In Ted Butler's Archive

Right In Front Of Our Eyes

By Theodore Butler

(The following essay was written by silver analyst Theodore Butler. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

There were two extraordinary developments last week. Although the connection was not made openly, they were very much related. The first development was the historic one-day sell off in the base metals on October 13. It is difficult to recall a day when metals such as copper, aluminum, zinc and lead fell by as much as 10%, with nickel falling more than 15%. But what is most extraordinary is the reason all fell like they did, when they did.

When you strip away the noise and the after-the fact reporting of the news (such as another slowdown in China), prices rise and fall solely upon the relative aggression of the buyers or sellers. The sellers on the day of the big sell off (and subsequently) were clearly more motivated and aggressive than the buyers. Or so it would appear. In reality, the sellers were tricked by the buyers into selling, even though those sellers are still not aware that they were hoodwinked into selling at distressed prices.

Of course, the sellers were, almost exclusively, the same brain-dead technical hedge funds that I write about so often in silver and gold. I don’t have a real financial interest in the base metals. My axe to grind here is strictly the distortion caused to the free markets by the mechanical tech funds reacting as one entity, and playing into the commercial dealers’ collusive bid rigging.

It was the same old game we’ve seen enacted continuously in COMEX silver and gold, only this time the main stage was the London Metals Exchange (LME), the world’s leading base metals trading platform. The COMEX copper market was also part of the manipulative sell off, and it is from the soon to be released copper COTs that we will be able to confirm that it was mainly dumb tech fund selling and crooked dealer buying that caused the sell off. The LME is nowhere near as transparent as the COMEX, and there are no equivalent COTs there, to my knowledge.

I want to keep this brief, so let me make my point. Intentional or otherwise, there is a sickness that all of our markets have developed in the past two decades, as a result of the emergence of these technical hedge funds and the colluding commercial dealers who harvest them. Even though they are separate entities, because these tech funds are operating on essentially the same price signals and moving averages, their effects on the markets are the same as if they were under the control of one person. I ask you to think about this new concept.

My main complaint here is that the law would clearly preclude any one entity from buying and selling as much as the tech funds (and dealers) collectively transact. Yet, if the tech funds are all essentially doing the exact same thing, at the same time, isn’t the net affect the same as if they were one entity? In other words, what’s the difference (in market impact) between one entity buying or selling 50,000 contracts in a time-urgent manner, and 50 tech funds transacting 1000 contracts simultaneously? And I don’t think these tech funds even realize that they are acting as one. They jealously guard their secret trading formulae, when in reality it doesn’t matter what super computers they are using to compute moving averages, as the end result is essentially the same for all of them. Numbers are numbers.

Commodity law would never allow one speculative entity to control or transact 50,000 contracts of anything because it’s obvious that would manipulatively impact the price. Yet 50 unrelated tech funds controlling and simultaneously transacting the same amount of contracts for the same silly mechanical reason has the exact same manipulative effect on price. I submit that both should be disallowed. Remember, the very purpose of commodity law is to prevent speculators from setting the price.

Incredibly, there exists a simple solution to this problem of tech funds and dealers controlling the markets and setting prices, that’s already on the books. It’s called speculative position limits and you have seen me write about it often. These limits, when applied with common sense and fairness, would solve the issue of tech fund and dealer paper trading dominance over prices. If tech funds and dealers are going to transact massive positions collectively and in unison, reasonable speculative position limits should apply to the collective position. This isn’t rocket science.

So where are the regulators, namely the CFTC and the exchanges? I’ll tell you where they are – accommodating the dealer community. You see, it is the dealer community that sets the rules, and they would never set a rule that would cost them money. They earn great sums harvesting the tech funds and want to see the manipulative game continue. There’s even a hard to believe extra kicker that the dealers reap from the tech funds. In addition to taking the opposite side of whatever the tech funds buy or sell (euphemistically referred to as “market making”), the dealers actually do the tech funds’ trading for them, in the dealers’ dual role as tech funds’ broker and competitor. That means that the dealers always know the tech funds position and likely behavior and actually buy and sell for the funds, while trading for the dealers’ own benefit. This is an extremely unfair advantage, similar to being able to see the other guys’ down cards in a poker game. If that’s not unfair and corrupt, nothing is.

Unfair and corrupt. That leads us to the next extraordinary event of the past week, Eliot Spitzer taking on the insurance industry. While I am sad that there is so much wrong in America, I am glad that there are men like Spitzer trying to right the wrong. He is a true American hero. That is why I wrote to him in the first place about silver and AIG. I knew there were few men with the courage to stand up to such a powerful corporate juggernaught.

I am going to resist the temptation of patting myself on the back for first making the Spitzer and AIG link, and concentrate on analyzing the silver connection with this latest insurance industry scandal. But as I have written repeatedly, that AIG has apparently departed the silver business is solely because of Spitzer’s behind the scenes involvement. You don’t go from being the dominant force to running away for no good reason. I would suggest that those new readers unfamiliar with the issue look up past articles, as there weren’t many in the last year in which AIG was not mentioned.

There are some similarities and differences between the silver market and the unfolding insurance scandal. One similarity is that the practices under attack in the insurance scandal, from bid rigging to contingent commissions, were longstanding and widespread. It was only after an outsider, Spitzer, looked at them from a different perspective, that they were seen by all to be corrupt. Similarly in silver, we have longstanding practices that defy legitimate economic explanations, like the concentrated shorting of more silver than exists and the corrupt practice of leasing. Let Spitzer publicly question those practices, and not me, and the reaction will be profound.

Another similarity between the silver manipulation and the insurance scandal is that there exists an extensive body of law and regulatory apparatus expressly created to prevent the very wrongs being revealed. And in both cases, that body of law and regulatory apparatus failed to deal with the wrongdoing. In silver, the CFTC and the NYMEX actually deny any manipulation exists. It is a denial that will prove more embarrassing and damaging than the failures of the state insurance agencies that were just out to lunch.

In all of Eliot Spitzer’s great successes, from the Wall Street research scandal, to the mutual fund timing scandal, to getting AIG out of the silver business, and to the new insurance scandal, there have been designated regulators who were asleep on their watch. Without him, it would surely be (crooked) business as usual. To his great credit Spitzer is obviously motivated by a desire to help the regular guy. Also to his credit is his desire to reform as opposed to just punish. He is concerned with making the system better, not destroying it. If he wanted to, he could have snapped AIG like a toothpick, in either the silver matter or this insurance issue, so compelling was their bad behavior.

Also similar are the repugnant conflicts of interests that exist in both silver and insurance, from the insurance brokers taking commissions from both customers and insurance companies for the same policy, to the silver dealers taking commissions from and allocating prices for fills for tech funds and the public alike, on trades they take the other side of, as principals.

Perhaps the most glaring similarity between the silver manipulation and the insurance scandal was the regular bid rigging, price fixing and lack of real competition in both. That I have consistently used these very terms to describe the silver market and they are being used by Spitzer to describe the insurance scandal is no coincidence. Neither is the fact that one firm, AIG, is central to both scams. Whether it is an insurance broker creating phony bids for insurance to rig the price, or the COMEX silver wolf pack collusively pulling bids to snooker the tech funds, this is a distinction without a difference. Both were done to create an artificial price.

There are some big differences, however, between the silver manipulation and the insurance scandal. For one, I think the silver manipulation is more serious in that a single price has been manipulated, as opposed to individual insurance policies. Artificially low silver prices over the past 20 years have bankrupted some mining companies and caused the US Government to dispose of much of its silver at unfair price levels, to cite just two examples. It is because the silver manipulation is potentially more serious than the insurance, mutual fund or Wall Street research scandals, that Eliot Spitzer has chosen to work behind the scenes in silver, rather than publicly, in my opinion.

Another big difference is that the insurance companies involved and others not accused, stopped their bid rigging and conflicted commission arrangements immediately. Silver is still a bid rigging and price fixing crime in progress. Sure, AIG may be gone in silver, but the wolf pack still dominates. It will be a great day indeed when we can speak of the collusive bid rigging and price fixing in silver in the past tense.

The biggest difference between the silver manipulation and the insurance scandal, as well as the mutual fund and Wall Street research scandals, is that the others were unexpected and originated on basically a single complaint or revelation. Not so in silver. In silver, the manipulation has been openly discussed and debated for years. More than 3600 people, an absolutely enormous sum, have signed a petition to Eliot Spitzer beseeching his assistance. There were no such public pleas in the other scandals. In silver, the CEO’s and general counsels of the Silver Managers were personally notified of their firms’ involvement. In silver, the regulators were contacted more times than can be counted, by others and myself. There will be no claims of ignorance when silver blows.

The main lesson from the shocking developments over this past week is the reconfirmation of widespread institutional financial fraud in every nook and cranny. There can be no reasonable doubt as to the extent financial institutions will go to make an easy buck. It is against this backdrop of new revelations that I raise an issue I have harped upon recently, namely where are the metal mining companies in all of this, particularly the silver mining companies, that they don’t see what is right in front of their eyes?

Why a copper company, for instance, would remain silent as the price of its product drops 10% in a day, solely due to the tech funds being tricked from their paper positions is beyond me. But it is the silver mining companies, particularly PAAS, CDE, HL and SIL, which bear the greatest scrutiny. Silver has been manipulated for 20 years, copper hasn’t. Their collective silence on the silver manipulation issue defies analysis. One, PAAS, has actually taken to continue to publicly attack me, as if I’m some great enemy of silver.

I had always assumed that it was stupidity, cowardice or just plain stubbornness that accounted for these miners refusing to help themselves and their shareholders by speaking out against an increasingly obvious silver manipulation. Especially since other silver miners have broken rank and bought silver. In light of this week’s new developments, namely, the base metal massacre and the Spitzer attack on the insurance industry, the silver miners continued lack of concern is bizarre. I’m starting to agree with those that have suggested a more nefarious motivation. Is there some type of quid pro quo that we can’t see?

With so many new revelations concerning widespread financial fraud in so many areas, it’s getting close to the point that if you believe silver is not manipulated, you must also believe it’s the exception. Given all the facts, that’s just not reasonable. At the very least, the silver miners should be objective enough to acknowledge the possibility of a silver manipulation. The fact that they fight the very idea that it’s possible that silver is manipulated raises serious questions about their inaction. In the case of PAAS, its chairman Ross Beaty, has publicly written that gold is likely manipulated, but definitely not silver. Huh?

Make no mistake; it has been the silver miners’ lack of involvement that has prolonged the manipulation. A primary producer questioning a continued low price carries more weight than an analyst’s complaint. The flip side is that if events play out as I expect, great shame will be heaped upon those miners who did nothing, and great praise on those who did something.

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