FMX Connect Morning Gold Fix: Silver Warehouse Shenanigans Or The Real Deal?

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From FMX Connect

Silver Warehouse Shenanigans or the Real Deal?

Our friends at Zerohedge did some excellent discovery and analysis last night on the recent drawdown in Comex Silver stocks eligible for delivery. We have personally seen this activity before, and while we do not doubt the authenticity of the draw down from the Registered (for delivery) stockpile described below; We add that this has happened many times in the past in short -cons meant as exit strategies for big longs.

So far, if this is an exit strategy, it is basically what happened in 1997 when Buffet took delivery, but on a much bigger scale, a long –con if you will. But if the reason is that someone bigger that the usual investor community with pockets and a will deeper than all the Bullion Banks combined has decided to de-dollarize their FX reserves, like say China, then this is the way to do it. We think this is real and will describe why briefly after the ZH analysis.

The essence of ZeroHedge’s work is here:

A week ago we noted something peculiar: in one day, COMEX depository Scotia Mocatta (one of five in the world) saw a 25% transfer of silver from "registered" (or deliverable physical) to "eligible" (or "undefined" - a distinction discussed previously, and also below:….And while last week it was Scotia Mocatta, today it is HSBC and the Delaware Depository, and the reason given: "Adjustments include reporting classifications of t oz that were moved from Registered to Eligible. Please see Special Executive Report reference 5736 for additional information. http://www.cmegroup.com/tools-information/advisorySearch.html#."

The CME’s Detailed explanation goes like this:

A correction to the COMEX Metal Depository Statistics Stock Reports published on April 27, 2011, has been made to reflect a change in the reporting of metal from the Registered category to the Eligible category. This change reflects paper warrants that have yet to be converted to electronic form. The metal represented by these paper warrants, which will now be reported in the Eligible category, will continue to remain eligible for delivery against COMEX futures contracts provided holders of the paper warrants convert them to electronic form.

Exchange metal reported in the Registered category represents troy ounces of metal that meet the contract specifications as defined in the Exchange Rules for which an electronic warrant has been issued.

Exchange metal reported in the Eligible category represents troy ounces of metal that meet the contract specifications as defined in the Exchange Rules for which an electronic warrant has not been issued.

They go on to cite SilverAxis in describing what Eligible vs. Registered means

And as a reminder for those unfamiliar, here is a distinction between "registered" (real) and "eligible" (somewhat "questionable"), courtesy of SilverAxis

For those who aren’t familiar with the terminology, the registered category of COMEX warehouse bullion stocks generally refers to gold and silver bars against which COMEX warehouse receipts are outstanding. The COMEX publishes these stocks on a daily basis and they can be found here: Silver | Gold. The registered category is the total pool of gold and silver available at any time to meet delivery requirements under expiring futures contracts or to establish initial futures contract positions through a transaction called exchange-for-physicals (I’ll explain this another time). It is important to realize, however, that many parties holding COMEX gold and silver in registered form have no intention of making their holdings available for delivery. By this I mean that such parties are neither (1) holding a short futures position against the warehouse receipt nor (2) willing to sell their registered metal (warehouse receipts) to a party with a short futures position. Indeed, a substantial portion of those holding registered metal would have acquired the COMEX warehouse receipts by holding long futures positions for delivery. In other words, these registered stocks are held for investment and not for commercial purposes.

In comparison, the eligible category of COMEX warehouse bullion stocks generally refers to bullion held in the warehouses that meets the specifications of an acceptable COMEX bar (proper weight, size, purity and refiner) but does not have a COMEX warehouse receipt issued against it. For example, an investor might purchase several 1,000 oz. bars of silver from a dealer and then deliver the bars for allocated storage at a COMEX warehouse. This is a private arrangement and has nothing to do with the COMEX. Unless these bars are officially registered (the easiest way to do this is through the aforementioned exchange-for-physicals), they will remain in the eligible category until withdrawn from the warehouse by the investor. Thus, the appropriate way to treat eligible COMEX warehouse bullion stocks is that they represent metal that could potentially be registered at some point in the future but cannot presently be used to make delivery under a short futures contract.

Our Two Cents

What could this all mean:

1. A long is setting up his exit strategy by creating the impression that there is less silver available that actually is. – if this is true, it is irrelevant. Perception is reality and someone is taking the risk.

2. In the past the short-cons were conducted by trading firms like Phibro with the complicity of the Bullion banks, who got out of their way. If someone like Phibro is involved, and we do not think they are, they could be as agent for someone much bigger than Buffet or Soros. Someone like a country.

3. We think the wildfire of this strategy (if it is not a fully genuine delivery issue) is spreading to gold. This would be unprecedented for the following reasons.

a. One can control the Silver market with much less capital than gold.

b. Silver does not have currency status, gut Gold does. Every cental bank has gold in its reserves. We don’t think any have Silver.

c. Silver is consumed while gold is essentially not. Hard to create a squeeze in something that every ounce that has ever been mined still is in existence.

This make Silver the perfect product to buy if you genuinely think it is undervalued, want to de-dollarize your reserves, or just want to screw with the Banks who have become complacent over the years doing metals “carry trades” wherein they lease Silver, short it and take the proceeds to invest in something with a higher yield, betting they can get producers to sell to them when needing to cover. But ZIRP and TBTF have given them the feeling that their VaR issues are not their own, they are the tax payer’s. At what point does a dollar cost averaging strategy just become a Martingale bet? And as we know, 0 and 00 do come up once in a while in Roulette, making Martingale bets a bad long term strategy.

It doesn’t matter if it is an exit strategy or not. We are sure the monster is stronger than the creator now. The grass roots movement into Silver has contributed greatly to this. It is a form of proletariat uprising if you will.

Gold: the new Silver?

But Gold is acting strangely now as well. Spreads have weakened over the last month and option buying has exploded. If the Silver play is successful then could Gold be next? We don’t think so, but a large sympathy move could happen at some point in the least. “ Hey, it worked in Silver, let’s spend a little in Gold and see if we can make spook the market and take profits of it before Uncle Sam taps our bosses on the shoulder.”

In Silver the “Tell” is the spread market, as options are not continuously traded. In Gold, it is the options activity that gives better clues for our own analysis.

Also worth noting to all you JPMorgan haters:

There are a handful of players in Bullion. And historically, when the outside sheep have been sheared (the supply of producers clients selling too cheaply, investors buying too high is exhausted or insatiable) they almost always cannibalize one of their own.

So, with 5 major players sitting at a poker table, one of which has exclusive info in the form of a client order… how is he going to get filled? He is going to take on another bank. And the last bank to figure it out is toast.

1994- silver call exercise: Republic smoked the other banks although it want their order to fill.

1997- not sure anyone did well here as Phibro was ninja like in its execution for Buffet. And then took delivery for him. The producers took the fall on this one

1999-Gold Ashanti default- Goldman and we think MS cleaned up at the expense of all the other dealers (Ashanti was their client and defaulted. Goldman knew first. Their credit department got smoked, but their trading, not so much.

The Banks Will Eat Their Own:

We think cannibalization is starting here, and although the TBTF concept will save any and all who suffer, it also lets any receiver of government largesse live in denial that much longer. There is some suffering now. Our empirical evidence in Gold is that the dealer sell side business has dried up in calls, while at least one dealer is buying everything.

One thing you have to say about the Bullion Banks: if they cannot keep markets managed, they are quick to recognize the grass roots phenomena that is public interest in Silver, and (maybe Gold)and get in front of it.

Our Advice:

If you are long Silver and feel nervous about it then sell 1/3 of your position. If you are not nervous then you should be. We are headed for a blow-off top with a quick reversal, or a sustained rally for another year or 2. You should be equally miserable if either of those happens. So sell some.. go buy farm land in Argentina with your profits.