The use of High Frequency Trading (HFT) computer systems to execute large deals rapidly in electronic markets typically allows their users to take advantage of short-lived pricing disparities in large size.
Furthermore, the growth of HFT in the silver derivatives market is exerting an ever-increasing influence on the price of physical silver. Unfortunately, the hedge fund crowd is now often mindless, relying on computers to do their thinking for them.
These imperfect but rapid trading systems evolved to exploit markets that were originally intended to create a fair place to discover price and generate capital and funding for business. Now that the human element is increasingly being replaced by computer programs, the HFT process has morphed into the game of picking up pennies in front of a steam roller.
Another highly undesirable result of HFT is that it can cause and exacerbate mini flash crashes, which can increase volatility by creating wild price swings in the silver market.
Silver Derivatives Used to Suppress the Physical Price
Silver's price has been manipulated lower for years, and JPMorgan Chase (JPM) often takes the blame as a primary source for silver's price suppression.
While everyone in the market knows JPM is short silver, the likely conclusion of the CFTC in their ongoing silver market manipulation investigation will show that JPM's massive short futures position is largely acting as a hedge against the bank's underlying customer business. This will probably justify JPM's manipulative silver trading activities in the minds of most people.
Nevertheless, the real manipulation may be happening in the greater markets. Trading volume from derivatives, equities and options (including miners) are being rented by the more than 40 dark exchanges that now account for at least 30 to 40 percent of trading.
This is where price discovery has ended up, as profit-center exchanges with a strong ability to influence regulators and markets have taken over the price of silver and other strategic commodities.
The old 'market maker' system has been replaced by electronic systems that engage in front running. This can add and subtract liquidity at will, without any concern about the fair value of the underlying assets or equities being traded.
The Scarcity of Real Strategic Assets
With precious metals, the net effect creates (1) a huge mountain of paper derivatives, (2) the tightening of real physical inventories on exchanges, and (3) an increase in the number of shares held short at metal-backed silver ETFs. All of these factors contribute to determining the price of silver.
In the meantime, beneath the surface, the value-based buying interests originating out of Asia and from other large entities are quietly entering the silver market based on the favorable fundamentals for silver.
For example, if only 100,000 investors decided to deploy $20,000 each to purchase silver at $30 per ounce, their acquisition would equal 200 percent of U.S. annual silver mine production, or approximately 67 million ounces.
The irony remains that once the virtually inevitable silver bull market gets underway again, it will be these same algorithmic traders that will ultimately cause silver prices to overshoot to the upside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.