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Ted Butler Commentary
July 5, 2006
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The Road Ahead

Just this week, the Commodity Futures Trading Commission (CFTC) filed manipulation charges. No, not concerning the COMEX silver market, but in propane, where they charged a subsidiary of BP, the giant oil company, with manipulating the physical propane market, back in 2003 and 2004. In its press release, this is what the CFTC said,

"Cornering a commodity market is more than a threat to market integrity. It is an illegal activity that could have repercussions for commercial market participants as well as retail consumers around this country. This case clearly illustrates that complex and covert trading patterns will not prevent us from aggressively pursuing and exposing those that violate the Commodity Exchange Act," said Gregory Mocek, the CFTC’s Director of Enforcement.

The press release went on to explain that BP dominated and controlled the market, and was able to dictate prices, because it owned 88% of all TET propane at the end of February 2004. The amount 88% is very interesting. The CFTC considered this amount and BP’s actions to be a corner and a manipulation.

While there are differences between the alleged manipulations in silver and propane, there are remarkable similarities. One similarity is the figure 88%. Like BP’s position of the propane market in 2004, 88% is the amount that the 4 or less largest traders now hold of the entire commercial net short position in COMEX silver futures, according to the most recent Commitment of Traders Report (COT). One has to wonder why 88% is considered by them to be a corner in one market, but not in another.

In addition, the 88% share of the total net short commercial position that the 4 or less largest traders now hold is a new record. Never before has the biggest trader(s) held such a dominant and controlling share of the commercials’ net short position. The actual numbers are quite revealing.

Of the total commercial net short position of 37,970 contracts (just under 190 million ounces), the big shorts hold 33,252 contracts (just over 166 million ounces). In other words, if the big shorts’ position did not exist, there would only be a commercial net short position of 4718 contracts, or 23.6 million ounces. The most concentrated silver shorts hold more than 7 times what the rest of the commercials hold in total. Talk about a dominant and controlling position.

Ask yourself this question – what would the price of silver be if this concentrated short position of 88% did not exist? If instead of a 190 million ounce short position, there was only a 24 million ounce short position? Is this not what the CFTC asked itself in the propane case, namely, what would the price of propane have been without BP’s 88% ownership? Why is it that 88% dominance and control is different to the CFTC, depending on the market?

It must be remembered that the law does not distinguish between a long corner or a short corner, or a long manipulation from a short manipulation. After all, excessive short selling means excessive additional supply dumped on the market, obviously as much as a price depressant as BP’s long propane alleged corner artificially enhanced prices.

One of the big differences between propane and silver (aside from the biggest difference that the alleged propane manipulation is over, while silver is a crime in progress) is that the data in the propane case was private and was only uncovered through deposition and subpoena. In the case of silver, all the data pointing to manipulation is public and published by the CFTC itself. The CFTC does not have to go far or dug deep to get at the evidence. No depositions, no subpoenas, just public data in the COT.

Facts are stubborn things; they are hard to make go away. All the allegations made recently about a silver manipulation are based upon facts and data provided by the CFTC. The real issue here is not if the data proves a manipulation in silver, but why won’t the CFTC uphold the law and move against this self-evident manipulation? They will not be able to refute or deny the facts or data in their inevitable response to these allegations. So, how will they respond?

My guess is that they will try to dance around the issue. They will not, and cannot, directly refute any factual statements made by myself or Carl Loeb (please read his new letters to the CFTC, the SEC, and Congress, of June 30, attached below), as those statements were based upon the Commission’s own data. Rather, they will try to introduce peripheral information, designed to deflect the facts. Since they can’t deny the concentration, they will try to excuse it and show why it doesn’t matter, even though concentration is the key element in every manipulation case they have ever prosecuted, including the new BP propane case.

Most likely, the CFTC will try to show (but not prove) that the concentrated short position is backed by real silver or legitimate hedging arrangements, or that the concentrated shorts hold a corresponding and offsetting long position in some other market. This will be bunk and easy to rebut. Not only will they not verify or document any real silver held or offsetting positions (they will say, "just trust us"), it wouldn’t matter, in terms of manipulation, even if they did, for the following reasons.

Even if the big short held real silver, owning a dominant position, as is shown in the BP case, does not confer the right to manipulate the market. The key question is still what the price of silver would be without the concentrated short position. Additionally, holding an offsetting long position elsewhere (conveniently outside the CFTC’s jurisdiction), only heightens the prospects that predatory COMEX pricing caused the low prices in the first place, allowing the offsetting longs to have been established unfairly. Finally, an offsetting long position held elsewhere by the concentrated shorts only enhances the likelihood for default on the COMEX, which would then cause an explosion in the price of silver and great rewards for the offsetting long position.

The simple fact is that the law of supply and demand has been turned on its head by excessive and uneconomic short selling of pretend silver. The big shorts pretend that they have real silver and the CFTC and the COMEX look the other way. Only now the short sale of pretend silver has grown so concentrated and obvious that it cannot be overlooked.

I hope I am wrong and the CFTC finally does the right thing, perhaps because it has a new chairman. But I’m not holding my breath. If the CFTC did its job and followed its mandate and enforced the law fairly and impartially, the silver manipulation would be over in a heartbeat. However, I don’t expect them to say, after 20 years of denial, that they blew it and that silver is a manipulated market after all. I genuinely believe that to be the case, but I don’t expect them to ever say that.

I have a confession to make. I made a mistake several years ago, that I don’t intend to make again. I raised these issues of concentration with the CFTC before and when I received their reply I assumed, from the way one letter read, that they understood the problem and would work privately to address and correct the manipulation. I stood back, thinking they would surely fix the problem. I couldn’t have been more wrong, as they did nothing. I’m not going to stand back again.

Here is where I have to ask for your help. When the CFTC finally responds and tries to deflect the clear data proving the silver manipulation, that will not be the end of the matter. It will only be the beginning. It is at that point, after they have been given the opportunity to rectify the problem and have refused, that they can and must be forced to do so. It is at this point when Congress must be pressed to force them to enforce the law and end the manipulation.

The CFTC, like all bureaucracies, will not do something it does not want to do, unless it is forced to. Especially something that could bring great shame to the organization, like missing an ongoing manipulation in a major market, even after it was repeatedly brought to their attention over the years. They must be forced to take such action. Only Congress can force them. This is where you come in.

To get Congress to force the CFTC to act, pressure must be brought on Congress. It will take more than one person to force Congress to do anything. I know these are complicated issues, but don’t worry – I will do my very best to make the issue, both the problem and the proposed solution, easy to understand and implement. What I will need from you is persistence with your local Representatives and Senators to get them to pressure the CFTC. We must not take no for an answer.

In the meantime, separate pressure will continue to be brought on the CFTC to do their job until they respond. Again, when they respond, the real pressure must begin. Here are some new letters from Carl Loeb to the CFTC, Congress and, interestingly, the chairman of the SEC. It would appear, thanks to the new silver ETF that was approved by the SEC recently, and the NYMEX/COMEX’s plans to go public, that the SEC has direct jurisdictional concerns in a silver futures manipulation. It used to be, in the old days, the CFTC regulated commodities and the SEC regulated securities. But in our new world of derivatives and securities backed by commodities, the jurisdictional responsibilities are blended. Maybe the SEC can help bring about an end to the scourge of the ongoing silver manipulation. It certainly doesn’t hurt that securities naked short selling is a hot topic for Congress and the SEC.

The silver manipulation will end when the concentrated short position is terminated. That short position will be terminated one way or another, namely, by CFTC action, by the SEC, by Congress or by market forces. It is inevitable. It’s just a question of which comes first.

Here are Loeb’s new letters. Take my word for it, they are compelling.

Honorable Christopher Cox

Chairman

Securities and Exchange Commission

100 F Street, NE
Washington, DC 20549

chairmanoffice@sec.gov

Dear Sir,

I am writing to call your attention to a situation in the silver futures market that has direct bearing on a security under your regulatory purview, specifically SLV, issued by Barclay’s Global Investors.

As argued in the attached letters to the CFTC and the NYMEX/COMEX exchange, and by any traditional measurement, the publicly reported data on the concentrated trading position of a handful or possibly single trader in silver would indicate that an on-going manipulation of the price of silver is underway. It is certainly a fact that for many years, manipulation in this market has been alleged by many analysts. What is different today is that the CFTC’s own data now seems to make manipulation self-evident, and it is perplexing why the CFTC has not applied the same standards of intervention in the silver market that it has in the copper, propane, financial derivatives and other markets. Further, as an SRO, NYMEX/COMEX has an affirmative obligation to ensure transparency and fairness in its markets, and a lack of action to address excessive speculation in silver by a few traders falls short of fulfilling this duty. The Exchange plans a public offering at some point in the future, and it will be incumbent on a publicly traded , self-regulating company to be diligent in the execution of this fiduciary responsibility.

The value per share of SLV is purely a function of the London Fix for an ounce of silver. If the price of silver is artificially depressed through manipulation by a concentrated net short position on the COMEX, shareholders of SLV (like me and thousands others) are adversely affected.

I have to date received no reply from the CFTC nor the Exchange, although I understand these responses take time. Meanwhile, I would ask that the SEC begin to conduct its own review of the situation, as in the new world of complex derivative instruments, fraud in one market has an effect on many other markets.

Respectfully,

Carl F. Loeb

Cc: Honorable Reuben Jeffery III, Commissioner CFTC

Mr. Richard Schaeffer, President, NYMEX/COMEX

* * * * * *

June 30, 2006

The Honorable Reuben Jeffery III

Chairman

Commodity Futures Trading Commission

Three Lafayette Center

1155 21st Street NW

Washington, DC 20581

Mr. Richard Schaeffer

Chairman

NYMEX/COMEX

World Financial Center

One Forth End Avenue

New York, NY 10282-1101

Re: Concentrated position in COMEX Silver Futures Market

Sirs,

I noted with interest your filing yesterday against BP Products, North America, alleging manipulation of the April 2004 TET propane market. In your press release describing this action, Mr. Mocek, Director of Enforcement for the CFTC noted that "Cornering a commodity market is more than a threat to market integrity. It is an illegal activity that could have repercussions for commercial market participants as well as retail consumers around this country. This case clearly illustrates that complex and covert trading patterns will not prevent us from aggressively pursuing and exposing those that violate the Commodity Exchange Act." In the complaint itself you define a "Corner" as a situation where "an entity seeks to, and holds, a dominant or controlling position in a commodity market for the purpose of being able to command or dictate the price at which it will sell the commodity." It is noteworthy, and quite correct that you do not differentiate between a "short corner" or a "long corner". While it is gratifying that the Commission is pursuing an apparent crime that occurred two years ago, I again want to call the Commission’s attention to what appears to be an ongoing crime in progress; that is, of a "short corner" currently occurring in the silver futures market.

I believe that it can be argued that the sheer size of the reported net short position in the 4 largest traders in silver relative to global production or deliverable inventories makes the position by definition manipulative. However, I believe that this position also meets the CFTC’s own criteria previously established by the Commission to identify manipulative schemes; specifically In re Cox, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) & 23,786, at 34,061 (CFTC July 15, 1987). In this ruling, the Commission established 4 elements of a manipulation2:

1) that the [respondent] had the ability to influence market prices;

(2) that [the respondent] specifically intended to do so;

(3) that artificial prices existed; and

(4) that the [respondent] caused an artificial price.

In applying these elements to the Sumitomo copper manipulation case, the CFTC argued that:

  1. First, Sumitomo had acquired a dominant position (approximately 5% of global copper demand), and this position "certainly had the ability to influence market prices" by virtue of Sumitomo’s "massive futures positions".
  2. Second, Sumitomo’s concentrated positions "were not intended to meet Sumitomo's legitimate commercial needs. The intent motivating the acquisition and control of both the cash market positions and the futures market positions was expressly to create artificially high absolute prices and artificially high and distorted premium of nearby prices over futures prices." In other words, the lack of a valid commercial purpose in the position was used by the Commission as the "sine qua non of manipulation."2
  3. Third, the Commission argued that artificial prices were deemed to exist because "sharp price ……. increases resulted from Sumitomo's acquisition of dominant cash and futures positions which were not related to their legitimate commercial needs." 2
  4. Fourth, the Commission found that "it is clear that Sumitomo's conduct was at least a substantial cause of these artificial prices." 2 Note that the Commission did not find that Sumitomo’s conduct was the sole cause of artificial prices, but rather was a substantial cause.

Applying the Commission’s logic in the Sumitomo and other cases with regard to these elements of manipulation suggests that a manipulation can be established as existing in the silver market:

1. The first element of a manipulation requires that the holder of a position is capable of influencing market prices. In silver, this certainly seems to be satisfied in that the concentrated silver short position is large enough by any rational metric to accomplish that objective. In the Sumitomo case, the trader responsible for the manipulation, a Mr. Hamanaka, was referred to in the copper market as "Mr. Five Percent" because his firm traded approximately 5% of global demand for copper per year. In silver, the current 170,000,000 ounces net concentrated short position represents 19.7% of global silver demand. If 5% of global demand satisfied element one in the Sumitomo case, certainly 19.7% should satisfy it in the silver situation. Even if the "largest 4 traders" holding this position have the position evenly spread out amongst themselves (highly unlikely), each holds a concentrated position about equal to that of Sumitomo.

 2. The second element of a manipulation requires that the holder of a position be shown to have intent to manipulate. This element is satisfied in silver by the same criteria established by the CFTC in Sumitomo. In that case, the Commission did not enter into the minds of the traders at Sumitomo to determine intent. Rather they focused on the "legitimate commercial needs" of Sumitomo, which they found lacking and used as prima facie evidence of manipulative intent. In silver the current net short position certainly appears to exceed any reasonable estimate of total global deliverable silver and calls into question whether any legitimate commercial purpose for this position could exist.

Even if the holder(s) of this position actually had 170,000,000 ounces in a vault somewhere, if they don’t deliver the silver, the position is not a hedge, it is a manipulation. It is far more likely that if they have the physical silver they will continue to hold it, and profit in the futures market from the depression in price their concentrated position creates. When they close out their short position, the price of their physical silver will go up as a result of their own short liquidation and they will profit twice. This is still a manipulation, and still exhibits no legitimate commercial need.

Further, if the holder(s) have established a reciprocal contract or paper long position in other markets beyond Commission visibility, it again begs the question of what the legitimate commercial need or purpose for such a monumental hedged paper position is? If the long contract position is surreptitiously established in a market without CFTC visibility or control, while the short position is built in the market with transparency it could well be to depress the Comex price and lower the cost for the long contracts acquired elsewhere. This would be a lot of trading for no particular purpose if these positions are simply netted out against each other at some point. If a reciprocal long position exists in some other market, it is not unreasonable to at least consider that the purpose of this straddle of markets is that there is no intention of netting these positions, and the COMEX short side of the position will be disposed of through default.

3. The third element to prove a manipulation requires that the Commission determine that artificial prices exist. "As the Commission has observed, when a price is affected by a factor which is not legitimate, the resulting price is necessarily artificial. See Indiana Farm, & 21,796, at 27,282 n.2." On the basis that there is an extremely concentrated position with no apparent legitimate purpose the criteria established in Indiana Farm apply if an effect on prices can be shown as a result of the position.

A short sale is essentially an expression of supply, and a long purchase an expression of demand. Indirectly at a minimum, short sales are supposed to be backed by physical supply someplace in the world, which clearly is not the case in silver which has an aggregate short position of 550,000,000 ounces – 85% of every ounce of identifiable silver on the planet.4 Consequently, when the Commission allows unlimited short sales in excess of deliverable silver, it has in essence allowed the creation of artificial supply which is offset by either real or artificial demand. The supply may not really exist, but its effect on pricing is dictated by the laws of supply and demand. Increase the supply through short sales to meet any demand level, and prices will go down. By extension, this artificial and seemingly bottomless paper supply must have caused the price of silver to be lower than it would be without the artificial supply. The third element appears to be satisfied.

4. The fourth element the CFTC has established to prove manipulation requires that the manipulator caused artificially lower prices through his or her actions. I believe this element is satisfied in silver by the standard set in the CFTC’s recent filing against BP Products. In this filing the Commission has alleged that BP acquired 88% of the deliverable February 2004 TET propane and "BP’s scheme to corner the market caused the price of TET propane to become artificially high." In silver, the 170,000,000 ounce concentrated position is likely to exceed all available deliverable silver by a factor of 2. Surely if a position that is 88% of deliverable supplies causes artificial prices, a position double that percentage must accomplish the same manipulative objective.

I, and other commentators, have suggested that the size of a concentrated position like that which exists in silver is de facto manipulative when one considers the overall size of the futures market, the available stocks, the global production of the metal, and when compared to any other major market. However, it also appears to be manipulative when the Commission’s own standards are applied to the analysis. How the Commission can fail to act under the circumstances is frankly beyond comprehension, and I certainly hope you act quickly while there is still time to avoid significant market disruptions.

In a previous letter I reiterated remedial steps the Commission may consider taking in this case that were first suggested by Ted Butler. Specifically, satisfy yourself that the holder(s) of this huge short position have the silver to deliver, or have them put up the money to cover what could be a multi billion dollar loss if this unravels at higher prices, which it must.

I would like to further suggest that this situation could have been avoided if the Commission had merely established speculative position limits for any trades not backed by physical silver, and that establishing these limits now are the appropriate first step to unwinding this manipulative position.

"The Commodity Exchange Act, §4a(a), specifically holds that excessive speculation in a commodity traded for future delivery may cause "sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity. That section provides that, for the purpose of diminishing, eliminating, or preventing such problems, the Commission may fix limits on the amount of speculative trading that may be done or speculative positions that may be held in contracts for future delivery. "

If ever a commodity is subjected to "excessive speculation" it is silver. After all, open interest is very nearly equal to global production and if that doesn’t qualify for excessive speculation, nothing does.

Speculative limits have no adverse effect on legitimate hedgers; by definition they only limit speculators. In corn, the Commission has established speculative trading limits in a world wide market of 25,000,000,000 bushels of 110,000,000 bushels, or ½ of 1 percent of global production. Applied to silver this would suggest a limit of around 650 contracts, not the current 33,300 contracts for the largest 1 through 4 net short holder(s). If you think this is too low, double it and add some more and make the limit the same limit you apply to the spot month of 1,500 contracts.

Whatever solution you arrive at, a solution is certainly needed. Following your own guidelines and practices, the proof of a manipulation is before you, as well as your duty and the means to solve it.

Respectfully,

 

Carl F. Loeb

Cc: Honorable Christopher Cox, Chairman, Securities and Exchange Commission

Honorable Michael G. Oxley, Chairman, House Committee on Financial Services

Honorable James A. Leach, Ranking Majority Member

Honorable Barney Frank, Ranking Minority Member

Honorable Richard H. Baker, Chairman, Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises

Honorable Jim Ryun, Vice-Chairman

Honorable Paul E. Kanjorski, Ranking Member

Honorable Rick Larsen

Honorable Richard C. Shelby, Chairman, Senate Committee on Banking, Housing and Urban Affairs

Honorable Paul S. Sarbanes, Ranking Member

Honorable Chuck Hagel, Chairman, Senate Subcommittee on Securities and Investment

Honorable Christopher J. Dodd, Ranking Member

 

* * * * * *

June 30, 2006

Honorable Michael G. Oxley, Chairman, House Committee on Financial Services

2308 Rayburn House Office Building
Washington, DC 20515

Dear Congressman,

I am attaching a recent letter to the CFTC and the NYMEX/COMEX exchange that builds on the evidence available from public records that a manipulation in the futures price of silver continues, and that the standards applied by the Commission in other manipulative schemes are not being applied in this case for reasons unknown.

I continue to urge Congress to simply ask the Commission and the Exchange why the standards applied to other markets to identify and punish manipulation are not being applied to the silver market. The solution to this problem is relatively simple; the consequence of not solving it relatively dire.

I would also point out to Congress as I have to the Chairman of the SEC that a new derivative offered on the AMEX exchange, SLV from Barclay’s Global Investors, creates a linkage between any manipulation on the COMEX and the interests of shareholders protected by the SEC. Simply put, if a manipulation continues on COMEX to depress the price of silver through a concentrated short position, it is harming small investors in SLV whose price is pegged to the price of silver.

Respectfully,

Carl F. Loeb

Cc: Honorable Christopher Cox, Chairman, SEC

Honorable Reuben Jeffery, Commissioner, CFTC

Mr. Richard Schaeffer, President NYMEX/COMEX