Sunday, January 25, 2009

Silver investigation: Stakes are enormous

By Rob Mackinlay 

If the US regulator’s current investigation into the silver futures market is looking at allegations of ongoing price manipulation it is the first of its kind – according to a former CFTC director of enforcement. 

Previous Commodity Futures Trading Commission (CFTC) investigations have been into market manipulations that have already taken place. The potential for the current silver investigation to halt an ongoing manipulation could have significant implications for the price of silver. 

Geoffrey Aronow, a partner at law firm Bingham McCutchen and Gregory Mocek a partner at McDermott Will & Emery, both former directors of the Division of Enforcement at the CFTC, said that the division would not be carrying out the investigation if there were not legitimate grounds for concern. 

Aronow, who oversaw an investigation into manipulation of the global copper marketin the late 1990s, said: "I don’t know if this is allegedly ongoing conduct that an investigation will stop. Usually, an investigation occurs after the behaviour stops and the price moves back to where it’s supposed to be in an 'unmanipulated' market." 

"Usually what’s happened is that the conduct has stopped. The evidence that there was price movement back to a new equilibrium is in fact part of the indication that there may have been a manipulation. Usually the return to a 'normal' equilibrium is pointed to as further evidence that there was manipulation. Now I don’t know if that’s the argument here." 

However the existence of  long-term manipulation is an issue of contention in itself. Aronow said: "One of the things I will observe is that anyone who has looked at manipulation would say they [manipulations] can only be maintained over the short-term. So most of the time what you have are short-term manipulations. Prices spike and that becomes part of the investigation." 

Are UK investors ignoring silver?

Financial Express data show that only one fund in a database of 56,000 has a silver ETF in its top ten holdings. 

Silver ignored by UK investors: will it all be gone by 2034? 
Analysts say silver fundamentals are strong with or without manipulation.

Leon Diamond, portfolio manager for New York-based Castlestone Management including Castlestone Aliquot Precious Metalwhich holds equal measures of physical gold, silver and platinum, notes that the correlation between gold and silver is key to understanding the latter's importance as an asset that can withstand economic downturn. 

At current consumption rates it is likely that by 2034 there will no longer be silver left that can be economically mined, Diamond says, against estimates that gold production can be sustained until 2060. 

"Roughly speaking, silver is twice as rare as gold in the long term since it is not recycled like gold. It is recycled only about 40% of the time, compared with 99% for gold. This means that silver is literally disappearing, never to be recoverable." 

"Currently the gold to silver ratio is around 75:1 measured by troy ounces. The long-term mean for the last 350 years has been 30:1. Gold and silver tend to move in similar direction, therefore if the reversion to mean theory stands, silver must move nearly twice as fast as gold on the upside and twice as slow on the downside."

"If they’re looking over the long term, to maintain a manipulated price, that’s a very different notion. To sustain that for an extended period of time, that would be an extraordinary situation. The amount of resources required to maintain an uneconomic price against the market would be huge and the question would be: what is the economic benefit that is gained from that?" 

He said: "For the CFTC, in recent years, virtually every investigation has been based on the notion that the uneconomic behaviour in one market benefited the behaviour in another market. For example manipulating the closing price in an uneconomic way in the futures market but you had a much larger position in the OTC market that was settled off that price. But that’s a short-term manipulation at close of contract. Part of the question that has to be asked is that, if they are doing it for an extended period, what is the pay off?"

Ted Butler, whose allegations of ongoing manipulation are believed to be the subject of the current investigation, said that Aronow’s points were “encouraging”. 

He said: "He (Aronow) confirms a number of contentions of mine: One, the CFTC has never busted up an ongoing manipulation (crime in progress), and therefore, has no experience with one." 

"Two, the allegations are based upon evidence that is from their own data, so it doesn't matter what participants may say or know about the entire market. 

"Three, that evidence is credible enough that it obviously warrants an investigation. 

"Four, they are obviously afraid or reluctant to talk to me, even though it is clear I am the instigator of allegations. 

"Five, because it is a long-term manipulation, the stakes are enormous." 

Butler agreed with Aronow that there had to be an intent to manipulate the market and an economic justification for doing so: “There is no legitimate economic justification (for large short positions held by one or two players in the silver futures market) and the intent to manipulate couldn't be more clear, namely, financial survival for the big concentrated shorts.“ 

Butler said: “To lose control and be forced to cover shorts would set off a price explosion that would cripple them (those involved in the alleged manipulation) financially and expose the manipulation for all to see. The "return" to free market prices he talked about.” 

When the current investigation was revealed in US press in September 2008, CFTC Commissioner, Bart Chilton, said he had received 700 emails complaining about large short positions in the silver futures market. 

In an email to a member of the public on 27 December, Chilton said: “I requested an investigation, which is ongoing. I have been briefed and believe that the investigators are making progress." 

Greg Mocek, who left the division in July 2008, said that the division only responds to legitimate tips, not political pressure and that the validity of complaints had to be vetted before full investigations were initiated. He said that “if” Chilton had requested the investigation it was probably not politically motivated: "since you don't hear U.S. politicians crying about silver prices being too low." 

He said: "There are currently four commissioners and they are all political appointees, so everything they do is politically motivated to a certain degree. But that being said, I ran the division for seven years, and we investigated hundreds of tips that were legitimate." 

"The CFTC will look to the source of the allegations and the conduct involved to determine whether a tip is in fact legitimate. If it is, then the government will pursue a matter and use government resources to investigate the facts. 

"However, a tip and a subsequent open investigation do not indicate illegal conduct. It just means that the CFTC saw smoke." He also said: "When I was there, there were no politically motivated investigations. I assume that has not changed." 

Aronow made a similar point: "Often you get someone complaining and then market surveillance sees nothing. My guess here is that there was enough that they (CFTC staff) said at least they could look behind it and use enforcement power and look at people’s trading. At least it got past the stage of market surveillance taking a look at it."

However Aronow had a different take on the CFTC’s reaction to political pressure. In essence he agreed that political pressure was subservient to evidence. 

He said: "I’m certainly not aware of circumstances where some influential person says there’s something going on and they start a full scale investigation. They take information from wherever it comes from and treat it seriously." 

However, he added: “The reason I say 'in a certain sense' is because, if there’s a major problem or issue in the world, they (the CFTC) are going to be sensitive to that and the oil investigation is a perfect example of that." 

"If there are widespread public concerns expressed, they’re going to take a look to see if there’s anything amiss. In that sense the CFTC will respond to 'politics' in the broad sense of the word." 

Allegations of manipulation in precious metals markets are not a new phenomenon.

However, this may be the first time they lead to action by the CFTC that could result in regulatory changes that would affect the price of an asset that could in turn affect the NAV of metals funds. 

Silver Investigation: CFTC does U-turn 

Similar allegations have been made about the price of gold. 

Gold Conspiracy: Can you afford to ignore it?

"Again the length of time that these allegations have been around and the attention that they are given, may be why they are taking it seriously.” He said that whatever the outcome of the investigation, the CFTC might “feel that the attention and interest in this, even if the answer is that there’s nothing, is that they want the full and complete picture." 

As such the silver investigation may be politically motivated. Aronow said: "This goes back to what I was saying about how 'politics' in the broad sense can affect investigations and that a government agency may, properly from my perspective, respond in different ways to a subject that has keen public interest and make sure they run an investigation that will satisfy the public attention or interest." 

Mocek and Aronow’s comments suggest that there must be some validity to the complaints – as does the CFTC’s initiation of an investigation so soon after publishing a report that had rubbished similar allegations. However Aronow’s view that the CFTC can start investigations for political reasons, suggests that the CFTC may still be unconvinced by the allegations it is investigating in relation to the silver market. 

Ted Butler said: "I do agree with Mocek that Chilton's calling for an investigation wasn't political in the normal sense of the word, as low silver prices aren't a political topic." 

Mocek was aware of Ted Butler and his allegations. He said: "The rest of the story is that over the years, there have been many Butler subscribers who have made public allegations based on Ted Butler’s silver newsletter. Mr. Butler and his followers want silver prices to be higher." 

Butler said: "While it's true to say I want higher silver prices, that's a personal matter that should have no reflection upon whether my allegations are correct. It's more than just my sense that the CFTC is biased in this matter. When the investigation was 'announced' by the Wall Street Journal, the CFTC took pains to say they were still skeptical but were relenting anyway. What kind of impartial footing does that set for the investigation? And almost 4 months (and 23 years) have gone by and still they haven't interviewed the one making the charges?" 

For Butler, a major concern is that the CFTC remains unconvinced by the allegations and he believes that the regulator’s efforts to gather information from the silver analysts and investors who have complained in their hundreds about manipulation, is a delaying tactic and a red-herring. 

A spokesman for the CFTC told Investegate that this was not the case: "It most definitely is genuine. The Commission would not waste the public’s time or staff’s time on a 'charade'." 

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