JP Morgan and the Massive Silver Short: The Greatest Story Ever Told

Includes: JPM, SIVR, SLV
by: Kid Dynamite

Pssst, hey, did you guys hear the news? JP Morgan (NYSE:JPM) is short 4 quadrillion tons of aluminum. If everyone in America went out and bought just 2 cans of chicken noodle soup, we could bankrupt JP Morgan, cure hunger, and destroy the flu at the same time! Spread the word!

Sounds preposterous, doesn't it? In case it's not obvious, I made that up - JP Morgan is not short 4 quadrillion tons of aluminum, and you will not bankrupt JP Morgan if you run out and buy cans of chicken noodle soup. Guess what, JP Morgan is also not short 3.3 billion ounces of silver, and you will not bankrupt JP Morgan by going out and buying silver coins, although you might make the coin dealers rich.

If you still have no idea what I'm referring to, bless you for your innocence in this matter - as you've not yet been told one of the greatest stories/lies on the internet. Sadly, as we all know, on The Interwebs, the more something is repeated, regardless of its basis in fact, the stronger its "truth" value becomes. The story that JP Morgan has a massive short position in silver that you can use against them to force a short squeeze on and hence destroy the evil bank has been told so many times lately, by cartoon animals on Youtube, by American citizens on Youtube, by various organizations trying to promote the acceptance of physical precious metals, by pseudo journalists, but there's no evidence to back up the claim.

Let's take a step back and start with some facts, and perhaps we can then figure out where the facts morphed into Internet Folklore Legend. First of all, JP Morgan is being investigated by the CFTC (Commodity Futures Trading Commission) for alleged manipulation of the silver market. Second, JP Morgan is a large player in the precious metals derivatives markets. Third, many experts in the field estimate that the outstanding open interest in silver futures is very large relative to the actual supply of physical silver in the world. Depending on estimates, the outstanding interest in paper silver (futures and options) may be larger than the outstanding existing physical silver stocks. Finally, the CFTC has been debating instituting position limits in precious metals contracts, and is still working on that issue.

Now, let's get to Max Keiser, the vocal mouthpiece and leader of the "Bankrupt JP Morgan, Buy Silver" brigade. First, we should note that Max Keiser's website has ads all over it that presumably result in financial gain to him if his readers take his advice and buy physical precious metals. Of course, regular readers of mine know that I'm firmly against indicting people just because they have potential ulterior motives - but fear not, I will prove that Keiser's claims are incorrect - it's important to point out that he has incentive to manipulate the facts here though.

Keiser writes:

As part of the ongoing exposé, it has now become clear that JP Morgan is sitting on what is estimated to be 3.3bn ounce "short" position in silver (which they have sold short, meaning they don't own it to begin with) in an attempt to keep the price artificially low in order to keep the relative appeal of the dollar and other fiat currencies high. The potential liability for JP Morgan has been an open secret for a few years.

This is basically the crux of the issue - Keiser asserts that it has "become clear" that JP Morgan is sitting on a 3.3 billion ounce silver short. There's just one problem - this "fact" that Keiser has made up, which is the foundation for all of the hype, is false. I eagerly clicked on Keiser's link on the words "become clear," assuming that he would lead me to some sort of evidence to support his claim, but that link only cites the data point that as of the first quarter of 2009, JP Morgan and HSBC (HBC) combined held $7.9 billion in precious metals derivatives (more on this in a moment),

There are some sources of data online for potential precious metal exposure that JP Morgan might have. We have the Office of the Comptroller of the Currency, which provides detailed quarterly reports of the derivatives holdings of the large banks. We also have the COMEX website, which provides open interest information for silver futures and options on silver futures. Finally, we have JP Morgan's 10Q, which would show the exposure of their positions. Shall we look at some actual factual data?

From the COMEX website, we can see that as of the end of November 2010, the outstanding open interest in silver futures was 137,071. The open interest in options on silver futures was 134,779. Each option is for one futures contract, and each futures contract is for 5,000 ounces of silver. So the total equivalent notional silver if you add up all the open interest in listed futures and options is less than 1.4 billion ounces. How about over the counter options? The OCC report includes both listed and over the counter derivatives, and shows that as of the end of the second quarter of 2010, JP Morgan had total precious metals derivatives exposure of $8.441 billion dollars (table 9, page 32). If we look back at the report from the first quarter of 2009, we can see the source of the data above, that JPM and HSBC held a combined $7.9 billion in precious metals derivatives notional (table 9, page 30)

We can quickly see that the numbers disprove any sort of allegation that JP Morgan might be naked (note: here, "naked" means unhedged - it's different from the equity "naked short" meaning) short 3.3B ounces of silver. {EDIT: Please see addendum below} I'd still love for someone to show me any evidence that JP Morgan has a large naked silver short, or to point out any other real data pertinent to this discussion, but I feel quite confident declaring Max Keiser's claims to be flat out incorrect.

I am long the iShares Silver Trust ETF (NYSEARCA:SLV), and think the price of silver may rally still, but if it does, it's not because JP Morgan is going bankrupt lugging a 3.3 billion ounce short position in silver.

LATE EDIT: The source of the 3.3B ounce number commented on my SeekingAlpha post. You can read his logic (which I find poor) for yourself, making sure you check his data sources (specifically, the BIS data). I did this myself, and found his conclusions to be absurd and exaggerated, as I pointed out in my reply to his comment. Another SeekingAlpha commenter astutely mentioned that the OCC reports don't have the LBMA silver trading volumes in them, which is a good point. The BIS data, however, should incorporate much (but not all) of the LBMA numbers - I discussed these BIS numbers in the comment reply referenced just above. The BIS numbers show that as of the end of June, 2010, there was the total gross equivalent of roughly 7 Billion ounces of silver equivalent derivatives contracts outstanding ($127B / $18/oz) - and actually, that's all non-gold precious metals, but we can pretend it's just silver for discussion's sake. Thus, I cannot mathematically prove that JPM is not short 3.3B ounces. That said, the 7B ounce number is a gross number, and the BIS's detailed breakdown of positive and negative values of contracts (page 18) shows relatively balanced exposure, as one would expect, since the banks are not in the business of making naked $100B bets. I still feel quit confident in stating that JPM is not short 3.3B ounces of silver, yet it cannot be unequivocally proven by the available data.

Note: There's another separate issue at play here - the size of the open interest in silver futures relative to the availability of physical silver needed to actually settled these contracts. Let's have a quick lesson: for every person short a silver futures contract, someone has an offsetting long position. If the longs don't close out their positions (by either selling them, or "rolling" them - selling them and buying the next month's contract), then they take physical delivery of silver at expiration - the person short the contract has to actually give silver to the person who is long the contract. In other words, it's the longs that determine physical delivery - not the shorts. If the long contract holders think there is a massive shortage of physical silver, why don't they just force the sellers to deliver the physical and create their own squeeze?

Disclosure: Author long SLV