A Twist on the Silver Market : Are Banks Significantly Short?

Posted November 11th, 2010

Posted November 11, 2010

The silver market is extremely hyped right now.  Looking at the 10 year chart below confirms that this year’s moves in silver are anything but ordinary.

10 year silver price - short squeeze?

Silver has advanced approximately 56% this year.  We covered the fundamental reasons for this advance in a post 2 days ago (http://lakshmi-capital.com/2010/11/chart-of-the-day-silver-breaking-out/).  However, there may be other, less public reasons behind silver’s advance.

For months and in some cases years, conspiracy theorists and market pundits have been speculating about the manipulation of the silver market by large banks, including JP Morgan and HSBC.  Recently, these theories have been given significant weight as CFTC Commissioner Bart Chilton stated his belief that the silver market was being manipulated (http://online.wsj.com/article/SB10001424052702303341904575576203310056046.html).  Within the last 2 weeks, the CFTC has begun investigating JP Morgan and HSBC (http://www.reuters.com/article/idUSTRE69Q0SE20101027).

In reviewing the most recent CFTC Commitment of Traders Reports, we can see that there are currently 56,048 short contracts (or 280.2 million ounces) held by commercial traders (banks).  Usually banks take positions like these on behalf of producers who are trying to hedge their silver production.  However, a quick analysis of the global silver market indicates that these bets are more likely proprietary wagers by the banks rather than hedging activity.

At first glance, we can see that 2009 demand outstripped supply.  In 2009, the world mined 709 million ounces of silver.  On the demand side, 352.2 million ounces were used in industrial applications, 156.6 million ounces used for jewelry, 59.5 million ounces used in silverware, and 136.9 million ounces for investment.  An additional 24.6 million ounces were used in photography and coins.

Extrapolating that data to 2010 yields a compelling reason to buy silver.  Subtracting 2009 world silver production from all non-investment uses indicates that there were only 116.1 million ounces of silver production available to satisfy investment demand.  Projecting the 2010 data as the same as the 2009 data, if there are only 116.1 million ounces of new silver being mined available to satisfy investment demand, where will the remaining 164.1 million ounces come from?  (280.2mm short ounces outstanding from commercial traders minus 116.1mm new ounces being mined = 164.1mm ounce shortfall).

This huge shortfall indicates that the outstanding short position cannot be solely on behalf of producers, because there is a far larger outstanding position than could possibly be hoped to be mined this year.  Digging further into the Commitment of Traders report shows that 44.1% of the gross short position in silver is being held by the 4 largest traders.  Since JP Morgan and HSBC are rumored to be the 2 largest traders of silver, both banks probably have very significant short positions in silver.

The rumor on the street is that both banks will be forced to cover their shorts, and in doing so drive up the price of silver astonishingly.  Some traders I have spoken with are targeting the 40-50 level within 4 months.  Adding much intrigue to this rumor is the fact that silver began its most recent breakout the exact same day as JP Morgan announced they would be shutting down their proprietary commodity trading business.

Silver Short Squeeze JP Morgan HSBC

Rumor has it that JP Morgan is just looking to cut their losses in silver and cover their shorts.  This could be a possible reason why silver has skyrocketed in the last 2 months. website loading speed test .  Of course, JP Morgan’s involvement in the silver surge is little more than unsubstantiated rumor, but the basic premise still holds true.

Regardless of who actually holds these silver short positions, they will be forced to cover at some point, and this could cause an even larger short squeeze than the one we are currently witnessing, driving silver even higher.  Given the recent extreme volume we have witnessed in the silver market, it will be very interesting to see the change in short positions in the next Commitment of Traders report.  We continue to be long silver futures and call options for clients, and will add on all pullbacks.


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