Trouble afoot in financial markets, Part III

Commentary

— The following is the last of three edited parts of a speech presented at the recent Silver Summit in Coeur d’Alene, Idaho.

Evidence pointing to surreptitious market intervention by governments is not confined to the gold market. In the course of conducting research for the second Sprott report, this one on stock market manipulation, my associate Andrew Hepburn uncovered a highly revealing statement by former Clinton advisor George Stephanopoulos on ABC’s Good Morning America. Speaking as a correspondent in the aftermath of September 11, Stephanopoulos described the government’s efforts to prevent a free-fall when trading resumed. After listing a few conventional means of preventing a panic, he stated: “And perhaps most important, there’s been — the Fed in 1989 created what is called a plunge protection team, which is the Federal Reserve, big major banks, representatives of the New York Stock Exchange and the other exchanges . . . and they have kind of an informal agreement among major banks to come in and start to buy stock if there appears to be a problem.”

They have, in the past, acted more formally. In 1998, there was a crisis called the long-term capital crisis. It was a major currency trader, and there was a global currency crisis. And at the guidance of the Fed, all of the banks got together when that started to collapse and propped up the currency markets. And they have plans in place to consider that if the stock markets start to fall.

Stephanopoulos is not the only well-connected individual to have revealed this essentially unspoken interventionism. In the lead-up to the Iraq War, the Japanese secretary of the cabinet told a news conference that, “There was an agreement between Japan and the U.S. to take action co-operatively in foreign exchange, stocks and other markets if the markets face a crisis.”

I trust I have established that despite free market rhetoric, today’s major markets are susceptible to government intrusion. With this in mind, the recent price action in precious metals has been particularly suspicious. On the day after Labour Day, gold surged US$14.00 per oz., silver rose sharply then mysteriously slumped, and the unhedged gold index (the HUI) staged a powerful breakout. I closely watch the positioning on the Japanese futures market, the Tocom, which is considerably more transparent than its American counterpart, the Comex. Despite this robust unfolding strength in precious metals, there had been an ongoing aggressive buildup of short positions in gold by the usual suspects on Tocom, the large Japanese banks and one large American investment bank. At the same time, Comex floor sources reported that on the day gold rose US$14.00, a large seller blocked the advance of the gold price at US$648 on the December futures contract by selling indiscriminately until the buying was finally exhausted. The next day, gold was driven down, forcing the speculative buyers to unload their positions.

For five consecutive days, gold was pounded. The thinner silver market was correspondingly annihilated on the Comex, falling over US$2 per oz. in a 3-day period and continuing to fall in the aftermath, with the percentage loss reaching nearly 20%.

This decline, in a very short period of time, in a market with a physical shortage, is bizarre. But it is not without precedent. Often when the Comex opens, both gold and silver are smashed in unison, with the downdrafts looking identical.

In addition, the two metals are routinely crushed in quiet periods on the Access Market. The violent attempts to sell gold and silver through key support levels is not indicative of profit-maximizing longs unloading positions, but instead demonstrates orchestrated movements.

Why this is disturbing to me, other than the fact that it does not appear to be legitimate price action, is the fact that three or four traders hold over 80% of the Comex silver short position. Ted Butler, a gentleman who knows as much or more about the silver market than anyone that I have ever encountered, believes this represents manipulation and I agree with him. The size of the paper short position in silver in relation to the size of the physical market, whether relative to available inventories or annual production, is outrageous, particularly when this short position is concentrated in so few hands. If the longs called for delivery, where is the silver going to come from? If the short positions were smaller, wouldn’t it be axiomatic that the silver price would be much higher?

It is tempting to believe that the manipulation of precious metals markets is aimed at garnering illicit profits for certain traders. But I think this misses the larger point. Gold is widely seen as a barometer of economic health, and silver is tightly connected to its more expensive cousin. Thus, as gold analyst Reg Howe has observed, “Any efforts to affect interest rates through the manipulation of gold prices cannot safely ignore silver.” In this regard, my sense is that the recent clobbering of silver is a case of the metal being an innocent bystander in a greater conflict. To the extent that the silver price runs free, it may also free the gold price from the shackles of government influence. Think of silver as the well-meaning witness whose observations must be silenced.

But despite the repeated mugging of silver, those responsible for ensuring its safety have abrogated their duty to protect the metal. The Commodities Futures Trading Commission (CFTC) continues to allow manipulation to occur, despite the howls of ordinary investors. Yet the CFTC is not the only possible defender of a free silver market. In particular, the captains of the silver industry, those mining companies engaged in its production, refuse to publicly confront these lingering allegations of market manipulation. This is not acceptable. As someone who oversees a large precious metals fund, I cannot tell you how frustrating it is to witness this obvious manipulation. I feel like the newscaster played by Peter Finch, in that classic movie from years ago, Network, who would rant on air: “I’m mad as hell and I’m not going to take it anymore.”

It is further distressing to watch the mining companies suffer in silence, adamantly refusing to call the emperor on his lack of clothes — or his large short position — and demand appropriate remedies. If you take but one message from my talk, let it be this: It is time that the era of silent collaboration in the precious metals markets ends. If you are not vocally and publicly against the silver manipulation, your reticence is facilitating its continuation.

There is a tendency in financial markets to ignore questions of right and wrong. Many companies and investors seem to believe that so long as they are positioned correctly, what happens behind the scenes is but an irrelevance. If we see the economy as a mere vacuum, this view might hold currency. But markets are about more than trading paper. They involve outcomes that affect the daily lives of ordinary citizens. In silver, I am talking about the best interests of shareholders, of miners, and of the communities engaged in the metal’s production. All these stakeholders have needlessly suffered due to the manipulation of the silver price. And all stand to benefit should investors and the industry muster the determination to end the meddling. Today I ask you to do just that.

— The author is the chief investment strategist with Toronto-based Sprott Asset Management. For a copy of Mr. Embry’s speech, visit www.sprott.com/pdf/silver.pdf