How Will CFTC Commodity Price Investigations Affect Trading in Silver?

Jul.23.09 | About: iShares Silver (SLV)

Or more aptly some items of news and rumors which may have an impact on silver (and gold). The first is clear enough and is not rumor. Next Tuesday (28th July) the CFTC will begin its hearings into discussing position limits in energy commodities as well as the exemptions some so called hedgers enjoy when they multiply their futures contracts even more.

This will go on for a week before (we hope) some action is taken to curb the excessive speculation that went on in crude oil and elsewhere in 2007-2008. The reasons for this are deeply embedded in the public psyche – high gasoline prices and high energy bills. That in itself is enough motivation to not allow such a thing to hit the consumer's pocket again.

The Commission has promised to look into other commodities for, as we know, the impact of price rises was felt across the board. When this will be done is not clear yet. So how will this affect future trading in silver?

Clearly many blame speculators on unjustifiable commodity prices and they have a point, to an extent. The truth, however, was that speculators were merely amplifying a wave of demand for commodities led by China as capacity utilization went beyond need and more into greed. The bubble burst and the unwinding was something to behold.

Now as the research of Ted Butler and others points out, silver has the most negative net commercial position of all commodities and seems to have worn that dubious crown for years. The stranglehold a few banks have had on the short side in comparison to world production dwarfs that of any other commodity. This obviously needs to be brought into line with the reality of other commodities traded on futures exchanges.

However, the raison d’etre for the appeals for change by Ted Butler and others is that it will end a silver price suppression scheme led by the major shorts and silver will rise unhindered. Of that I am not too sure.

If the major shorts are forced to reduce the size of their positions, I asked myself who was going to take the other side of the longs when a contract is bought. Open interest goes up as the silver price increases, so it seems to me that if you limit the shorts then you are limiting the longs as well. The outcome of such a CFTC measure on silver may dampen the crashes we have seen in silver since 2004, but it may also dampen the run ups as well.

The outcome at best may lead to silver behaving more like gold in the future – less vicious price spikes and crashes. Only time will really tell.

The second piece of news or perhaps semi-rumor is that HSBC (HBC) may be getting out of the silver storage business. If its customers are forced to sell up and move on how will that affect the price of silver? Well, that really depends what kind of transitional scheme HSBC offers. Some other business may just seamlessly buy them out and take over the accounts (as happened with the Barclays (NYSE:BCS) iShares ETFs). A forced selling of all silver bullion leading to a market flood and price crash seems unlikely to me. Either customers transfer to another scheme or the scheme itself is taken over. Either way the outlook is neutral or slightly bearish as some just take the cash. Unless of course you believe HSBC has no real silver stored and customers start buying the real thing ….

The final item is not news at all but 100% good old mega-rumor. We love to read these now and again and experience that slight shudder of expectation and fear. If you haven’t heard already, there are claims running around that a major dollar devaluation is on its way and a forced bank shutdown (“holiday”) will ensue as the US government tries to once and for all fix the banking system before it fixes them good and proper. The timescale is put on the order of 120 days or so.

How do we rank this rumor? Do we rank it right up there with the “news” that the COMEX was going to default on gold and silver deliveries a few months back? Or perhaps it is the sister of the “US about to attack Iran” or “Osama is about to detonate a nuclear suitcase bomb in a US city” rumors? I have a simple rule which seems to work:

The probability that a rumor is true is in inverse proportion to the magnitude of the rumor.

Now we know that China and so on are not happy about the US flooding the world with dollars to quell the credit crisis. It is quite understandable when they talk about new reserve currencies but that is all saber rattling. Back in 1933, Roosevelt did indeed devalue the dollar by a large amount. But now we have floating exchange currencies with the odd insipid intervention by governments. The markets and bond vigilantes will pronounce on the Dollar, and just now it looks like it is breaking down again. No need for interventionist magic – the markets will do it for you.

So will there be a sudden financial shock within 120 days? I doubt it, but since I and perhaps you are invested in silver anyway it won’t matter. We are ready for any such eventualities whether they come grinding out of the rumor mill or are based on real and sound fundamentals.

Disclosure: The Silver Analyst is very much long silver.