ivy league kids working for me at one time. But I lay down with dogs too long and got a bad case of fleas. A big price was paid for that. And to save an incompetent compliance officer’s job I was punished harshly.
Post suspension, most firms wouldn’t touch me even as they burned themselves time and time again on derivatives risk in Energy and Metals. I then witnessed the FC Stone downfall fittingly from them cooking their own books ( Jeff Soman?) years after they threw me under the bus as their client ( Jeff Soman!). But you have to move forward.
Market Structure and Greedy Pols
As time passed I grew to despise manipulators but did not blame them per se. The market structures are the major culprit. Which in turn means the politicians who are lobbied by the corporations to alter market structure to protect Corporate interests are the culprits. In the end it is all about greed. Dodd-Frank was passed essentially blank. The “bankers will help fill it out. they are the experts” SMFH.
Then, I got my break. I was on other side of arguably, the biggest Commodity trade of 2007. My firm saw an arbitrage, borrowed money and took on the banks. Not only was Echobay right, but our counterparty, BMO was (ironically) cooking their own books. Their trader was David Lee and I feel bad for him as he was a victim of a greed cult and lost his ethics as I had in 2003.
In the end I was a material witness in BMO’s 2007 Nat Gas EOO scandal where they tried to blame the counterparties to their rogue trader. BMO settled the case within days of my deposition involving manipulated settlements. I havethe transcript of a 9 hour deposition to prove it.
So bring it, if you think my observations are flawed. I’m all about learning. A million facts do not add up to a single truth, especially where corporate lawyers are involved.
This isn’t the first time I’ve written on this and won’t be the last. During my career, I’ve been victim, observer, perpetrator and now despiser of market manipulators and the market structure that rewards corporate greed at the expense of free markets. The little guy can no longer compete. Watch, homogeneous counterparties will be the death of the markets. TBTF means too big to exist IMHO
Judge Engelmeyer, you got it wrong. Daniel Shak, you deserved better than you got.
– Vincent Lanci, Vlanci@echobay.com