Over the past few years there have been allegations made that J. P. Morgan (NYSE:JPM) and HSBC (HBC) are suppressing the price of silver (NYSEARCA:SLV), (NYSEARCA:PSLV)). These allegations need to be taken seriously because they come from credible sources including Bart Chilton (according to Bloomberg) -- a commissioner on the Commodity Futures Trading Commission (CFTC). A lengthy investigation into these allegations was recently dropped, but the controversy is still alive and well.
In this article I address these allegations. I will first discuss the notion of market manipulation. I then discuss the U. S. government's silver price manipulation in the late 1960s as a clear cut example of market manipulation so that readers can get an idea of what I mean by the concept. I then provide the arguments that the price of silver is manipulated today, although I demonstrate that while they are very compelling, they are also circumstantial and consequently inconclusive. Finally I discuss how investors should act given the possibility that the silver price is manipulated, even if readers come to the conclusion that it isn't.
The term "price manipulation" is complex and loaded. Before I offer my definition let us look at the definition given by the CFTC according to their glossary:
Manipulation: Any planned operation, transaction, or practice that causes or maintains an artificial price. Specific types include corners and squeezes as well as unusually large purchases or sales of a commodity or security in a short period of time in order to distort prices, and putting out false information in order to distort prices.
Essentially the definition boils down to the first sentence, and so we must look at the CFTC's definition of "artificial price":
Artificial Price: A futures price that has been affected by manipulation and is thus higher or lower than it would have been if it reflected the forces of supply and demand.
The obvious circular causality that exists between the two terms leads me to assert that the CFTC's definition of manipulation is completely worthless: they claim that manipulation leads to an artificial price, which is caused by manipulation.
I propose a simple yet forceful alternative below that provides specific conditions by which one can empirically test allegations of manipulation. Manipulation occurs when:
A: A market participant buys and/or sells an asset or a derivative contract related to that asset in order to control its price.
B: The participant does so in order to achieve some agenda other than directly profiting from the aforementioned trading activity.
This does not necessarily mean that the market participant doesn't profit from this trading activity.
Furthermore, this does not necessarily mean that the price manipulation scheme is successful, as this definition concerns itself with a market participant's intent and actions in the marketplace, not the results of his or her actions. The example I give below of the U. S. government's silver suppression scheme of the 1960's is an example of a price manipulation scheme that fails.
Finally I should note that under this definition of price manipulation, or under any similar definition, it is very difficult to prove because manipulation involves intent. We cannot simply conclude that manipulation has occurred because of unusual price activity: proof of manipulation requires a statement of intent. However, to a certain extent this is only true from a legal standpoint. From an investment standpoint, that is, from the standpoint that I take as an investor looking to act in the marketplace, overwhelming circumstantial evidence is sufficient. The fact that over 21 million silver futures contracts (105 billion ounces vs. annual production and recycling of about 1 billion ounces) traded on April 14th is not evidence from a legal perspective, but it is certainly enough to engender suspicion, and by Occam's Razor manipulation is a reasonable conclusion.
Silver Manipulation in the 1960s
In general, an allegation of market manipulation is not farfetched or conspiratorial. It has been done in the past numerous times, and it has been done openly. Consider the following example.
In the late 1960s the U.S. government irrefutably manipulated the price of silver. They openly set a price objective. They openly gave a reason for setting this price objective. Finally, they acted in the market in a way that was obviously intended to achieve this price objective.
On June 3, 1965 president Lyndon Johnson announced to Congress that silver would be removed completely from dimes and quarters, and that the silver content of half dollars would be reduced from 90% to 40%. In the statement Johnson claims that a primary reason for doing so was that there was a shortage of silver:
"There has been for some years a worldwide shortage of silver. The United States is not exempt from that shortage--and we will not be exempt as it worsens. Silver is becoming too scarce for continued large-scale use in coins. To maintain unchanged our high silver coinage in the face of this stark reality would only invite a chronic and growing scarcity of coins."
Ironically, despite the supposed shortage of silver mentioned just weeks earlier, on July 23, 1965, in another address to Congress Johnson states the following:
"If anybody has any idea of hoarding our silver coins, let me say this. Treasury has a lot of silver on hand, and it can be, and it will be used to keep the price of silver in line with its value in our present silver coin. There will be no profit in holding them out of circulation for the value of their silver content."
It is clear that this is a statement that fits into my definition of "price manipulation" above. The Johnson administration claimed that it had a price objective for silver, regardless of market conditions. Johnson states that the U.S. government intended to sell silver (to act in the marketplace) in order to achieve this price objective. Furthermore, there is complete disregard for the financial benefits/detriments of executing such a trading strategy. Finally, the U.S. government actually did sell silver into the market. According to The Silver Institute the U. S. government sold 674 million ounces of silver into the market from 1966 through November of 1970. The Silver Institute further claims that by 1971 the U.S. government's silver inventories had fallen to 170 million ounces from a peak of 2.1 billion ounces in 1959.
The conditions I provide above to qualify a market participant's actions as manipulative are clearly met. Furthermore, even if one disagrees with my above definition, it seems to be impossible for anybody to deny that what I have just described is price manipulation.
Is Silver Manipulated Today?
The pressing issue facing the claim that the silver market is suppressed today is that there is no direct evidence of either of the above conditions that would constitute market manipulation. There is, however, some very compelling circumstantial evidence that leaves little room for doubt.
We saw that in the 1960s that the silver market was clearly manipulated. There was a market participant (the U.S. government) that openly had an agenda (to set the silver price so that the value of the silver in a dime or a quarter remained valued at 10 cents or 25 cents respectively), and who sold silver into the market in order to attempt to achieve this agenda.
Nothing so obvious can be said about the current silver market. The theory espoused by manipulation proponents (GATA, Bart Chilton of the CFTC, and Andrew Maguire) suggests that J. P. Morgan and HSBC sell silver futures and option contracts into the market without holding any physical silver to deliver to the buyers of these contracts. By selling these contracts they attempt to turn market sentiment towards a bearish stance so that other traders and speculators sell futures and options contracts, thus pushing the price lower and creating a cascade of selling. When the selling stops the culprits who started the avalanche of selling cover their short positions or allow options contracts to expire worthless.
Whether this takes place or not is uncertain. There is a lot of circumstantial evidence that would lead one to jump to the conclusion that the silver market is manipulated downward. But the closest statement one can make to claiming that there is manipulation is that the manipulation theory can best explain a series of facts and events that otherwise seemingly make no sense. Let us examine this circumstantial evidence.
A: On March 25, 2010 Chris Powell of GATA claims in an article that on February 3, 2010, two days before the non-farm payroll data was to be released in the United States, trader and whistle-blower Andrew Maguire informed the CFTC that the precious metals market would be "attacked" upon release of the non-farm payroll data, implying that the silver price would decline immediately after this data was released. What Maguire had to say came true. It is difficult to imagine a scenario in which Maguire's prescience was the result of something other than his knowledge of some sort of manipulation agenda, although it certainly isn't impossible.
B: In a January 26th, 2010 letter to Eliud Ramirez of the CFTC (included in the aforementioned article), Maguire claims that the trading action in silver futures was incredibly suspicious: just before the "pit open" at a time when silver futures contracts were trading in lots of 5-10 contracts at a time, all at once 1,500 contracts were sold into the market. Maguire claims that there can be no other explanation than manipulation. After all, a seller of that much silver (7.5 million troy ounces at roughly $30 per troy ounce, or $225 million) must be wealthy and we can therefore assume that the seller is a sophisticated trader. Wouldn't it make sense for even an amateur trader to sell that silver into the market slowly in order to maximize the selling price?
Assuming that the trader was sophisticated then my second condition for manipulation is met, namely, that the market participant traded in order to achieve a certain price rather than to maximize trading profits.
Even if one plays "Devil's advocate" and suggests that the trade was foolish one could point to other unusual trading patterns in silver that seem to fit my second condition for manipulation.
- After the price of silver peaked at nearly $50/ounce in May, 2011 the market opened down in the thinly traded over-night Asian session by $6, and the price of silver closed that week lower by a third.
- On February 29, 2012 the price of silver fell nearly 10% in just a few minutes on no news.
- As previously mentioned, when the silver price crashed on April 14th of this year 105 billion ounces of silver, a figure that is multiples of the known above-ground silver supply, were traded in just one session.
Aside from extremely rare occasions such as those of the May 6, 2010 flash crash in the stock market (from which the market recovered almost immediately) and the October 1987 crash in the stock market, events like this almost never take place. Yet they seem to take place more regularly in the silver market. They don't even happen in the gold market, which tends to trade with the silver market.
The circumstantial evidence provided here is very compelling, but it is in no way conclusive as with the case of silver price manipulation in the 1960's. First, there is no statement of intent. J. P. Morgan, one of the supposed culprits, has come out denying allegations that it is manipulating the silver market, as evidenced by this interview with Blythe Masters who is the head of global commodities at J. P. Morgan. Second, there is no evidence that J. P. Morgan has actually sold any silver into the market other than through derivatives (and it is assumed that they cover their short positions). Masters has justified JPM's large derivative position in silver by claiming that it holds these positions for clients who are hedging their production. Whether or not she is being honest cannot be verified.
Investing in Silver and Price Manipulation
First, I want to say that manipulation cannot be used as an excuse for losses. Even if you believe the price of silver is manipulated and that it is going to $1,000/ounce, this is no justification for buying it at $40/ounce back in 2011 when it traded under $20/ounce a few months earlier.
That being said as an investor in silver it should not matter to me whether or not the price is manipulated. What matters is whether or not silver has good value at current prices. In my article Buying and Owning Silver Part 1: Arguments for Silver Ownership I maintain that silver does have good value at current prices, and I argue the point without once mentioning the notion of price manipulation. If the price is suppressed then as a long-term investor in silver the manipulation serves me because it provides a better price at which I can buy.
Nevertheless if an investor who is bullish on silver accepts the manipulation thesis then this should change his or her strategy in the silver market. If the manipulation thesis is true then the culprits are selling futures contracts and options in order to alter market sentiment in order to push prices down even further. Consequently the sellers of these contracts do not necessarily have the physical silver to deliver to the buyers of silver futures contracts. If a large buyer such as an industrial user of silver or a hedge fund purchases futures contracts and requests delivery of physical silver those traders on the other side may not be able to deliver this silver, and as a result they may have to either settle in dollars or cover their short positions when there are no sellers thus causing a short squeeze. In either event buyers of futures contracts may not be able to take delivery of the silver promised by these contracts, which could ultimately cause a disconnect between the price of physical silver through dealers and the price of silver futures contracts. Thus investors who accept the manipulation thesis should consider avoiding these contracts altogether and simply purchase silver bars and coins.
Furthermore, even if one isn't certain that manipulation is taking place, it might be in his or her best interest to assume that it is in a way that reflects Pascal's Wager. Blaise Pascal was a 17th century French philosopher and mathematician who admitted that one could not know for sure whether or not God existed; but given that the consequences of not believing that He does exist if He actually does are worse than the consequences of believing that He does exist if He actually doesn't implies that from a pragmatic standpoint it is better to believe in God's existence. Similarly, assuming that one is bullish on the price of silver, if one believes that manipulation is taking place when it isn't then one simply buys silver bars and coins as opposed to futures contracts and other derivatives. If one assumes that manipulation is not taking place when it actually is then one may be stuck holding futures contracts and other derivatives that are not worth the physical silver that they supposedly represent. While this might be burdensome insofar as coins and bars need to be stored, and that they are expensive to obtain given dealer premiums, this burden is similar to that assumed when a responsible individual purchases insurance. Consequently, from a pragmatic perspective, investors are better off accepting the price manipulation allegation as true.
Price manipulation is a ubiquitous fact of markets. But we have seen that it can occur as a matter of policy, such as the silver price suppression agenda of the U. S. government in the 1960s, or it is done behind the scenes by conspirators with a hidden agenda, as would be the case assuming the allegations against J. P. Morgan and HSBC are valid. The latter sort of price manipulation is far more difficult to demonstrate given that one is limited to public information in attempting to do so. As a result, concerning these allegations against J. P. Morgan and HSBC, at best what can be concluded is that the evidence given above is most easily explained by the manipulation thesis, but we cannot conclude that this is necessarily the case. Nevertheless, if one assumes based on this inconclusiveness that manipulation is not taking place, then one is at risk of losing his or her silver investment assuming that manipulation is taking place. Consequently, while we cannot be certain that there is price manipulation in the silver market, it should factor into the investment decisions of silver investors.