The Great Disconnect Between Paper & Physical Silver

This article proves how paper silver (i.e. silver futures market) has been able to cap the silver price despite exceptional strength in the physical silver market. The first quarter of 2013 revealed this great disconnect based on publicly available data. Besides, silver expert Ted Butler calculates an historic concentration of short positions by JP Morgan allowing the bank to control the silver price.
Silver started the first quarter at $30.45 per ounce (Jan 2^nd 2013) and closed more than $2 lower at $28.30 per ounce (March 29^th). During the same time period, investment demand for physical silver was historically strong and all data pointed to accumulation by investors. This evolution asks for an explanation; the answer lies in the paper silver market.

Physical silver (bullish): investors have accumulated at a record pace

In order to get an idea of the physical silver market, we use (1) the physical holdings of all silver ETF’s combined together with (2) US Mint sales of Silver Eagles. Those are leading indicators when it comes to investment demand for physical silver.
(1) The US Mint has sold a record amount of US Eagles when compared to the first quarter of all previous years (also described here in detail).

14.2 mio ounces (equaling 457.2 tonnes) of US Silver Eagles sold

(2) All silver ETF’s  combined increased their physical holdings by some 4.0% (also described here, based on Standard Bank Research)

Physical accumulation of 26 mio ounces (equaling 800 tonnes) in all silver ETF’s

Total silver holdings at the end of the quarter quarter stood at 655.8 mio ounces (equaling 20,400 tonnes)

To put these figures into perspective, one should remember that total mine supply in 2011 was 761.6 mio ounces (equaling 24,485 tonnes).
The key message that the physical silver market is signaling is one of EXCEPTIONAL STRENGTH. One should note that this trend is occurring particularly in silver; gold is not showing the same strength in physical investment demand. Given these facts, how is it possible that the silver price has moved down in the first quarter? The next paragraphs reveal the answer.

Paper silver (bearish): futures positions have held the silver price down

The paper silver market refers primarily to the futures market in which large traders (hedge funds, large commercial banks, bullion banks, etc) hold long or short positions. Silver expert Ted Butler has been analyzing this area for three decades, and reports the weekly evolutions into great detail in his market commentaries. This is an excerpt from his latest analysis:

By far, the standout price feature for the first quarter in silver was the reduction in the total commercial net short position on the COMEX from the high point of Feb 5. From the peak on Feb 5 through last Tuesday, 29,000 net contracts were bought by the commercials. This is the equivalent of 145 million oz of silver and is clearly a towering amount compared to any amount of silver produced or consumed within the quarter. Yes, these are paper transactions, but they are so excessive in size as to overwhelm the free market forces emanating from the real world of supply and demand. Simply put, the commercials on the COMEX colluded and rigged silver prices lower during the quarter to trick the tech funds into selling.

One of those commercials is JP Morgan. Based on his analysis, Ted Butler calculates their short positions.

I would now calculate JPMorgan’s net short position to be 23,000 contracts as of Tuesday March 26th. Simple math shows that JPMorgan held 96% of the total commercial short position of 24,000 contracts in the latest COT report. I doubt such an extreme measure of concentration has ever occurred in any other regulated futures market. On this measure alone, it is safe to conclude that JPMorgan has manipulated the silver price in the last month(s), as there would be virtually no commercial short position in COMEX silver without this bank. That the CFTC and the CME Group can sit by and allow such an unnatural concentration to exist shows how inept and corrupt the regulators have become.

To put things into perspective, the current short position of JP Morgan (one single entity) equals some 12.5% of total yearly silver mining production. This short position is so concentrated that it has the power to control the overall price.
Ted Butler points out that the paper market controlling the price is illegal practice; it is against commodity law.

How to stop this illegal practice?

For how long can the paper market control the silver price is a key question. Ted Butler wrote in his latest commentary in that respect:

The question that really matters is what will JPMorgan do on the next silver rally? This is the question I asked back in December 2011 and during the summer of 2012. Each time, the answer was resounding as JPMorgan sold as many additional shorts as was required to cap the silver price. I would imagine most would expect the same outcome again as who’s to stop these criminals, surely not the sad excuse we have as regulators. I can’t argue that the regulating agencies (CFTC or CME) will ever do the right thing in silver, but there is one thing that could persuade JPMorgan to stop manipulating the price of silver. That something is too strong of a demand for physical silver, the signs of which appear to emerge daily.
In retrospect, it was growing physical silver demand in late 2010 that prompted JPMorgan to refrain from selling short silver and which allowed the price to climb to near $50 in a matter of six months or so. The crooks at JPMorgan will see that physical silver imbalance coming before just about anyone and that will be what causes them to cease adding new silver shorts.

The market situation in silver is not sustainable long term. It can for sure go on for a while, but not ad infinitum. From a longer term risk/reward perspective, which is the fundamental rationale for physical silver investors, silver is an excellent asset to own.

I am still of the mind that we are close to a silver price bottom of some great significance and that the investment risk/reward ratio in silver has rarely been more attractive than it is currently. Whatever new price lows the commercials (read: JP Morgan) may rig in silver, it is important to recognize any imaginable price lower is vastly exceeded by the potential amount silver will move higher in price eventually. The essence of successful investment is to place funds into the thing least likely to lose money and most likely to show great gains. In this instance, silver is it.

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