Money: The Silver Trading Caper

Washington. Although silver trading has been resumed in New York, questions about what motivated its suspension in late January continue. How those questions are answered could have long-term repercussions for all US markets and for the American dollar.

The questions that are being asked in Washington, in New York, and, with fervid interest, in such competitive financial centers as London are: Did the silver-buying activities of big-time speculators like Nelson Bunker Hunt and family force the New York Commodity Exchange (Comex) to issue a "trading-for-liquidation-only" rule on January 21 in order to prevent "manipulation" of the market? Or, did other influential traders and companies with an interest in cheaper silver engage in manipulation of their own to drive the price of the white metal down?

The official justification for the suspension of all new position taking in silver futures contracts was that certain large silver speculators were threatening to create a "squeeze" on the supply of silver available for delivery. Many insiders, however, including sources at the Commodity Futures Trading Commission (CFTC) and Comex, believe the exchange's board of governors may have been motivated more by a financial squeeze on prominent members who had bet against rising silver prices by "shorting" the market—that is, selling silver for future delivery.

The Comex action had the effect of braking silver's rise and in fact causing it to fall from $49.00 to $33.50 an ounce within a few days. This allowed "shorts" to extricate themselves from their sell positions at lower prices, as it also accomplished the stated purpose of relieving the apparent shortage of deliverable silver. Further, it eased financial pressures on metals dealers, who had been getting huge margin calls on short hedge positions, which their banks became increasingly unwilling to finance. Gold traders with similar exposures may have benefited from a spillover effect.

A group of unidentified "longs" (those who had bought futures in anticipation of higher prices) are still considering a suit against the Comex for possible "conflict of interest," according to their counsel, Phillip Bloom. "A large number of people on that Board are known to have been short hedgers or sell hedgers," Bloom commented. "Many of them are such that they had inventories of metals that were not deliverable or in a deliverable state, who had been hedging them in the futures market and financing the cost of that inventory at major banks. And as the price of the metal continued to rise, the banks did not allow them to continue to borrow money for the purpose of paying variation margins [additional earnest money required to maintain a futures position].…So that may have precipitated the 'emergency'—not a squeeze."

Bloom has demanded all communications between the CFTC and Comex, as well as the proceedings of Comex meetings, the names of participants, and their positions in the market. The Chicago attorney, who says the Hunts are not among his clients, has not received a response to his Freedom of Information Request with the CFTC, and Comex has refused to release any information. Bloom vows that if Comex does not cooperate with his investigation he may "institute litigation and seek discovery." If he then determines there was "impropriety," his clients may sue for damages.

While this issue is being resolved, doubts about the integrity of American markets are rife. As a result, according to a number of traders and market analysts, US exchanges are losing business to foreign markets, and not only in silver. By reducing the liquidity of the futures markets, this drain of trading interest into foreign markets makes it more difficult for American producers and users of commodities to hedge their price risks via futures contracts.

Further, as prominent New York trader James Sinclair has noted, "if the interests who held those long positions in silver were bona fide international interests, specifically representing friendly OPEC nations, and we…reneged on their ability to take delivery, then we may have inadvertently seized their assets." That, he added, not only "takes interest away from our exchanges" but is "terribly negative for the dollar."

Sinclair says the "delivery squeeze," to the extent there was one, could have been handled through "negotiation" rather than through the drastic steps that were taken. "Longs" would have "acquiesced to taking reduced deliveries over deferred months." Bloom concurs, asserting, "My clients were willing to roll forward [their long positions].…Nobody asked them."

One Comex member, who did not wish to be named, has suggested that firms and traders with exposed "spread" positions had their "problems solved by the breakup of the silver market." (A spread, also called arbitrage, involves the simultaneous buying and selling of commodities in different months.) "You're either borrowing money on the physical and shorting the forward, or you're short the near [month contract] and long the far," he explained. Either way, the short side of the spread was creating painful financial pressures not offset by the long positions.

He said his firm had gotten a $90 million margin call on the short side of one of its spreads. "We're a moderate size arbitrageur," he noted. "If we're getting $90 million margin calls, my colleagues are getting $200 million, $400 million, and $800 million margin calls." Sooner or later, the banks "are going to shut you off," he declared. "And unless something comes along to turn around these markets, unless you work out of your spread positions, you could be in awful trouble."

Chris Feierabend, a New York commodity consultant, said he is "sure" the financial squeeze "had something to do with" the Comex action. He said those with "bull spreads" (long actuals or near months and short far months) were particularly strained by their banks. Asked if traders with such exposure may have used their influence to get silver trading shut down, one leading Manhattan bank officer with the knowledge of bank financing of arbitrage simply stated, "I assume that that's what happened."

What was the role of the CFTC? One silver trader asserted that the commission came under great pressure from big silver users and shorts, who succeeded in persuading the commodities watchdog that their interests coincided with the "public interest." As a result, he concluded, "the CFTC probably advised them to liquidate only, and by that time the Comex had so many wounded members that it was only too happy to oblige the CFTC."

One well-placed CFTC source confided that the commission discussed in advance the use of trading for liquidation only at a closed meeting in early January with representatives of Comex, as well as the Chicago Board of Trade and Mid-America Exchange. (Hunt came to the meeting uninvited and was refused entrance, the source said.) Asked if such a discussion had taken place, Commissioner Robert L. Martin replied, "I don't know if it was discussed. It was not raised by the commission, because I suppose that it is always a consideration.…We didn't pound on the table and tell them you've got to do this or you've got to do that." But Martin went on to say that the CFTC's main "concern was with the shorts in the market who were not going to be able to perform." Martin said he was prepared to grant an extension of the rule if the Comex requested it.

CFTC officials say the commission received considerable input from companies with an interest in lower silver prices. One recalled "three or four meetings" with the Silver Users Association. Another stated he had talked to "several" representatives of companies with an interest in lowering silver prices. In particular, he said a representative of GAF Corp. "was all upset that, through speculation only, the price was going up."

He added that Dr. Henry Jarecki, president of Mocotta Metals Corp., was "very vocal to the commission." He noted that this leading precious metals dealer "just had everything on the line with their banks.…I suspect they had something to say about it." Dr. Jarecki, a Comex board member, failed to return a reporter's calls, as did Comex president Lee Berendt. Silver Users vice-president Walter Frankland said that his input with the CFTC was "not anything more than we have always called for." He did say, however, that he had advocated "forced liquidation until speculators come under (contract) limits." Frankland added that Comex experienced only an "apparent shortage" based on the "formality of its delivery requirement."

The latter CFTC source felt the closing of the silver market (until February 13) was "basically done by Comex members who had large short accounts and not by public customers." He did not know to what extent the commission influenced the decision, or was influenced to approve the decision by short interests. But, recalling the earlier suspension of grain trading, he noted, "the major grain people flooded Washington," and it "became quite apparent that it was all because of their actions that the commission closed down wheat trading for two days. The CFTC came out and said, This is in the public interest. We have to let everybody digest the news, when in point of fact it was the grain companies that had this tremendous clout."

Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.