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Rein in Rampant Speculation Or Face The Black Silver Swan
By Dian L. Chu, EconMatters
If you think the crude oil market has gone totally out of control in the past month or so, observe the Silver. The Silver market has basically gone parabolic in the week of April 17, going from $41.75 on April 15th to $46.69 on April 21st--a 12% move in 5 trading days, topping off the move with a 5% move on Thursday (See Chart).
As Silver is a thinly traded market, one thing the CME could do is to raise margin requirements for Silver speculators; otherwise risk is setting up the silver market for an record-setting crash, which could impact many other markets in the process of correcting, especially other commodities like Gold and Crude Oil.
A Silver Contagion
We are not talking about a 5% correction setting up at these levels for silver, we are talking in terms of a 20% down day that poses a contagion effect to markets in general.
The reason the contagion risk in the Silver market is that while Gold is going up half a percent to one percent, Silver is logging in 3.5% days routinely (See Chart below). Well, what goes up, must come down... eventually. So, when this market breaks, it is going to break hard to the order of 10% easily.
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| Chart Source: FT.com |
That kind of market selling will not occur in a vacuum, especially since commodities have been trending up as a group, i.e., the same hedge funds and banks are trading all the risk-on commodities as well, like Gold, Copper, Crude Oil, Wheat, etc.
In other words, if Silver gets a 10% down day, which it almost will for sure, and if it isn`t cooled off considerably with proper margin requirements instituted by the CME, then, the rest of the commodities will be forced to overshoot to the downside as well.
ETF Trading & Portfolio Rebalancing
There are a couple of reasons for this. With the advent of commodity funds, silver is part of the basket of commodities in the funds. Also, because traders will not want to fight the tape, shorts will come in and take advantage of the selloff in Silver to push other commodities down through ETF trading vehicles.
Moreover, the same banks and hedge funds trading silver are also involved in the major commodity groups as well, and they will be liquidating other positions to keep their portfolios balanced with regard to risk. So expect a lot of portfolio rebalancing to take place if the Silver market drops 10% in a day across many hedge funds.
Price & Margin Out of Balance
The CME routinely sets margins based upon contract prices. So, if Silver goes up $10 more in price, then the ratio of margin to price goes down. In order to realign margins with the higher price, CME would raise the margins.
The reason this becomes a problem is that if price gets too far out of balance with margin requirements, the risk goes up, because traders will not be properly sized with regard to risk for a potential correction, and many trading accounts could be devastated due to overleverage.
Black Silver Swan
In addition, if Silver speculators are all heavily leaning towards one direction as the action of recent silver price movement suggests, then, there is an increased risk of a major market dislocation, thus creating a ‘black silver swan' day. That’s exactly the kind of event that exchanges try to prevent from occurring, as it is extremely unhealthy for markets, and bad for business.
It is obvious to anyone observing the Silver market that it is overheated to the Nth power. The longer CME ignores the problem, the worse the consequences will be down the line. When all the other risk-on commodity trades are putting in 1% days, and Silver is putting in 5% days, then you know the longer this goes on, the higher probability that this trade and market could end very badly.
Flash Crash 2.0?
As the very real possibility of a 20% two-day correction is moving towards becoming a very real probability, it could bring down a lot of other markets in the process. Remember, we had the flash crash around this time last year? Well, if the Silver market isn`t cooled off, it could potentially be one of the catalysts for another broad flash crash this year.
Raise Margin Requirements by 30%
The easiest way for the CME to lessen the probability of an epic crash in the Silver market, and the subsequent public and regulatory inquisitions, would be to raise margin requirements by at least 30%, as the starting point.
Actually, the CME could be a little late based upon the manner in which silver speculation has gone bizzerk, especially over the last trading week--the market has simply become parabolic. The CME could have raised margin requirements once Silver broke $40 an ounce, and without a doubt they should have raised margin requirements on the 14th of April, before this latest 12% weekly move.
The longer the CME fails to address the problems in the Silver market to rein in excessive speculation, the more risk there is of an extreme market crash.
Silver A Screaming Short
With gold/silver ration setting new 28-year low record almost everyday in April, it looks like the necessary elements are already set in motion for another horrid crash and burn contagion scenario--but this time originating from Silver--due to the interconnected nature and electronic evolution of modern day markets. Any intervention effort by that time would most likely be futile in the face of a multi-market algo contagion.
Related Reading - Crude Oil vs. Gold, Silver and Copper
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I don't know if I would count on [them] missing the switch to PMs as a monetary system.
There are some pretty good videos out there of people saying Ghaddaffi pushing to use a gold coin currency and going away from the dollar for Africa. And THAT boys and girls is why the "rebels" created a central bank so fast. They wanted to replace Ghaddaffi's 'bank' before that sort of stuff was allowed to get out of hand.
I wasn't saying they'd miss it I was saying they will not acknowledge it and your example is perfect proof of that.
I guess the definition of 'acknowledge' begs clarification.
To me they 'acknowledged' the move to gold by causing the unrest throughout the mid-east and bombing Libya.
There is also oil in Libya. Acknowledge I mean publicy address it; make a statement to that exact issue.
Gottcha!
And while yes...there is oil in Libya, over the past few days I've become a real believer that the whole MENA unrest is being 'pushed' from the outside and oil may or may not be part of it. Simply because [they] already control the oil there anyway. But the 'going to gold thing' reminds me of when Iran started that oil bourse outside of U.S. dollars and suddenly a bunch of submerged fiberoptic cables were 'damaged' thus re-routing internet traffic through....U.S.A.
There's no oil in Egypt or Syria.
This idea of selling my metal is just not on the horizon. If it goes down 10-20% Yahoo!!I'm just gonna back up the truck. Go away with this panic selling concept you are ignoring the fundos of this rally. I'm going to believe this bubble is on when my bank stops renting safety deposit boxe at such ridiculous low prices and giving 3 months free rental.
There has been an inundation of articles like this for every day in the last week; more in the financial media than in any of the MSM outlets. Usually this means that the banksters are getting ready to pounce; could be on Tuesday; let's see. To all here any 10% or more correction would be the cue to rent a U-Haul and two ex-military with AK47s and head for the nearest dealer.
For many years China has been the driver for all fiat currencies to devalue against one another. There has been a race to the bottom to keep exports competitive.
Now, if China starts to let their currency appreciate in a meaningful way the pressure will be off of the rest of the world to keep up the devaluation of their own currencies.
As china lets it's currency appreciate the chinese will not have the same incentive to save in PMs.
PM is a world market.
We may be in the early stages of the correction in the long downward spiral of fiat. The Chinese are in charge. As they raise interest rates and lending requirements, the rest of the world will have the leeway to gradually do the same. Remember currencies are valued against each other. They could all start a gradual rise. It is just a matter of someone going first.
I think this is what Bernanke had in mind with his devaluation of the US$. He has forced the Chinese to confront their inflation and break the tie to the US$. He may be a better trader than he is generally given credit for. It is interesting sometimes how perceptions of people and policies change over the span of decades. They often are seen in a different light over the longer timeframes.
Of course, markets can be "wrong" for extended periods of time, just as traders can also be wrong.
thoughts,
gh
You forgot to mention that China is using their excess US doollars to covertly aquire Gold, Silver,Oil and other minerals. It's so easy to place the our bets, it's no brainer!
People in Asia don't use PM as savings. They use it as jewelry. Only central banks in Asia would store PM
Really? Tell that to Indian families who save up for dowry by buying jewelry for the PM value.
Yes as the Yuan increases in value those Chinese people who can buy more silver and gold will certainly not want to. That makes perfect sense.
Will they buy iPads instead?
Will they get HBO, Armani suits, Louis Vuitton handbags, Ferragamo shoes, GM Volts, dine at Mickey Dees, go to the tanning salon....all of that on their Visa & Discover cards?
Armani stores are like 7eleven in HK they are on every corner, it is one giant supermarket of high end euro stuff that they seem to love. Mainland chinese millionnaires come to HK aquire a flat to speculate, never live there and it gets filled with vuitton bags and luxury fashion by the wifes who cant bring it all back home to factoryville. Makes the whole place a little depressing...
Have you been to china recently? If not, dont talk such a BS please... The yuan is rigged just as the dollar is and will be. I also dont understand people here in this board saying they want to exchange some yuan. I had some yuan leftovers and it was really hard to find any chinese who wanted to change back again
Did you read what I wrote?
I said we may be in the early stages of a change in the direction of world currencies.
If you are able to actually visualize all possibilities in a market you may be better able to assess your risks.
Read every word, and then put them all together into sentences. And then, TRY, to assimilate the concepts that are presented.
And I will try to serve up my ideas in a more cogent and easily understandable way.
But I refuse to take part in any circlejerk just because "everybody" is in on the fun.
gh
Your discussion of Bernanke and his monetary policies skips over the US government and its fiscal problems. The US debt will be $20T in a few years and it will never be paid off. Ever. Pls describe how it is going to be paid off, if you think otherwise.
Then pls incorporate your view of how it will be paid off, into your discussion of the recovery of fiat currencies keeping in mind that the USD is the reserve currency.
I've been to China recently and the most surprising to me was to see all the gold shops everywhere and the massive amounts of gold objects like mao statues, animals etc made of gold, one piece was a rice bowl and chopsticks made of gold witch is a little sick when you think of it.
...any Golden Calf's on the block????
A rice bowl and chopsticks made of gold. That is truly a useful means of exchange.
There are many all over the world buying gold and silver to save.
Saving in PM is ultimately deflationary unless one never spends the savings...
gh
The chinese have a term called the iron rice bowl which translates to a secure job like a tenured faculty or high senority union position. I wonder what a gold rice bowl represents.
Edit: Mr. Google says "The gold rice bowl set represents prosperity, abundance, wealthiness, improving career and flourishing business forever"
Silver to gold ratio from 1873 to the present is an anomaly caused by the demonitization of silver by the coinage act of that year and the Comstock and Colorado finds of the late 1800's. As the dollar loses its value as money and all those former reserve/foreign dollars look for a home one would expect the 16/1 ratio of silver/gold natural abundance to reassert itself. Once the dollar falls and gold is $8000/oz then silver is $500/oz. Math is easy and actually so is checking historical facts.
"Once the dollar falls and gold is $8000/oz then silver is $500/oz. Math is easy and actually so is checking historical facts."
BINGO
It is alright to be bearish on whatever, just get your facts straight and be consistent....
I hope that anyone shorting oil based on your post of ~2 weeks ago is recovering from being monkey-fuckin-hammered....
To short anything now, except cos. that face serious margin compression is fraught with peril. Better to buy some puts than getting your face ripped off. Old traders have a term, "the puke moment", it is when you realize that your position is fucked and you just feel like puking..
Just let the CME raise margin requirements to 100 already, then we can relax and get on with the program sans drama.
The problem is not some overheated bubble of the silver market, but rather a gradually spreading awareness that our dollar is a POS masquerading as a respectable store of value. Feel free to short silver you shill, even better, do it on margin. Make it cheaper for eccentric silverites to accumulate their favorite shiny metal.
Oh Heavens! Let the coming storm be soon, to cleanse us of these trolls! May they melt in the sunlight of logic!
Silver was at 9 in Oct 2008. Today it is 46 or so. Thats a 5x increase in 2.5 years. Try pricing stocks in silver from Oct 2008 to today (Leo).
A 20% dip? Great, I've been holding back some cash for a few months and would love to re-buy at that price.
Margin hikes are designed to prevent cheap credit from amplifying and distoring the physical demand. So what's wrong with that?
If you follow ZH, I'm guessing the perils of rampant debt creation are familiar.
Now, what really pisses people off is corrupting the rules to benefit kleptocratic elites (JPM).
The days of $20 silver are gone. I'm buying hard at anything under $30 and paying cash.
Dude's way behind the curve in terms of what's driving silver ($, squeeze).
CME margin raises - just a stalling mechanism, as we've seen.
Seriously, a 20% dip would bring us back to something like $37 - that was three weeks ago.
Up, up, and away...
If there's a 20% dip, I'll throw my whole life saving into it for a final bet. I may even sell my wife and children for that matter...haha......just kidding!!
maybe your wife will beat you to that short!...
Just BTFD...
Dian,
Parabolic charts mean nothing when the fiat currency system is chock full of fraud.
PARABOLIC?! PARABOLIC?! YOU WANT PARABOLIC?! I'LL SHOW YOU PARABOLIC?!
http://www.chartingstocks.net/2009/03/chart-of-the-us-money-supply-1917-...
Well said (or pictured)
Damn right. All these pundits predicting the imminent collapse of gold and silver (but never of course stocks with triple digit PEs) conveniently ignore the parabolic rise in money supply.
Is silver overvalued?
In 1962 a gallon of gasoline sold for 31 cents.
A 1962 silver quarter wouldn't quite buy a gallon of that gasoline.
Today that same silver quarter is worth $7.75, so at $3.90/gal that silver quarter is worth almost two gallons of gasoline.
Maybe the gasoline is just underpriced!!
thoughts,
gh
You're comparing apples and oranges. Your 1962 valuation is of oil priced in fiat, whereas your 2011 valuation is of oil prices in silver and then expressed as fiat.
A more valid comparison is to compare the inflation in gasoline (about 1300% from 31 cents) and silver (about 4000% from $1 an ounce) between 1962 to 2011. Or, to compare how many ounces it took to buy a gallon of gasoline in 1962 (1/3 of an oz.) with how many it takes today (1/10).
Either way, silver is MUCH more inflated today than gasoline, not the other way around.
BTW, I was reading Ted Butler and buying silver ten years ago at $4.15 and $4.50 an oz, so I'm certainly not trashing silver as an investment. But most of the catalyst for higher prices has been spent (inventories depleted, electronic uses rising, general commodity bull market) and now we're running on the fumes of speculation and greed. I'm lightening up and looking for another investment like I found in silver 10 years ago.
You might want to factor in that the pre-Great Society US in 1962 was still operating under Bretton Woods and such constrained to some fiscal discipline, did not have obligations of over 75 Freaking Trilliion Dollars (FTD), was solvent and was not buying its Own Freaking Debt (OFD) because the rest of the world knows the US is Freaking Broke and Doomed to Hyperflation (FB&DTH).
Sorry, I was channeling Mogambo Guru for a moment there - it's late and it must be the drugs.
it is possible gasoline was overpriced relative to silver back in 1962 and it is now only starting to become fairly priced relative to silver based on respective supply and demand.
Yup, it is important to remember that ANYTHING is possible.
gh
LOL. + (1/0)
The mark of a mania is when the true believers cannot see the down side.
How many people see a downside in the USD? Practically none. They just think the evil oil and food companies are ripping them off
You're right. The mark of a mania is when the true believers cannot see the down side of the US dollar.
I do not know anyone who is going to sell their physical silver if the spot price drops 20%. Not one single person. Not even if it drops 50%. I certainly am not.
The "correction" Western-style investors talk about only occurs when Western-style investors buy a financial object for the purpose of making a profit, and always with a view toward selling it eventually. Thus, the "greed/fear" cycle causes "corrections"; greed drives up the price, more Western-style investors pile in, there is a stochastic downward variation, then "fear" takes hold and Western-style investors sell into a downward movement to retain their "profits."
That is not what is happening, it is just the opposite. Fear, real gut fear, is driving the upward cycle, not greed. Every "trader" who is calling for a "correction" is missing this central point. Greed has nothing to do with it. Hundreds of millions of people all over the planet want gold and silver, not to profit from it as an investment, but to store wealth out of fear of fiat money.
If just 500k people had as much physical silver as little ol' me has stashed in bank safety deposit boxes and bank vaults, there would be no silver, anywhere. It would all be gone. And I paid a pittance for it. So it has gone down the rabbit hole, and that is where all physical silver is going. Its not coming back into circulation even if the fools who play "trader" on the CME manipulate the price downward 75%.
I suggest the lady who wrote this article count how many people there are in Chindia who want silver and gold. A conservative estimate is that there are at least 100 times more people demanding silver than there is silver to supply. Who is right, will be known in a year or less.
My suggestion is that you take every step you can to prepare for what is coming.
Good luck.
Agreed. Traders will do what traders do and in short term drops will try to assert they are correct even and the trend moves up. Buy, hold, go long. Trade if you want, but that's a really different game.
She doesn't get it. There is a paradigm shift occuring on several levels.
Silver is not approaching overvalued.
How can anyone say silver is a screaming short without saying US treasuries are screaming louder?
I agree. The problem with chart and momentum traders is that all they really see is the chart and not necessarily what is causing the moves. They live and die by history and theoretically human nature's herd instinct to consistently repeat.
The paradigm and reasoning is changing. Trader's will come and go and silver or gold will not go anywhere in a straight line. Look at the fundamentals of international debt, currency manipulations and social obligations and tell me that those factors are stable or improving. When you can show that then I will believe in metals dropping or at least stabilizing for the longer term.
One might think that when a commodity is in the process of becoming a store of wealth, it is very foolish to apply charts and trading principles drawn from other commodities not being so utilized.
In total hyperinflation, PMs can simply keep rising in price. As the dollar balloon deflates, PM prices inflate accordingly.
Applying moving averages, or any "undesold" or oversold" lines on historical charts, is completely useless.
Anything that makes holding dollars more attractive will hurt PM prices. The interesting issue to discuss involves if, how, and when that might happen.