Market Curiosity: Exploring Markets And Systems

February 15, 2011

Ed Steer and Ted Butler support the idea that it was bullion banks covering shorts not miners hedging

Filed under: Just Watching — Tags: , , , , , — Jeff Fitzmyers @ 10:28 am

As a followup to Main stream media is having a more challenging time painting silver negatively, Ed Steer with Ted Butler posted,

Alasdair Macleod at “The FT story [about 100 moz silver forward sales] implies the transactions were initiated by the mining companies. I think this is unlikely, there being a greater likelihood that it was initiated by one of the big commercials, such as JPMorgan. Bearing in mind these are forward transactions, they do not appear in the public domain, and can be completed at any price, giving the bullion bank the opportunity to do a very special deal with a nice fat premium for a possibly reluctant miner. And what better time to do this, when the price has fallen and there is uncertainty in the market… So my guess is that it one of the Big Four [JPM?] covering its shorts, because there is no other way of doing so and the timing is opportune.”

The FT story is misleading in some respects, because it insinuates that all of these forward sales had just occurred during the first six weeks of 2011, when silver prices were at their peak…then heading lower. That was not the case at all, as most of these hedges were placed many months prior to the end of 2010… Of that 100 million ounces, the standout was the 70 million ounces sold forward by Mexican silver company Minera Frisco…in which Mexican billionaire Carlos Slim has a huge position. These hedges were placed at $18.82 the ounce…and the last time we were that low in price, was back in the third week of August 2010…so that’s probably when it happened…

This is what Ted [Butler] had to say about it in a note [headlined “Hedging Insanity”] to his subscribers yesterday…”I don’t think I have ever seen such a dangerous hedge book [and I’ve seen plenty]. By my calculations, the company is already in the hole for upwards of $600 million on all its metal hedges…with silver accounting for $300 million of that total. Its additional exposure will be many times that amount if prices move higher, as they are expected to do.”

This sound exactly like what happened to Apex Silver many years back…and they ended up filing for bankruptcy. It’s also similar to what happened to Ashanti Gold…and AngloGold had to come along and take it over because their hedge book had become toxic. And let’s not forget a Canadian gold company called Cambior. As Ted went on to say…”The hedging experience [also] cost Barrick Gold $10 billion in total.”

Based on what happened to all four of these companies, I doubt that Minera Frisco will survive long enough to pay out its hedge book…and I also doubt that the owner [billionaire or not] will have deep enough pockets to cover his company’s ever-increasing losses.

Well, dear reader, I wonder what bullion banks were the ones that did the deals on all these forward sales? Without doubt, virtually every ounce was hedged in the OTC market…so all this happened without causing a ripple in the silver price… As Ted Butler pointed out, the Minera Frisco deal alone is equivalent to 14,000 Comex contracts that JPMorgan might possibly have been able to cover in the OTC market.

Feb 16: James Turk explained the possible hedging very well:

In a typical hedge, a bullion bank borrows physical metal, which it sells into the spot market in exchange for dollars. The bank then lends these dollars to the hedger. So hedging depresses the spot price. That’s why gold had so much selling pressure placed on it in the late 1990s and early 2000s when hedging by many gold mining companies was the rage. But look at what is happening to the spot silver market now.

There is no pressure on the spot price, as evidenced by the fact that spot silver has jumped more than $4 higher over just twelve days while these hedges were supposedly taking place – and of course silver is still in the extreme backwardation that I mentioned when it first happened last week…Click Here

In fact, the backwardation is steepening almost every day. The 13-cent backwardation to Dec 2015 I mentioned previously has now widened to 32-cents, meaning physical silver is becoming even more scarce – and the shorts are in an even more difficult position.

So even if a bullion bank is borrowing silver to sell spot to complete a hedge for a mining company, the important point is that the spot market is absorbing everything the bullion banks can throw at it, and even more importantly, silver remains in extreme backwardation which itself is growing. All of this is very bullish, but here’s another even more bullish interpretation of this hedging.

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