Creating Risk: SLV...the COMEX and FanDuel -- Keith Bronstein

After reading my Saturday column, I received an e-mail from a long-time subscriber...Keith Bronstein.

Keith served as Chairman of the Business Conduct Committee -- and as a Governor of the Clearing Corporation on the Chicago Board of Trade way back when. For that reason, his insights into the innards of the paper trading system on the COMEX and NYMEX far exceeds mine -- and mostly likely yours as well.

We had an e-mail exchange over the weekend -- and here it is...word-for-word....

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Hi Ed,

Great work again. Marvin Gaye….wow…perhaps the duet with Tammy Terrel next time.

I just thought that I’d add my own modification of view on the silver story.

After more years than I can remember being convinced of default and demise of COMEX, I think this may play out a little differently.

We have read the SLV document which you quote often. On that day, and it will happen, when SLV owners are notified that the “contracts” have now been converted to cash settlement -- and the COMEX will do essentially the same. Anyone with a silver future now has the closing price the night before, but that future cannot be converted to bullion -- and is now no different that an S&P futures contract.

The exception with be the “authorized participants” who will be allowed/ compelled to settle up with the bullion commitments they have. The silver futures contract will march on just like its new baby the 1/50 silver micro contract which starts trading any day. The CME group is in business for one thing and one thing only…FEES. The fees will keep on coming as the “trading world” algos etc. will trade any numbers offered and whether there is physical attached makes no never mind.

Real physical markets around the world will find real prices -- and anyone who wants can just dial in and make a bet on the next turn of the card at the COMEX. I imagine you know the history of the founding futures exchange.

The Chicago Board of Trade and the role of bucket shops (betting parlors) in early days. (My wife wrote the consummate exchange biography, My Word Is My Bond) early this century. There was a time that this would have really bothered me, but now I see the way of the world, I know that my ability to profit from understanding the true value of silver (other metals as well) will be rewarded and my need for physical is not dependent on the legitimacy of the COMEX. That’s current thoughts.

Watching and studying every moment of every day...all my best...KB.

My reply to that was as follows:

Hi Keith,

Very interesting -- and I'm certainly not disagreeing with anything you say.

But if what you say comes to pass, wouldn't such actions in SLV and the COMEX affect their legitimacy? It seems that conversion for physical is what gives both these vehicles that -- and with no physical backing them, they'll sink into irrelevancy. I'm sure PSLV would benefit.

Would these actions not precipitate a move of the physical price setting mechanism from the COMEX to an all-physical market such as Shanghai.

I agree totally about the 'fee' aspect of the COMEX...as Terry Duffy has never looked kind-hearted to me....but wouldn't they be cutting their own throats doing that? That would/could send the pricing of all physical commodities offshore/China...which would not be what 'The Empire' would want to see happen.

Your thoughts,

Ed

And his reply to me on that...

Hi Ed...Great input...Here is an expansion of my thoughts...

First of all, I want to bifurcate SLV from the CME Group...

SLV is this “semi-private” product of Wall Street which has been a nice income source for its originator like most ETF’s have been.

As discussed, we both know the documents provide for a gentle exit for the sponsor should sponsorship become excessively difficult to continue.

There once was an ETF for Japanese government bonds. For many product specific reasons , it was quietly and gently de-listed. In 1989/90 when my firm had a very active Japanese equity trading desk there were so many constraints to short interest that we were only able to capture the ultimate bursting of that price structure through buying cash corporate debt that had inverses equity options attached. Ultimately a profitable venture, but incredibly complicated and costly to engage in setting up. The basic ETF products were “unavailable”

On to silver. You have done a great job for years in following the ins and out of physical silver between SLV and COMEX and their vaults. I’ve often wondered the following given my long history with dealing with ins and outs of cash commodities where futures exist:

If I were an industrial user of silver, before I used the derivative market as a source of supply, wouldn’t I check cash options first for price and timely execution.? If I were a producer/merchandiser of physical, wouldn’t I do the same with my production? The answer in a normal world is yes to both. Yet, as you documented for years, we would see inflows of metal and then outflows…day after day, week after week. In volume. Why haven’t these guys just met up and made a two party trade bypassing the COMEX? This went on when silver was $18 and now at $88. The original construction of futures trading was built on have a place where someone would provide price liquidity to a producer who had a need, or a supplier who had inventory...but due to calendar extension(harvest in fall and usage in spring) they were not ready to meet -- and thus the trader/speculator assumed that commercial risk for both and hoped to profit for his efforts.

McDonald’s didn’t need a potato futures market since their daily demand was satisfied by Simplot...an able producer. There are other similar examples. My recycling firm has no need for the copper futures market as there are industrial users who contract with us for production including timing and freight solutions. Giant industrial entities need silver. Production is concentrated in identifiable hands.

As for speculators: they bet on price now, more than ever in our history. Who has a “spec” position at COMEX that understands “basis”, freight etc.? CME is joining up with FanDuel. That’s gambling, not speculating. Building a business not on assuming existing risk but on creating risk.

That’s just fine. For those who want to do more than bet on price…which, by the way, will reflect the real world price of physical, there will be PSLV and exchanges in Singapore, Shanghai , Emirates and other places. There will be dealers who are able to sell us a handful of ingots/coins to stick in our sock drawer or if one is more deep pocketed, bars to put in a depository.

SLV and COMEX are still working off the legacy manipulation/abuse of the last couple of decades. “Unallocated metal” was the golden calf and now the sack of shit they have to carry around until it’s done.

I emphasize again, the CME business model is transactional. VOLUME. Physical commodity are incidental. If they don’t cause a problem…fine. If they do, just recreate the old bucket shops...which the creation of the CEA/Commodity Exchange Authority, ended. That was over 100 years ago. Betting is good, drugs are legal...times change.

Frankly, as a trader/investor for a long time, I think we’ll all be better off without the price management initiatives at play.

There is always more to report and think about -- and I deeply appreciate your daily missives.

All my best...KB

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Well, dear reader, as you know I...along with a whole legion of others...have never been fans of SLV since its inception -- and wouldn't touch it with a ten-foot cattle prod. That's even more the case since BlackRock took it over way back when.

It's up to you to do your own due diligence on such matters. I'm just presenting what I've been told by someone who is far more expert in this area than you and I.

Ed