The Shorts are Different

April 28, 2000

In another stunning display of a metals market going out of control, the New York Mercantile Exchange's April Platinum contract entered the Commodity Hall of Shame this week. Over a two-day period, the contract rocketed 60%, from under $500/oz to $800/oz., on zero news. And get this - it was due to a mismatch of 40 contracts. I kid you not. While the conventional analytical community was quick to label this horrendous affair as an aberration, there is a real message of alarm here.

You see, the fireworks in April Platinum took place on the last two trading days of the contract. This is the critical time in the life of any tangible commodity futures contract. This is the time when the futures price must converge with the underlying cash market. At the end of trading in a futures contract, all trades must be settled. Longs must sell out or accept delivery. Shorts must buy back or make delivery. (We've talked about this before). This is the put up or shut up time. No more bluffing. Let's keep it simple - the shorts couldn't deliver, they had to buy back at any price.What's remarkable, and scary, is that the Commodity Futures Trading Commission (CFTC), the watchdog government agency created to prevent this very occurrence, failed miserably, once again. To make matters worse, the CFTC's main approach (I would say only) is to closely analyze and monitor trading in the delivery month. Thisagency and the management of the NYMEX are truly pathetic. But I don't think you need more proof of that, let's move on to more important matters.

The real lesson here is that, just like the explosion of gold in Sept '99, and the default in TOCOM palladium, the April platinum disaster connects more dots in my central theme - naked short selling has manipulated the price andhas created unstable markets. Shorts not being in a position to fulfill what they have contracted for, is the root cause of most problems in the market. The time has come to address what should be so obvious to everyone (save those whose job it is to oversee). I am not against short selling. I am against short selling that must end in default. To that end, let me offer the only constructive solution to this serious problem, especially in silver.

The solution to preventing the continuing certain defaults and disorderly market conditions is for the authorities to adopt a simple rule - by first notice of delivery day, all shorts must certify that they have the ability to make delivery in that month. As it stands now, the traditional practice is to force longs only to deposit the full cash value of contracts held. In emergencies, the exchanges sometimes enforce full margin requirements on the shorts as well, but that is rare. The point is this - making longs put up the full cash amount is fine, because that's all the longs would have to do if they accept delivery, anyway. But what safeguard does making shorts post full cash values offer if they don't have the actual material? Shorts don't just write a check, like the longs, they must deliver physical material. Make them deposit physical material. These shorts are so arrogant because of current rules, that they'll try to bluff you till the last possible moment - just like TOCOM palladium and NYMEX platinum proved. By allowing shorts to remain in the current delivery month, with no assurance of their ability to fulfill contract requirements, the NYMEX and the CFTC have sanctioned the very practices they have sworn to disallow - manipulation and disorderly market conditions.

I can't believe how easy the NYMEX and CFTC are making it for me to warn about silver. Recently, I have pointed out that owning COMEX silver registered warehouse receipts is the best way to own physical silver in size. I didn't think the market would confirm that analysis so quickly. Consider this - if you had a position in platinum, only by holding NYMEX platinum warehouse receipts would you have been able to cash in on the extraordinary movement in April platinum. This very same phenomenon will transpire in silver - dramatic premiums being paid for the real stuff, in good deliverable form. If you own physical silver in size, and it's not in COMEX warehouse receipts - you better ask yourself why.

The real question of why, should be asked by those short silver, especially those who have borrowed silver to sell forward. To the NYMEX's credit, they did not just shut the exchange down, as the shameless TOCOM did in palladium. If the NYMEX allows the COMEX silver market to stay open, the shorts have lost a major escape route. All those miners and others who have obligations to return physical silver, are in exactly the same position as the hapless shorts in April platinum on the last two days of trading in that contract. When the final demand for silver comes, it will be for physical metal. Not more margin, metal. Real metal, not more contracts. Then, the market will invert dramatically for prompt silver, creating instant bankruptcies by the score. Let's see, it took a demand for delivery for 40 contracts to expose the shorts' bluff in platinum. How many contracts will it take in silver - 500? 1000? Anyone naked-short and bluffing on silver at these prices is crazy or crooked. And that certainly includes miners short years worth of production. As April platinum proved to anyone with half a brain, overnight the game can be changed to - give me metal, and give it to me now. What you have in the ground won't count.

Only in the commodities markets are the shorts allowed preferential treatment, even though the law is clear that there is to be no favoritism between shorts and longs. Because the CFTC and the exchanges extend unfair benefit to the shorts, our markets have evolved into a sick pattern. The naked shorts manipulate prices until all supply is exhausted, then we explode in chaotic conditions. This sick pattern could be changed in an instant, if the CFTC and the NYMEX would do the right thing and level the playing field. Make the shorts certify their ability to fulfill their commitment, just like the longs have to. Shorts are different than longs. They have to fulfill their obligations differently. Make the longs show you the money. Make the shorts show you the stuff. It's only fair, and it should be the law.

The Incas thought gold represented the glory of their sun god and referred to the precious metal as “Tears of the Sun.”