We at the U.S. Commodity Futures Trading Commission (CFTC) normally reply to private correspondence with a private response. We are, therefore, attempting to respond directly to about 500 of you who have written to us expressing concern that the price of silver has been artificially depressed, allegedly as a result of manipulative activity in the futures market.
What are the major points of the allegation of manipulation?
With silver consumption exceeding new production for many years, it is generally acknowledged that the production deficit has been primarily filled by a drawdown of stocks. Some argue that this decline in silver stocks cannot persist and, since stocks have fallen to low levels, silver prices should have been rising sharply. There is further conjecture that, over the past 20 years, a group of commercial traders have held short futures positions that are large enough that they cannot serve legitimate hedging purposes because they cannot be backed by real silver. These traders have allegedly used these “naked” short positions to manipulate the price of silver downward.
What is the Commodity Futures Trading Commission’s response to these allegations?
While there has been a production deficit, there has been no supply deficit. Large silver stocks have existed throughout this period and been made available as a source of supply at prevailing prices, presumably by many different and independent holders from around the world. This has had a dampening effect on price. There is no evidence, however, that silver futures prices have been distorted relative to cash silver bullion prices.
Moreover, while commercial traders are free to speculate in the futures market, our review indicates that the so-called “naked” shorts are not naked at all but are, for the most part, hedging.
The allegations imply that these commercial traders cannot be hedging because their positions exceed immediately deliverable silver stocks. In any futures market, however, the supply of the commodity that is deliverable (for example, silver stocks in NYMEX warehouses) is generally only a small portion of the total stocks or supply of that commodity that can be hedged. Anyone holding the commodity faces price risk and can hedge that price risk without ever intending to make or take delivery on the futures contract.
Is the CFTC concerned about the level of prices in the silver market?
The CFTC has absolutely no bias with respect to the level of prices in the silver market or any other market we oversee.
Does the CFTC care about manipulation?
Absolutely. Protecting our markets from manipulation is one of the most important things we do. Any trader who engages in manipulation is violating the Commodity Exchange Act and is subject to punishment by both the Exchange and the CFTC.
Has this production deficit caused a decline in silver stocks?
Yes, it has. Any level of consumption in excess of current production must be met by a drawdown of stocks. As a result of the production deficit, both privately held and government-owned silver stocks have declined during many recent years. In its most recent annual report, Gold Fields Mineral Services estimated that the implied net reduction of privately held silver stocks during the 10 years, from 1994 to 2003, was 687 million oz. — about 69 million oz. per year, on average. The survey is underwritten by several of the world’s largest mining companies, who would gain no apparent benefit from undervaluing silver.
Most of that reduction took place during the earlier years of the period. Since 2001, there has been a slight build-up of about 6 million oz. in privately held stocks.
Why hasn’t this production deficit caused silver prices to rise?
Because, in spite of the production deficit, there has not been a supply deficit. Prices have not risen higher, because there has been no shortage of silver to meet consumption demand at prevailing prices. The drawdown of existing silver stocks has, for many years, bridged the gap between production and consumption. Holders of stocks have made silver available for consumption at prevailing prices, without any evidence of coercion or manipulation.
Is a long-term manipulation of the type alleged possible? What mechanism could cause it? What would be the motive?
Even if the commercial short positions were not hedge positions, and even if their selling did cause the silver price to decline, artificially low prices could not persist. Because there is unrestricted access to the market, many knowledgeable and well-capitalized traders would readily buy any silver offered at artificially low prices.
The buying by these traders — buying that the alleged manipulators would have no way of preventing — would quickly cause the price to rise to its appropriate level.
The allegation of a long-standing manipulation also fails to offer a plausible motive. The purpose of any manipulation is to make a profit. The allegation is that, over a long period, the commercial shorts have continued to sell at what they know to be artificially low prices. This defies rational explanation.
Would it be a violation of CFTC rules for commercial firms to hold positions that are not for hedging purposes?
No. Commercial firms may legally hold futures positions for hedging or speculative purposes. The mere holding of speculative positions by either commercials or non-commercials is neither a violation of CFTC and NYMEX rules nor evidence of manipulation.
Is there any evidence of collusion among the large short traders in the market?
No. We have, from time to time, looked for relationships among the largest traders and have found no evidence that short traders are colluding to manipulate the price of silver downward; nor has any such evidence been provided to us by those making these allegations.
What has been the relationship between commercial selling of silver futures and silver prices over time?
Since at least 1990, the largest commercial short positions have been held during periods when the price of silver has been relatively strong, and the smallest commercial short positions have been held when silver prices have been low. This is the complete opposite of the situation assumed in the allegations at issue.
Since 1990, the average price for silver has been about US$4.83 per oz. During periods when the price has been above that average, reportable commercials (a reportable position in silver is currently 150 contracts) have held significantly larger short positions than during periods when the price has been below that average. One example of this recurring pattern is the fact that the smallest commercial short positions (equivalent to around 110 million oz.) were held during the second and third quarters of 2001, when silver prices were in the low US$4 range. Also, in March 2004, when silver prices were well above US$7.50 per oz., commercial short positions were close to the highest level since 1990.
Does the CFTC have information that shows that the largest commercial short positions are not “naked” short positions?
Yes. The CFTC has substantially more information than it is permitted under the Commodity Exchange Act to make public.
We have used this information to evaluate the overall exposure, market power, and trading incentives that a trader’s complete “book” of positions would present. Based on the information we have, we are satisfied that what may appear to be large net short futures exposures are often offset by other market positions, including physical silver inventories, forward positions, positions in other derivative products, and positions in non-U.S. markets. We believe that the characterization of the largest commercial short positions as “naked” short positions is simply not correct.
What are the implications of this, with regard to the allegation of manipulation?
The allegation that naked short positions are the means through which silver prices have been kept artificially low is the linchpin in the allegation of manipulation. As we have said above, we do not think it would necessarily be evidence of manipulation even if these positions were held for speculative purposes. However, it is clear that if this characterization is not correct (if, as we believe, these commercial short positions in silver futures are not “naked” shorts), then the allegation of manipulation has no merit.
Traders with offsetting long and short exposures have neither the market power nor the incentive to manipulate the price of silver, either up or down.
— The preceding is an edited version of a letter written to silver investors by the director of the U.S. Commodity Futures Trading Commission in Washington, D.C. The full version is available by visiting www.cftc.gov
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