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business newsWhat's the Real Price of Silver?
There is no debate now regarding any physical shortage of silver. It is real, and it is undeniable.
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Going back to May 2011, 2,166 contracts stood for delivery in the silver futures market. By the end of the first full week, two-thirds had accepted cash settlements to forgo claims on physical metal. For July 2011, 2,397 contracts stood for delivery. In the first two days of July, 697 have already given up their claims compared to only 120 contracts filled by supposed physical delivery. The COMEX only has about 29 million ounces available for delivery to serve those 2,397 contracts (representing about 12 million ounces), so there is no doubt that they have every incentive to induce cash settlement.
At least the contract holders in May had the massacre to excuse their cash switch. Because the price had fallen so sharply during that first week (from near $50 per ounce to around $34) there were probably more than a few who had contract strikes in the $40s. Financially, the huge mismatch between the strike and the spot was unappealing enough for May contract holders (speculators) to accept a cash payoff. That payoff was likely far above the spot price, meaning that they were able to pare some of the losses incurred during the silver crash, though I believe more than a few actually made money.
The price of silver going into July has been pretty steady, though volatile. However, there is no crash-induced incentive to accept cash over physical. The fact that so many are taking the cash route so early in July is highly suggestive of a hefty premium being paid to compensate contract holders to give up delivery rights. Is there any other possible financial reason that contract holders would take the trouble to deposit funds into their COMEX account to fully prepay silver delivery (each contract is for 5,000 ounces), and then just accept a cash settlement?
These speculators, as much as they are dismissed as greedy and evil, are performing a simple task that all markets are supposed to feature: price discovery. If there is a physical shortage, and these cash speculators show that it is very real, it should follow through to the price of the metal. Only price discovery can alleviate the shortage – that is the free market way of allocating scarce resources. Yet, after May’s price action, it has not.
This brings up an important distinction that is not supposed to materialize in a free market exchange. If these speculators are indeed obtaining a cash premium in the futures market, then that premium is the actual price of silver. The published spot rate is nothing more than the show price. The fact that there are multiple hidden prices means that the silver market is not performing its vital function of resource allocation.
Market efficiency depends on correct and timely information. This is not to say that all markets are efficient, indeed no market is efficient and there is always a disparity in knowledge. But the marketplace itself is supposed to weed out these disparities in a concerted effort to level the playing field. The COMEX is doing the opposite.
Whether or not you believe the margin increases in May were intended to force the price lower to coerce contract holders out of delivery intentions, every investor has to at least recognize that this establishing pattern of cash settlements in the futures market is happening in the dark. Transactions are supposed to occur in the light of the marketplace, not as private deals between parties. The silver market is not intended to be an OTC marketplace, but it is behaving like one.
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