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Copyright © 2008

by A. E. Fekete

All rights reserved

PUTTING LOIN-CLOTH ON THE

NAKED BOGEYMAN

A Primer on the Silver Basis

Antal E. Fekete

Gold Standard University

aefekete@hotmail.com



I started writing this piece as the sub-prime crisis was unfolding. I wanted to establish the

connection between the silver basis and the budding banking crisis caused by phony bond

insurance schemes and the lack of hedging irredeemable dollar debt with metal holdings. My

original title was Putting Clothes on the Naked Bogeyman. As writing progressed I realized that

it would take more than one article to dress up the bogeyman; hence the revised title.

Trading hedged corn

When I tell my audience at Gold Standard University Live that huge quantities of

commodities are bought and sold every day without any reference to the price, my words are

received with an incredulous silence. It appears incredible to the uninitiated that the price risk

can be neatly side-stepped. I have to explain to my listeners that when the professional grain

trader gives an order to buy or sell corn, he may be unaware whether the price of corn is up or

down. He doesn’t care. He is buying and selling hedged corn, and he takes his clues from the

basis, not the price of corn itself. He has replaced price risk with basis risk which he knows

how to handle as its behavior is less erratic and more predictable. Most people don’t realize

that the bulk of grain trading on the futures markets is driven not by the price but by the basis.

In the grain market by basis is meant the difference between the futures price and the

local cash price of the grain. Thus the basis varies from place to place, and from one delivery

month to another. Trading the basis means buying or selling hedged grain. The merchant

The myth of naked shorts

The silver market is similar. Large quantities of silver are bought and sold every day without

reference to the price. Professionals trade hedged silver on clues from the silver basis. They

are not gambling on the price variation of silver: they want to earn a reliable income on

physical silver already in store. They may do this on their own account or, more typically, on

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customer account. The ever growing inordinate and concentrated naked short position in the

face of a strongly rising price is a myth.

I defined silver basis in my earlier articles as the difference between the nearest futures

price and the cash price of silver (see references).

It is puerile to assume that most professional traders are naked short in silver, just as it

would be sheer ignorance to suggest that most professional traders of grain are naked short in

corn. They are not. You may rest assured that their corn is well in place in a grain elevator

somewhere. If the elevator is registered with the commodity exchange, then the hedger may

post a reduced margin on his position. But the elevator need not be registered, in which case

the hedger posts full margin. While this is not typical in the grain trade, it is quite common in

the silver trade. Rightly of [or] wrongly, the silver trade is surrounded with far more secrecy than

the grain trade. This has to do with the fact that silver is considered a monetary commodity by

many in the first place, and an industrial commodity only in the second. We must understand

that lots of people are accumulating silver not so much for the ride to $1000, which may or

may not happen, but in protest against low interest rates on passbook savings and certificates

of deposit. They are happy to post full margin instead of the lower hedge margin on their

short position in silver in exchange for anonymity. Of course, the exchange knows that theirs

is a hedge position, but must treat this information as confidential. So must the C.F.T.C.

Let’s start by reviewing the differences between the grain and silver trade. As most

grain is sold to the ultimate consumer within the year of production, the basis has a yearly

cycle with trough just before and peak just after harvest. By contrast, the silver basis is not

cyclic. Silver is typically accumulated year after year by investors and bullion banks. Instead

of an annual cycle following the crop year, the silver basis has a long-term falling trend, [which is] a

strong hint of a slowly developing shortage. It is impossible to predict when shortage will hit.

After every major price advance there is profit-taking by unhedged investors, and after every

major price decline there is short covering by hedged investors and bullion banks. Net selling

through profit-taking and net buying through short covering may or may not balance out.

Accordingly, the trend towards a permanent silver shortage is going to be uneven.

Historical sketch of the grain trade

Farmers produce billions of bushels of grain every year. Most of this grain is sold several

times in the futures markets as part of the basis-trading before it is consumed. An

understanding of the historical development of the futures markets may be helpful.

Standardized futures contracts began trading on commodity exchanges in the late 1800’s.

Futures markets revolutionized the way cash grain was traded and gave the grain elevators

and the farmers the ability to buy and sell more easily and profitably. Grain companies

learned how to use futures contracts more effectively to manage risks, and to maximize

income from their elevators. The big revolution was the advent of basis-trading, to replace

price-trading. This revolution is not mentioned in school curricula; not even in university

curricula. This is a pity. The story of basis trading is a story of capitalism triumphant. It

teaches how the free market can overcome the capriciousness of nature. As more and more

people learn the skills of basis trading, profitability grows and business expands.

The grain business prospered until the 1930’s when the Great Depression began and

governments became heavily involved in grain trading. Government programs dominated the

marketplace. Storage of grain was encouraged and construction of new elevators was

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subsidized. However, the market was stagnant, to a large extent precisely because the new

elevator space was taken up by government-owned grain. This grain was just sitting there in

the elevators, until it was ultimately given away to other governments or to charities.

In the 1970’s governments decided to reduce their presence in the grain market. A new

era started when market forces were allowed to prevail once more. The grain business relearnt

how to increase efficiency, manage risks, and generate income through basis trading.

Generally, the abundance of grain kept the market stable. Under these conditions the

opportunity for trading was confined to buying and holding grain. This is known as the “carry

trade”: buying when the basis is at its highest and selling when it is at its lowest. The basis

was following a consistent pattern and as it declined from harvest to the end of the crop-year,

the grain trade was provided with a reliable income.

It would take a sizeable drop in production to cause any significant move in the price

and a deviation of the basis from the customary pattern. While it did not happen very often,

the market came away with the flying colors proving the superiority of trading the basis over

trading the price especially under volatile conditions.

The 21st century brought new challenges to the grain trade. The market became

demand-driven. Increasing population and improved living standards around the world

opened up markets to more people and boosted demand for processed food and other

consumer products. There has been a tremendous growth during this first decade of the

century. In addition to the carry trade, “value added trade” has put in an appearance and

started growing. In this environment grain does not sit around in elevators for a long period of

time. The market absorbs it and makes it into all kinds of products for human and animal

consumption. Most recently grain has started trading also for use in energy production. All

these changes contributed positively to basis trading as it has changed the dynamics of the

marketplace.

Of course, not all grain traders are trading basis. A dwindling number still trade price.

Most of these traders are barely surviving. They will have to learn the skills of basis trading,

or perish. It is a safe bet that no new grain elevator is being built with trading the price in

mind. They are built with trading the basis in mind. Those who are still trading price are

missing one of the great opportunities of the century by not understanding basis.

Historical sketch of the silver trade

Second only to gold, silver is a monetary metal. This means that above ground silver

represents several years’ output of the mines. One should not be misled by the propaganda

line that this silver “has been consumed by industrial applications”. The recovery of scrap

silver is a function of the price. As the price of silver rises, the rate of recovery will rise with

it, sometimes dramatically. In addition, an unknown but substantial amount of silver still

exists in monetary form. Owners do not want to reveal their identity, or the size of their hoard.

But this does not mean that monetary silver has disappeared in consumption. There is no

support for the claim that silver is in short supply, or that silver has ceased to be a monetary

metal. Any apparent shortage simply means that the carry trade holds back stocks from the

market in hope of an early price advance. At the right price it will make the metal available.

Prior to 1873 the price of silver was stabilized through monetary legislation at $1.29

per oz. After the Civil War the U.S. Mint was closed to silver. The German government also

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closed its Mint to silver in the wake of the Prussian victory over France about the same time.

Silver was dumped in the markets in unprecedented amounts, driving the price down to as low

as 70 cents by the end of the 19th century. Although the price spiked back to $1.29 at the end

of World War I, it did not last and during the Great Depression it hit a low of 25 cents. We

may add that upheavals in the silver market were a direct consequence of government

meddling. Ultimately people have learnt how to neutralize the destructive influence of the

government in an effort to control money, and they borrowed a leaf from grain merchandising

manuals in trading the silver basis.

Through all this time up to 1965 there was no silver trading on the organized

commodity exchanges for reasons of insufficient volatility. By 1965 the world market price

threatened to exceed the statutory price, as demonstrated by the disappearance of silver

coinage from circulation, and volatility perked up. Silver trading on the organized commodity

exchanges started. However, secrecy continued to surround the silver trade as one monetary

crises followed another at more or less regular intervals. There was a conception that silver

could also be confiscated as gold was in 1933. In the event, the ban on gold ownership and

trading was lifted in the U.S. at the end of 1975, allowing gold futures trading to start and

giving a boost to silver futures trading already in progress.

Secrecy prevailed and manuals on how to trade basis in the gold and silver markets

were never made public. Those anxious to learn basis trading of the monetary metals had to

buy the manuals for basis trading in grains, and work it out for silver and gold on their own.

This is not as easy as as it sounds, because of pitfalls due to the fact that trading monetary

metals differs from trading grains in almost every respect. Having said that, there is no

question that basis trading in gold and silver is a wide-spread practice preferred by the most

conservative investors, and even the more venturesome cannot do without at least a

rudimentary understanding of the underlying principles. We have mentioned above that

trading the basis for grain instead of trading the price was a triumph of capitalism. Man has

learned how to overcome the capriciousness of nature. The same also happened in the silver

market: trading the silver basis increasingly replaced the trading of the silver price. The

difference is that here it was not the capriciousness of nature but the capriciousness of

governments that has been overcome. Governments want you to believe that they can create

and destroy value at will by monetizing debt while demonetizing silver and gold. In effect

they cannot do either in a durable way. Government magic goes only so far as gullibility of

the people.

Gold Standard University Live is a world leader in offering regular panel discussions

and primers on basis trading of the monetary metals. There are plans to run workshops as well

on basis trading. The next session is scheduled from July 3 through 6 at the Martineum

Academy in Szombathely, Hungary, to be followed by a session in Canberra, Australia in

November (see Announcement at the end of this article).

The Last Contango in Washington

Volatility in the gold and silver markets is like a dormant volcano. Unannounced, it erupts

periodically with increasing ferocity. As it does, trading the gold and silver price is becoming

ever more treacherous. There can be no doubt that the answer is basis trading, that is, buying

and selling hedged gold and silver. It is only a matter of time before a trading house or bullion

bank will offer this service.

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The significance of the silver and gold basis can be found in the role they play as an

early warning system. Under normal circumstances backwardation in gold and silver is an

aberration. Monetary metals must be sufficiently plentiful in order to serve as such. This

translates into contango. But at the time of monetary disturbances, like the one triggered by

the sub-prime mortgage crisis, the monetary metals tend to go into hiding. As they do, the

cash price goes to a premium against futures prices, and the basis goes negative, indicating the

extent of scarcity. If hyperinflation is in store, gold will go into permanent backwardation,

foreshadowed by a steep decline in the basis.

In an earlier article I have, somewhat flippantly, described this momentuous paradigmshift

as “the last contango in Washington” (with a bow to the movie The last tango in Paris.)

The historic contango of gold will give way to permanent backwardation. It will mean that

gold is not for sale at any price ― not against the irredeemable dollar. Note that while the

gold price is open to government manipulation, the gold basis cannot be so easily falsified. It

reflects the truth as it is. The basis never lies.

Canary in the coal mine

According to one hypothesis, permanent backwardation in silver will precede that in gold.

Thus silver is the „canary in the coal mine”. But you have to have ears to hear the canary sing.

In other words, you must be able to read the message carried by the silver basis. If deflation

and depression is in store, then the case for silver is not so clear-cut, in view of silver’s

extensive industrial applications. It is possible that silver will be dumped by investors fearing

that industrial demand is vanishing. But again, it is also possible that the rush into gold, a

regular feature of depressions, will spill over as a rush into silver. Whatever happens, the

silver basis will provide a reliable early warning sign. The return of contango in silver is an

indication that bullion banks are dumping silver. Continued backwardation is an indication

that investors and bullion banks are still accumulating silver. Investors and traders would do

well to learn all they can about the silver basis to be able to interpret events correctly as they

unfold, even if they never intend to trade the silver basis.

The inordinate size of the short commitment of traders indicate that bullion banks

actively trade the silver basis. Among their customers are wealthy investors and, possibly,

governments or government agencies. C.F.T.C. investigators insist that there is no market

manipulation in silver. I am willing to take their word at face value. Basis trading is not a

market manipulation, even if done on a large scale. It is dynamic hedging, and hedging is just

what the futures markets are for. While futures trading would not work without an adequate

speculative following, it is not primarily for the benefit of the speculators. It is for the benefit

of the hedgers. Speculators are supposed to know this and they should stop crying “foul

play!”

What is seen and what is not seen

Those who hold that there is market manipulation are victims of an optical illusion. What

appears as an oversize naked short position involving no more than eight trading houses or

bullion banks, is just the visible side of basis trading in silver. But there is another, invisible

side as well. The invisible side is hedged metal in private hoards, in the reserves of bullion

banks and, possibly, in secret government depositories.

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It is well-known, for example, that the Chinese government controls large stores of

silver, remnants of the long-lasting silver standard in China. A lot of the silver that

governments and private individuals dumped in the West after the 1873 demonetization found

its way to the East, where the Chinese Mint was still open to silver. At that time China offered

the only unlimited market for silver. There is some controversy about the question whether

silver was flowing into or out of China between 1934 and 1949. Be that as it may, after the

overthrow of the Nationalist government the Chinese Communists inherited untold amounts

of silver. If there was an outflow of silver from China before the Communist takeover, it

certainly stopped after 1949.

Chinese hedges are no Texas hedges

It is a plausible assumption that the wily Chinese presently trade the silver basis under a seal

of secrecy. Some of the world’s largest banks are in China, and they definitely have bullion

trading desks. Unlike their opposite numbers in Japan and the West the Chinese banks are not

brain-dead. While they also have a large portfolio of dollar-denominated assets, they are

probably fully hedged by their holdings of silver and gold. The Chinese banks don’t have to

carry the ideological baggage of anti-gold mentality, so prevalent in the United States. Their

financial condition is incomparably superior to that of banks in the dollar orbit.

In order to understand the silver saga it is important that we put ourselves into the

Chinese mindset. For the Chinese silver is money, and the US dollar is a dishonored promise.

They see no reason to exchange their silver for paper, of which they already have more than

their fill. Their perspective on the market is entirely different from that of silver investors in

the West. Their participation in the silver market is motivated by their desire to earn a return

on their holding of silver in silver. A price explosion would frustrate their strategy. They don’t

want a supply shock in silver. On occasion they have to pacify the restless silver market

through selling, with the idea of buying the material back, preferably at a better price. This is

not naked short selling; this is dynamic hedging. No crusade of the “insanely bullish” can

reclassify it as market manipulation.

The difference between the Chinese banks and their Japanese and Western

counterparts is that the Chinese hedge paper with metal, while the Japanese and their

American mentors hedge paper with paper. Theirs are Texas hedges (with reference to the

anecdotal rancher who [not] hedges his herd with long live cattle futures contracts).

Silver basis and the banking crisis

The present banking crisis necessitating unprecedented bailouts of multinational banks is not

unrelated to silver basis trading. By now it is clear that the cause of the crisis is the banks’

inordinate portfolio of assets concentrated in debt denominated in the irredeemable dollar,

unhedged by gold and silver. By contrast the Chinese banks, which also have large dollar

assets, are hedged in metal. The Chinese banks are in no need of a bailout. So much for

diagnosis. The prognosis: more bank failures in the West and in Japan; further relative

strengthening of banks in China.

It is unreasonable to expect that exchange officials and C.F.T.C. investigators disclose

the hedging activities of bullion banks, Chinese or otherwise. I repeat, trading the silver basis

is not market manipulation. The high concentration of short positions is due to the fact that

governments and wealthy individuals wanting to earn a return on their silver holdings prefer

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to take their business to a select few trading houses and bullion banks with the necessary

expertise and capital to trade the silver basis on a large scale. This offers them the best chance

to preserve anonymity. The sluggishness of silver deliveries is explained by the long lines of

communication. It takes time to get the silver from the East for delivery in the West. One

should not read imaginary shortages into this. Presently silver is not in short supply. If it were,

silver could not drop in price as much as $5 an ounce or 25 percent in a matter of days, and

continue trading at the lower end of the range. Paradoxically, sluggishness of deliveries is the

very proof that there is no corner in the offing ― not yet. If there were, the metal would move

from East to West in supersonic aircrafts.

The best little warehouse in Comex

I strongly disagree with the tactics of Comex in putting a limit on long positions in silver and

on silver deliveries, which looks like an admission that there is a shortage. Silver in approved

warehouses is there to be delivered on demand. Let the chips fall where they may, and let’s

see what the market will do if the last bar of silver is removed from the warehouses. Limit on

deliveries does not prove shortage; it only proves that the exchange is inefficient and does not

favor transparency. In limiting delivery it undermines its own usefulness. The exchange

should oblige hedgers to keep sufficient silver in the warehouses ready for delivery at all

times, in return for protection of their privacy. Failure to comply should be penalized with

margin call on short hedge positions, possibly higher than the value of the underlying

contract. This would enhance the credibility of the exchange more than anything else. As it is,

the best little warehouse in Comex is for window-dressing only. For serious business, such as

you know what, you had better go to another warehouse.

Bleeding to death in the bull ring

It is not in the interest of wealthy individuals, bullion banks, and governments with large

stockpiles of silver that the price go to $100 overnight, which could happen if secrecy were

breached and anonymity blown away. As they can derive an income from their silver holdings

already, these owners of silver prefer a controlled rise in the price. And that’s exactly what

we’ve got.

Failure to understand this may lead one to all kinds of superstitious beliefs concerning

the power of the bullion banks to manipulate the price of silver. The panicky short covering

predicted when silver was trading below $5 never materialized during the run to $20 and

higher. There has been and will be a lot of short covering, but nothing what could be called a

short squeeze. Not until the curtain falls on the Last Contango in Washington.

As a quick back-of-the-envelope calculation shows, if the naked silver bogeyman were

real, he would have by now lost an arm and a leg after losing his shirt. He would have bled to

death in the bullfight. Let’s be generous and admit that he does have, at the very least, well, a

loin-cloth to wear in confronting the charging bull.

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References

By the same author:

It’s Not a Dollar Crisis: It’s a Gold Crisis, June 5, 2008

The Saga of the Naked Bogeyman, November 2007

Exploding the Myth of the Silver Shortage, September, 2007

The Last Contango in Washington, June, 2006

The Rise and Fall of the Gold Basis, June, 2006

Monetary versus Non-Monetary Commodities, May, 2006

Ultracrepidarian Musings, May, 2006

Bull in Bear’s Skin? May, 2006

What Gold and Silver Analysts Overlook, May 1, 2004

These and other papers of the author can be accessed on the website

www.professorfekete.com

GOLD STANDARD UNIVERSITY LIVE

Session Four is to take place in Szombathely, Hungary (at Martineum Academy where the

first two sessions were held). The subject of the 13-lecture course is The Bond Market and the

Market Process Determining the Rate of Interest (Monetary Economics 201). It will be

followed by a panel discussion on the topic: The Silver Basis and the Present Banking Crisis:

Phony Bond Insurance Schemes and the Lack of Hedging Irredeemable Dollar Debt with

Monetary Metals.

The date is: July 3-6. For more information please see www.professorfekete.com/gsul.asp or

contact GSUL@t-online.hu. Registration can be made by e-mail upon payment of the preregistration

fee. The remainder of the registration fee is due 3 weeks prior to the session.

Space is limited; first come, first served.

Preliminary announcement: Gold Standard University Live is planning to have its Session

Five in Canberra, Australia, in November, 2008. This Session will include a Primer on the

gold and silver basis, prerequisite for a Workshop on the basis offered at Session Six (planned

to take place in the Spring, 2009).

June 12, 2008.

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Market Manipulation or Not??

Fekete disputes the “illegal naked short selling of the silver managers” articulated by Ted Butler.



Fekete:

Butler:

Peter R. writes:

The Fekete Effect

Professor Antal Fekete of Gold Standard University recently published a provocative essay called, "Putting Loincloth on the Naked Bogeyman: A Primer on the Silver Basis." In it the professor makes several assertions that get to the heart of whether the price of silver—and gold—is, or isn’t, being manipulated. He offers an explanation that excludes price rigging for silver price movements on the COMEX. If, as he asserts, there is a market-based explanation for the price movements of precious metals over the last decade, than that seriously undermines all claims of manipulation.

Because this is such a fundamental issue, it is worth exploring. So, first I offer my own summary of Professor Fekete’s thesis and then pose a few questions to him. His original essay can be found in its full glory at http://www.goldisfreedom.com/

The good professor (who is a gold "believer") starts off by explaining that it is normal for traders to buy and sell commodities in relation to the "basis," or the spread between cash prices and future delivery contracts. This basis is not price-dependent but represents a premium on time, location and expectations.

Professor Fekete goes on to compare stored silver to a crop, like corn, on which one can earn income by trading the basis. He then emphatically asserts that the COMEX silver shorts are not naked shorts, but rather like corn hedgers who possess enough corn to cover their commitments and are simply earning extra income on this supply. To believe otherwise is "puerile" (i.e. childish, or silly). Professor Fekete, who undoubtedly knows his grain trading better than I, concludes, "Of course, not all grain traders are trading basis. A dwindling number still trade price. Most of these traders are barely surviving. They will have to learn the skills of basis trading, or perish. It is a safe bet that no new grain elevator is being built with trading the price in mind. They are built with trading the basis in mind…"

The professor than continues with a key extrapolation: because most grain shorts are not naked, neither are the silver shorts. "…there is no question that basis trading in gold and silver is a wide-spread practice preferred by the most conservative investors, and even the more venturesome cannot do without at least a rudimentary understanding of the underlying principles…trading the silver basis increasingly replaced the trading of the silver price."

Furthermore, "Those who hold that there is market manipulation are victims of an optical illusion. What appears as an oversize naked short position involving no more than eight trading houses or bullion banks, is just the visible side of basis trading in silver. But there is another, invisible side as well. The invisible side is hedged metal in private hoards, in the reserves of bullion banks and, possibly, in secret government depositories."

The professor postulates that this hidden hoard is being held in China, that the CFTC knows about it and, "…the high concentration of short positions is due to the fact that governments and wealthy individuals wanting to earn a return on their silver holdings prefer to take their business to a select few trading houses and bullion banks… The sluggishness of silver deliveries is (because) it takes time to get the silver from the East for delivery in the West… silver is not in short supply. If it were, silver could not drop in price as much as $5 an ounce or 25 percent in a matter of days, and continue trading at the lower end of the range."

After giving much thought to Professor Fekete’s essay, I was left with a number of unanswered questions, so I wrote an email to him asking about them. As of 6/15/2008, I have not gotten a reply, but in the meantime I hope that sharing my thoughts will motivate others to also explore the issues he raises.

Dear Professor Fekete: [The following appears to be largely a rehash of Butler's points, so I'm not too surprised that Fekete has not made it a priority to directly respond. In fact, most of the below is already addressed by Fekete. Also, if Fekete is right, he could make a lot of money as a consultant and it is not in the self-interest of such a consultant to correct misconceptions of less insightful investors. Altermately Fekete could make eouugh money to have a nice life and pursue his studies by speaking to more receptive folks who pay to attend his lectures. - FNC]

As always with your essays, I find A Primer on the Silver Basis to be both enjoyable and educational. After reading it however, there are still several issues that puzzle me.

If there exists somewhere a hoard of silver large enough to cover all the short positions, then it follows that there is no natural constraint on silver supply — only a man-made one. If there is a man-made shortage — and a rise from $4.02 per oz. to over $16.00 is evidence of it — why does it exist? Is the price rise meant to draw out new supplies for the shorts and accumulators to acquire? This does not seem to have happened, partly because most silver production is a byproduct of other mining operations and is therefore insensitive to changes in the metal's price. What the price rise has done is to rekindle investors’ interest in the metal, which provides competition for anyone trying to buy substantial amounts of silver. Besides, as you explained the shorts can trade the basis at any price level, so why not keep prices low and investors comatose?

Another item that I have difficulty understanding is your willingness to accept the CFTC’s assurance that there is little naked short selling of silver occurring. Taking the CFTC at their word is a matter of personal trust and belief, but I have to point out that prominent Americans, from former Treasury Secretary Paul O'Neill to former White House Spokesperson Scott McClellan, have charged that truth is not highly valued in Washington, so please consider that.

Thus, I am far more inclined to judge our public servants by their actions than by their words. According to the CFTC’s 2004 letter denying silver market manipulation, "The CFTC has absolutely no bias with respect to the level of prices in the silver market or any other market we oversee." Yet the action they have taken is to restrict delivery of silver, while leaving shorts sales unencumbered by limits. If all the silver short sales are, in fact, hedged than what is the purpose of this limit on deliveries and why doesn’t it exist in other commodities?

I know you decry the limited delivery policy as misguided, but actions speak louder than words. Until the CFTC lifts its delivery limits, the onus remains on them to prove that the shorts are capable of delivery. To assert, "The CFTC has substantially more information than it is permitted under the Commodity Exchange Act to make public," is not sufficient to convince many people that the regulators are telling the whole truth. Furthermore, I can only wonder how definitive this secret proof is if much of the hedged bullion is located out of their jurisdiction, in China.

As a straw in the wind, the SEC has a similar mission to the CFTC to prevent market manipulation, except the SEC patrols the equity markets. How well they are accomplishing this task is suggested by a recent report that a Taser International Inc. proxy vote drew ballots from 80 million shares, even though the company has only issued 60 million.

You make the point that many commodities have major traders who conduct their activities according to the basis. Secrecy is crucial for them all, regardless of the commodity, otherwise the large traders would never be able to get in and out of positions without being frustrated by smaller, nimbler competitors. Why is it that only the monetary metals— silver and gold — have accumulated such a concentrated group of short sellers? What is the special, mysterious quality that leads to such concentrated short positions in the monetary metals, but not in other commodities?

Given that silver and gold have more than quadrupled off their bottoms, the explanation that suggests itself is that these short sellers are very special shorts, indeed, because they do not mind losing money. They have held large short positions at every step up from the bottom. If they are making money off their basis hedge, than to offset their paper losses they must be selling physical metal somewhere. Surely reports of heavy sales of bullion would be noticed and isn’t this inconsistent with the delivery limits on the COMEX and the various reports of spot shortages in the retail market?

So my final question is, if bullion sales to offset paper losses are not taking place, who might it be that trades monetary metals without concern for monetary gain? The possibilities are, I believe, quite limited.

All of the above is offered with the greatest respect and admiration for your work. It is also not meant in any way to detract from the significance and utility of the silver basis in evaluating silver market conditions. Thanks again.

Sincerely,

Peter R.

P.S. One more thought on the "Putting Loincloth on the Naked Bogeyman: A Primer on the Silver Basis" essay.

Silver prices on the commodities exchanges are generally quoted for 1,000 oz. bars. It is quite possible to have a temporary surplus of these large bars while at the same time a shortage exists of every style and type of silver that is popular with retail buyers. Eventually some of the 1,000 oz. bars will be converted into other sizes, but that takes time for delivery, fabrication and shipping. Thus retail shortages are not incompatible with a temporary slump in the exchange price. These retail shortages can persist, particularly since silver deliveries from COMEX warehouses are both limited and frequently delayed. Therefore, a short term drop in price does not preclude the existence of a general silver shortage.