After a recent article I wrote about the potential of a silver bubble, I got a question about the behavior of JPMorgan Chase (JPM 2.03%) with regard to the silver market, specifically the allegation that the bank was actively involved in manipulating the silver market through a sizable short position. The basis of the question seemed to be a request to bring forth the issue and address how silver was trading as a result of JPMorgan's activity and within the context of the global economy in general.
As of last December, the last major complaint against the bank was dismissed in a federal court, as well as by the Commodity Futures Trading Commission. That doesn't mean that no wrongdoing occurred, but it does suggest that insufficient evidence exists to take the matter forward.
In terms of the overall economy, an uptick in the overall strength of the global economy creates competing forces that drive silver. The defensive nature of precious metals means that general economic prosperity is bearish. On the other hand, the industrial uses for silver are such that economic activity can also be bullish.
The recent case
On Dec. 21, the case of 44 plaintiffs against JPMorgan was turned town in the U.S. District Court for the Southern District of New York. The class action suit alleged that over the course of several years, the bank had acted to manipulate silver prices at various times, primarily through a 24% to 32% control over all short positions. Many of the positions were inherited from Bear Stearns, but the plaintiffs alleged that silver prices had fallen on specific dates in 2007, 2008, and 2009 as a result of bank activity within the position.
To prove a prima facie case of manipulation, there are four specific elements:
- The defendant's ability to manipulate prices.
- Intent.
- The presence of an "artificial" price, as in the existence of manipulation.
- A direct link showing the defendant was the or a cause of the manipulation.
In the absence of all four elements of the crime, no case for manipulation can succeed. The two hardest elements to prove are intent and the existence of an artificial price. The very nature of markets is such that we often see "unusual" prices without an immediate ability to explain them. Anyone who remembers the flash crash can attest to the fact that prices became unusual very quickly long before anyone was able to explain why. Even with the magnitude of the investigation that ensued, finding an artificial reason was very difficult.
The intent element is also extremely challenging to prove, because you must show that the motivation for the behavior was the manipulation of the market. If JPMorgan initiated short positions that it would have initiated anyway, or as a part of some other trading motivation, the company lacks the intent to manipulate prices. Essentially, it requires an insider to come forward and say that he or she was a part of an effort to drive prices away from their natural equilibrium to generate profits. This is not an easy feat and not one that was accomplished in this case.
Here is where the logic and common sense come into play. You can argue -- given that JPMorgan owns roughly 25% of the short positions in existence, according to some reports -- that it should be obvious that the bank wants to keep prices low. The other, equally plausible, explanation is that the bank inherited a huge short position from Bear Stearns and is now trying to manage that position by trading around its core opinion on the direction of the market; in other words, the size of the position it is stuck with necessitates large trades to unwind the original position carefully.
The silver market
Whether you choose to believe that JPMorgan is actively engaged in silver manipulation, or you agree with the court, as I do, that nothing untoward has happened, no case is likely to proceed in the near term. In broader terms, silver looks well positioned moving forward. Industrial uses continue to grow faster than supply, and no satisfactory replacement exists. Furthermore, the theoretically improving health of the economy is not as certain as some would prefer us to believe.
As long as the Federal Reserve continues on its current course of quantitative easing, inflation remains a serious concern. Against the backdrop of the continuing need for agreement out of Washington, it remains uncertain when things will be stable again. All of this favors an increase in silver prices.
My favorite play in silver remains Silver Wheaton (SLW 4.16%), largely as a result of its model that allows it to leverage the upside in silver prices without being as acutely affected by increasing production costs. The silver streaming model of buying the production of other producers at a fixed, predetermined price gives the company an edge over pure miners such as First Majestic (AG 8.26%) and Pan American Silver (PAAS 3.07%). Despite a record quarter of production, ballooning costs have hurt Pan American; the stock has not traded as one would hope for a company operating as strongly as it is under current conditions.
Ultimately, I don't believe the price is being manipulated. Silver continues to look strong at current levels and deserves a spot in your portfolio. Either way, if you're with the skeptics, remaining on the sidelines appears to be the only option.
