As news breaks that certain large banks are under investigation for rigging metals markets, I’m reminded of an incident that took place years ago which opened my eyes to how metals prices are manipulated--specifically through paper contracts. We advocate taking possession of physical precious metals as the best way to secure your wealth and while the representatives of the companies involved in the probe stay silent we’re going to spill the beans on what’s really going on with futures contract delivery.
It was 2008, just before the market crises that would jump start the recession, and I received a phone call from an individual looking for assistance in taking physical delivery of their two 5000 ounce silver contracts. The broker on the client’s account had no idea how to deliver the metals promised by the contract because almost no one asks for the physical metals—they usually roll over the contract or bank any gains made. Even when the participant does decide to take delivery, they generally pay a fee and leave them in the custody of the vault.
Each silver contract represents five unique bars, each approximately 1000 ounces. Each individual bar has the “Hallmark” identifying the manufacturer, the actual weight and the purity of the bar. A single 1000 ounce bar is the size of a large loaf of bread and weighs about 70 pounds which is hardly easy to move or store if you did decide to take delivery outside of custody. But that’s not the function of futures contracts anyway; they are set up to be used for hedging or trading like other financial instruments. A contract gives you the ability to buy at a specific price at a set point in the future or the option to not execute the contract if the market price is lower.
When people trade paper contracts, they also affect the market price of metals. If these contracts can be manipulated by traders or other sources by short selling it distorts the price across the board and can be lucrative for those in the game but disastrous for others.
We were looking at moving a significantly large amount of silver – over 700 pounds - and had everything set up to make the trade but found that the process was being delayed. After some searching, I was finally able to get in touch with an HSBC worker in charge of managing the physical metals. When I asked why it was taking so long the trader casually remarked, “Oh we have to assign new bars to release these bars from other contracts.” Not believing what I had heard, I asked him to repeat it and he said the same thing; that the silver bars for my client’s contract were also promised to other clients and they had to be released from those obligations.
The HSBC worker had assumed I knew how the game works because I was a broker but then realized I was a broker who dealt with physical precious metals not futures contracts. Realizing the significance of his admission, I tried to get him to repeat it again so I could record it, but he had realized the gaffe and curtly told me, “It will all be taken care of this afternoon.” And the call promptly ended.
I think this is direct evidence of fraud. If someone promised you that you own a specific item and told that to multiple other people--it would be fraud. Not only do multiple people think they own the same unique item, it provides the illusion of higher availability of above ground silver. There’s less physical metal than is represented by paper yet the market price does not reflect this disparity. More implied supply would effectively result in lower silver prices.
By asking for actual physical delivery, we interrupted HSBC Bank’s fraudulent scheme. Now, HSBC is not new to controversy and when they’re not fraudulently promising multiple people the same metals, they’re laundering money to Mexican drug cartels. But I digress.
The trade was taken care of that afternoon and it’s a story I tell clients regularly. It’s why we don’t recommend paper contracts as a method of investing—mainly because you’re not in possession of the metals, but it’s also unethical how traders game the system and manipulate prices. We’re not sure how often this happens because it’s very rare that anyone tries to take delivery of any commodities contract and in this case it was likely due to a misunderstanding by the client of how paper contracts work. But the ramifications of the trader’s admission are seen every day. While manipulation of metals markets can occur in a variety of ways; that multiple paper contracts are backed by the same pile of metal is disturbing and highly unscrupulous.
Despite price manipulation in metals markets, we still believe they are a good way to diversify your investments as long as you make sure you are in physical possession of them. The price can only be suppressed for so long, so now is a good time to take advantage of these low prices.