Two months ago, after a confederation of followers of the Reddit and other websites succeeded in forcing a market squeeze in the shares of GameStop and other companies that had a high percentage of their stock sold short, some began to suggest that this practice could be repeated in the coming expiration of the COMEX March 2021 silver futures contracts.
That attempt to push up silver’s price didn’t work out well. Those who thought they could cause a short squeeze didn’t do their homework to discover two major obstacles to a successful campaign. First, they didn’t realize that the bulk of silver trading activity is handled by paper contracts, with very little physical (as a percentage of trading volume) changing hands. A high percentage of the effort to force a silver supply squeeze was conducted through purchasing paper contracts, which simply led to more short-selling of paper silver.
Second, holding down the price of silver is one tactic used by the U.S. government to help suppress the price of gold. Remember, the prices of gold and silver are effectively report cards on the strength and stability of the U.S. government, the U.S. economy, and the U.S. dollar. Both metals move up or down in tandem most of the time. Therefore, one way to restrain the price of gold is to make sure that silver’s price is in check.
The U.S. government is explicitly authorized to manipulate the price of gold since 1934 through use of the Exchange Stabilization Fund. In addition, the federal government can call upon the primary trading partners of the Federal Reserve Bank of New York, the Bank for International Settlements, and allied central banks to cooperate in efforts to hold down gold and silver prices. It also is supported by actions of the COMEX.
Declassified government documents confirm that gold prices have been manipulated almost continuously since 1934 up to the time of the most recently released documents – somewhere around 10 or so years ago. Is there any reason to think that the government would have discontinued such activities in more recent times?
When gold futures contracts started to be traded on the COMEX in the mid-1970s, that was established as one more way to control the price of that metal.
The COMEX gold and silver futures markets are essentially a fractional-reserve system. Only a small fraction of contracts is covered by physical inventories in the COMEX bonded warehouses. The reason why that can work, in normal markets, is that the overwhelming number of investors in COMEX futures contracts are investing in the price, with no intention to take delivery of the physical metal at contract maturity. To avoid having to take or arrange for delivery of a mature contract, the long and short sellers typically buy an offsetting contract before maturity to close out their position, often to re-establish their position in a new contract with a maturity further into the future.
To give you a current example, the COMEX April 28, 2021, silver inventories in its bonded warehouses were reported to be a total of 117,932,837.29 ounces of registered and 242,687,267.093 ounces of eligible silver. Registered inventories are committed to be available to deliver against a maturing contract called for delivery. Eligible inventories are simply being stored in the COMEX warehouses, but are not committed to satisfy delivery on a maturing contract unless, and until, the owner elects to reclassify the silver to the registered category.
As of the final April 27, 2021, report, the COMEX had open interest of 172,470 silver contracts, each representing 5,000 ounces of silver. That means a potential liability to deliver 862,350,000 ounces of silver if every holder of a long position asked for delivery. In effect, the COMEX registered silver inventories cover less than 14 percent of outstanding contracts. Even including 100 percent of the eligible inventories, that covers less than 42 percent of open positions. These coverage percentages are about typical for the COMEX.
While some silver futures contracts on the COMEX do not mature until as far out as July 2024, a total of 150,313 contracts (751,565,000 ounces) mature no later than July this year.
It is this huge disparity between the COMEX inventories and the open positions that theoretically presents the opportunity to try to squeeze the silver market.
This time around, the Reddit crowd and its allies are trying to cause a silver supply squeeze by avoiding the purchase of paper silver and instead purchasing physical metal demanded for delivery. One tactic calls for their followers to purchase a 100-ounce silver bar on May 1. If 100,000 people would do so on the same day, that would create an instant demand for 10 million ounces of physical silver that are just not available in the over-the-counter market right now. It could force some COMEX contract holders to call their maturing contracts for delivery of physical metal.
Theoretically, this could result in a silver supply squeeze that results in a noticeable increase in the price of silver.
Practically, this will not happen to a significant degree. Here’s why.
A sizeable percentage of COMEX silver investors on the long side of the contracts use leverage. Most of their investment is made with borrowed funds. The COMEX periodically changes the margin requirements on leveraged investments. In the event of a developing supply squeeze threatening to push up the price, the COMEX could impose a major increase in the margin requirements that would force many long parties to sell off some or all of their positions to short sellers.
If that were not enough to break the attempt at a supply squeeze, the COMEX could almost certainly avoid many deliveries of physical silver by the other options for fulfilling a contract called for delivery – a cash settlement, delivery of shares in a silver exchange traded fund, or delivery of some cash plus a contract in the London silver market for the same number of ounces.
No, I don’t think a sudden demand for 10 million ounces of physical silver, if it were to develop, would be enough to cause the price of silver to soar soon. So, the question then becomes how much silver demand would it take to achieve such a result?
A good example happened in 1997-1998 when Warren Buffett’s Berkshire Hathaway purchased around 130 million ounces of silver in paper contracts, then unexpectedly demanded physical delivery instead of rolling over the contracts at maturity. This move resulted in the price of silver rising more than 15 percent as short sellers scrambled to find physical silver. The price could have gone higher except that Buffett accepted cash payments reputed to be about 7 percent of the value of the silver to accept a six-month delay in delivery of the silver.
Since then, the establishment of silver exchange traded funds puts a further obstacle in the way of trying to force a silver market supply squeeze. Still, I expect the existing tightness of physical silver supplies will continue to exert pressure for noticeably higher silver prices before the end of this year.
Patrick A. Heller was honored as a 2019 FUN Numismatic Ambassador. He is also the recipient of the American Numismatic Association 2018 Glenn Smedley Memorial Service Award, 2017 Exemplary Service Award, 2012 Harry Forman National Dealer of the Year Award and 2008 Presidential Award. Over the years, he has also been honored by the Numismatic Literary Guild (including twice in 2020), Professional Numismatists Guild, Industry Council for Tangible Assets and the Michigan State Numismatic Society. He is the communications officer of Liberty Coin Service in Lansing, Mich., and writes Liberty’s Outlook, a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at www.libertycoinservice.com. Some of his radio commentaries titled “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 a.m. Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio archives posted at www.1320wils.com).