Things That Make You Go Hmmmm - Where There's Smoke There's Fire

From Grant Williams

Any time you see smoke amidst a whole stack of paper, it’s likely a fire is about to break out and that certainly happened this past week as the paper futures market led a drubbing in prices for the silver contracts that, even by silver’s standards, was pretty spectacular. But as the fall in the COMEX contract price captivated the world and headlines in print media, on TV and across the blogosphere seemed to delight in the pummeling being dished out to the former favourite, a curious thing was happening in the physical market.

Sadly for anyone trying to drive the price of silver lower through the futures market, the temperature at which silver melts down is 961.93oC - and THAT is the kind of heat you aren’t going to get by setting fire to a bunch of paper.

As you can see from the picture (above) the price of physical silver simply traded on huge premiums to the spot price throughout the collapse on the COMEX (this snapshot was taken on Friday AFTER silver’s bounce, but, as you can see from the column marked ‘Yesterday’s Price’, prices at the nadir were still in the mid- to high-$40s).

This dichotomy in silver must come to a head at some point soon. Stocks of physical silver are declining rapidly, bids for physical silver are through the roof and yet the paper price of a futures contract can fall 30% in a matter of days. A look at the backwardation in silver futures only makes the smoke start to billow harder as Atlantic Capital point out in this article:

In January and February 2011, leasing rates jumped as the SIFO curve fell all the way into the negative. These moves were in anticipation of a difficult delivery month of March, where approximately 1,800 contracts actually stood for physical delivery. Although it only represented about 9 million ounces, on an exchange that advertised over 100 million ounces in its vaults and 50 million ready for actual delivery, it took the entire month to service all the contracts. It even went all the way down to the last weekend before all the contracts settled. we approached the first notice date for the May delivery month...[t]he open interest “problem” reappeared with an increased vigor above even March. The COMEX data shows almost 2,200 contracts standing for delivery, about 20% more than March.

Hmmm..... I smell smoke.

Full letter

Hmmm May 08 2011