30 March 2010

"How to Corner the Gold Market" By Janet Tavakoli

Janet Tavakoli wrote an interesting essay that was just posted over at the Huffington Post called "How to Corner the Gold Market" which can be read in its entirety from her website here. I started to comment at the HuffPost, but the system there limits comments to 250 characters, so I left a brief comment which is probably still being moderated (note: and still is five hours later - J) and will post my entire comment here while it is fresh in my mind.

First I wanted to thank Janet for dropping me a note about this piece. She knows I have an abiding interest on this topic of market imbalances and regulation in general. I find the US markets fascinating these days, in particular where they involve leverage and derivatives. And Janet is one of the most 'on the ball' and smartest people that I know who are looking at this, and making the good calls well in advance of the situation.

What struck me as odd is that I just wrote a blog piece along similar lines on the same topic today, raising many of the same issues, but that is from the opposite perspective. You can read The Case for Position Limits: What is the Spot Price and How Is It Set? here.

I think Janet and I come to the same conclusions but from a very different perspective, the other side of the table in fact, I wanted to reflect at length on her essay because I think it is important, and in some ways a good formula for manipulating a market from either the short of the long side. In the metals markets today, most of the 'gorillas' are the TBTF crowd, and they seem to be on the short side. That does not mean that they are not being sized up for a market showdown that could be destructive if there is a mispricing of risk and market imbalance.

First, and its not really a quibble, I think the Hunt Brothers attempt to corner the silver market back in the 1970's was overturned not only by a pre-emptive action by the Fed (and it was not an accident as I recall but a conscious response to inflation speculation) but also actions by the exchanges that broke the corner by altering the rules. I have not read the essay she references but I recall the situation first hand since my stock broker at Bache, Halsey Stuart was keeping close track of it, and liked to discuss it with me. Since I was not trading that market at such a tender age, it was a interesting voyeuristic experience, being in the stands watching the men in the arena. When I saw a spec silver trader in their office breaking out in hives during the trading day, being crushed and ruined lock limit down, I resolved to stay away from that sort of action.

This is important because today, having apparently learned their lesson, the exchanges are generally willing to increase the margin requirements when there appears to be undue speculation, especially on the long side of the trade by the speculators not in the in-crowd with the exchange. This is probably more common in the commodity markets, but most commodity traders are well aware these margin changes. They have to be since it requires them to put up more capital, and the specs are often thinly capitalized.

Second, I believe that the commodity exchanges already have the ability to force a cash settlement between counterparties in the event of a market imbalance. I think they even have the option to force a settlement in a commodity ETF, including some which Janet discusses as possibly being the objects of manipulation.

So think in sum that there is little evidence that anyone is willing to take on the exchanges, even the big players, and try and force a corner or even a squeeze against what they perceive as mispricing, such as Soros and so many other big players did with the British Pound , and most recently other big hedge funds did with mispriced products from the latest bubble in the debt markets, and financial stocks. They may be vilified after the fact, but they were right and served a valuable market function. Whether they did anything illegal is another matter.

The piece I wrote today and reference above is about a situation in the precious metals markets which has the potential to become another serious problem for almost the same basic reasons as the debt markets in our most recent financial crisis: excessive leverage concentrated in a few TBTF institutions, lack of transparency, regulatory laxity, and a mispricing of risk.

Janet alludes to the same thing. My prescription is position limits and accountability the collateral and any other deliverables backing the trade. If indeed there are excessively naked shorts, then not squeezing them is of course one resolution, but the other is to rein them in. I should add that the major players claim that they are not naked short, and reference hedges which I believe are undisclosed.

It was kind of odd to hear this story told in a conspiratorial way, referencing the Hunt Brothers. Anyone who would take on the government sponsored banks like JPM and HSBC at this point would have to be rather well-heeled and gutsy indeed. And what is most ironic is that a whistle-blower's testimony appeared at the recent CFTC hearing, and seemed to allege that JPM is manipulating the silver market. It was widely covered in the blogosphere, but very little of it in the mainstream media. I don't think it was covered at all at the Huffington Post, so Janet may not have seen it.

And of course there was the subsequent story about the man and his wife being struck by a hit and run driver the next day in London, and the usual fear of smears and intimidation that must accompany all those who testify against the vested interests. That story remains to unfold. I hope it turns out better than that of Harry Markopolos, who was widely ignored until the worst happened and the Madoff Ponzi scheme collapsed. As I recall he was subject to intimidation and fears for his safety, warranted or otherwise. It must be hard to come forward with this sort of knowledge.

But let's cut through the verbage. Here we are again, with TBTF institutions playing the excessive leverage games and possible naked shorting and mispricing of risk in under-regulated markets, and putting the 'global markets' stability at risk.

If Janet has any specific knowledge about a conspiracy to take advantage of this she should immediately contact the CFTC. I recommend Bart Chilton because I hear he is responsive and interested in this very topic, and just helped to sponsor hearings on this topic as I understand it. If I knew anything at all like this I would as well. So far all I see is a market relatively dominated by the usual TBTF suspects. If some longs are sizing them up there is certainly nothing wrong with that, and if they are vulnerable to a default, then we can either ban short selling (or I guess in this case it would be buying what they are short) or we can try and tighten up the market and correct any obvious imbalances that might exist now in an orderly manner.

But based on the last three years experience of financial misdeed exposed, I would hesitate to account for something by a criminal or even conspiratorial intent what can be attributed to short term greed and sheer reckless stupidity, crony capitalism and regulatory capture, and some intelligent market players seeing this and using legitimate means to confront it, and give it the market players a thrashing they may deserve. But there could be things happening well behind the scenes that I, a reasonably intelligent and trying-to-be-informed market participant cannot see. Is the squid on the hunt again? It is hard to imagine anyone big enough to take on the jokers that seem to be batting the US markets around at will these days. But therein lies the problem to my way of thinking - opaque and excessively leveraged markets that favor the big predatory trading desks.

As anyone who reads my blog knows, I do not think the contrarians are at the heart of our issues here, those who were shorting the mortgage bubble and the derivatives associated with them, although there is always that possibility. I am much more concerned about the establishment, those who are pulling the strings of power, and influencing the regulators, and I found a resonant chord in Janet's essay about this.

The markets are in need of reform. And as concerned as I was before, as shown by the blog which wrote earlier today, I am even more concerned now because Janet seems concerned, and we are coming at this from two very different perspectives: her from the possibility of an engineered short squeeze, and I from the dangerous condition I think I see in the market structure as it is today, with many of the same large institutions at the epicenter of the most recent crisis doing the same thing all over again, different day, different market. same players and modus operandi.

If there are elements trying to manipulate the markets from either side of the trade, then I agree with Janet, that I wish nothing to do with them, and want to see them exposed and prosecuted. But so far that does not seem to be happening very much, anywhere in the system except for some relative 'small fry.'

It feels like groundhog day.