World silver spot prices are determined by a once sacred, but now inept, process. While the evolution of futures contract for the modern age helped facilitate the industrial revolution, it has now been completely usurped and abused. This is especially the case in gold and silver, even to the point where confidence in this market threatens to turn the world financial system upside down.
The Heart of Darkness
For now, world price discovery for precious metals resides at the COMEX, owned by the for-profit Chicago Mercantile Exchange (CME).
It is here where the spot price is determined and the heart of technical analysis is controlled.
No other exchange currently holds as much power as the CME. While it is possible that this power could change, the owners- the CME and the giant speculators (hedge funds dressed up to look like banks) are too big to fail. Additionally, loose regulation is free to profit here, which makes change unlikely.
Silver in a Futures Contract
The futures contract is a potentially beautiful thing - a really good idea. Unfortunately, trading of these contracts has become infiltrated by players with no business belonging there to begin with.
Practically anyone can take out a contract for future delivery. For every new buyer, there is a seller who takes the other side.
The spot, or current price, is calculated somewhat obscurely) and is rather like a net asset value - similar to what the Sprott Physical funds have.
Originally, the futures were set up to level the playing field and smooth out price volatility by allowing producers and users to come together and hedge production or lock in prices.
The exchanges or platforms are now for-profit entities. They make money by allowing whoever wants to participate - including giant multinational quasi banks/investment and hedge funds, aka hot money flows.
These big players play the momentum and rarely close out positions. They simply roll them into the future. Very little metal is delivered relative to the amount of paper (largely unbacked) positions outstanding. If shorts (sellers) were forced to go out and buy the silver needed for delivery, the system would break.
The delivery mechanism itself is a reflection of the good intentions of a contract to begin with; it is quite controlled and well structured.
Physical Demand Profile
Silver has a strong demand profile. Industrial demand is ongoing in spite of severe economic downturn.
Physical investment demand rises on falling price (the opposite occurs in just about everything else), a fact that is relatively unknown. Analysts are vaguely aware of investment demand and industrial use - but never acknowledge competition for physical.
The assumption is that it is easy to acquire and then take delivery of a futures contract if needed. In other words, because price and price performance underlie commentary, silver must be plentiful.
In reality, while the logic makes sense, the relationships are totally distorted.
The Future of Gold and Silver Futures
A wide ratio exists between the amount of paper represented by the mostly unbacked contracts and the actual physical metal available anywhere for delivery. As such, these markets are an accident waiting to happen.
The potential triggers are numerous, ranging from the mild shift away from COMEX toward more physically oriented to outright default or failure to deliver.
Somewhere in between, investment for physical could drive up premiums on the street. Otherwise, an industrial may begin stockpiling in reaction to a delivery delay. Each could put more pressure on alternative delivery mechanisms and the physical market would break free of its paper shackles.
Price discovery on the largest precious futures trading system goes on protected by a financial system and legal system desperate to protect its importance. It is fraudulent. The only positive is that manipulation cannot go on forever and there is still time act accordingly.