Chat-room threads and the real significance of the hunt for silver
- There was a time when John Landis’ 1983 film ‘Trading Places’ was required watching for every new employee on the trading floor. Having had his life ruined by his erstwhile employers, the commodity magnates Duke & Duke, the hero Louis Winthorpe III (played by Dan Akroyd) teams up with con artist Billy Ray Valentine (played by Eddie Murphy on his screen debut) to bring the Duke brothers down and enrich themselves in the process. Winthorpe’s pep talk at the start of the climactic final scene on the floor of the New York commodity exchange is the stuff of legend, and has to be quoted in full:
- The film’s theme of the servant rising up against his master is borrowed from Beaumarchais’ 1778 play ‘The Marriage of Figaro’, better remembered today for Mozart’s subsequent opera of the same name. Indeed, the opening scene of ‘Trading Places’ is set to the overture from Mozart’s opera. The film’s plot of an attempt to corner the commodity futures market is also borrowed, this time from the Hunt brothers’ eventually unsuccessful gambit to corner the silver market.
- The Hunts, an oil family from Texas, spent much of their time in the inflationary 1970s trying to preserve the family wealth by investing in silver. Like any Greek tragedy, hubris was their downfall, and a sensible hedging strategy became a money-making obsession, and greed got the better of them. After buying physical silver to create a supply shortage, they then forced up the prices of futures’ contracts on the commodity exchange which made silver rise from the low teens to almost $50. The jeweller Tiffany memorably took out an advert in the New York Times decrying the iniquity of it all. Eventually, rising interest rates and higher futures margin costs caused the Hunt brothers to have a liquidity crisis, forcing them to unwind their positions and seek protection in the bankruptcy courts. The silver price collapsed and has never regained the levels of the early 1980s.
- So when a rag-tag army of retail investors called ‘r/WSB’ (Reddit/WallStreetBets) began to take an interest in the silver market, communist supremo Karl Marx again appeared to be proven right about history repeating itself as tragedy and then farce. Whether or not r/WSB is really the driver of all this or whether there are ‘other forces’ behind it (the mainstream media and Twitter are in overdrive), the silver price started to move sharply.
- The graph below shows the spot price of silver (blue) jumping as the story broke. It also shows the CBOE Silver ETF volatility index over the same period in yellow. Options have been a key tool in the ‘weaponised gamma’ ramps of various stocks in the past year, so monitoring implied option volatility (in this case of options on the SLV iShares Silver Trust) is a key way of tracking such squeezes. The sharp sell-off in silver on the 2nd February followed the Hunt brothers’ pattern where the Commodity Futures Trading Commission (CFTC) hiked silver futures margins by 18% late on the 1st February to reduce speculation (marked with a red circle). Some market commentators noted that such margin hikes only occur on futures spikes, not on sell-offs. Do I hear conspiracy?
- Investors should be getting used to crazy price moves by now. With interest rates at or below zero, and with markets awash with liquidity following central banks’ 2020 splurge, odd things are happening all the time. What makes the r/WSB a little different and which has the media talking heads up in arms is that their aim does not appear to be making a profit but to ‘stick it to the man’. The recent spike in GameStop (GME.US) was all about squeezing hedge-fund shorts. After receiving $2.75bn emergency cash from sponsors Citadel and Point 72, according to the Wall Street Journal, hedge fund Melvin Capital (a high-profile short in GME) ended up recording a monthly loss of 53% of AUM in January.
- Paranoia about short squeezes has led to dramatic hedge-fund unwinding. The graph below shows the precipitous rise of the Goldman Sachs US most-shorted basket of stocks in January. This is all about rotation and de-risking. At the time of writing, the S&P 500 is up 0.5% for the year but the VIX volatility index is stuck in the 30’s suggesting highly-elevated risk levels (an implied volatility reading of 30 means a daily index move of around 2% up or down, so quite hefty). All of this because of some blokes in a chatroom ramping a few crowded shorts? Perhaps. The servants rising up against the master? That is the really interesting question.
- Back to silver. The problem here is that the bullion banks are generally short silver futures and would lose money in a squeeze. The lads on r/WSB talk about pushing silver to $1,000 (dream on), and this would easily bankrupt the banks, including too-big-to-fail ones like JP Morgan and HSBC. This really would be a scalp. There is ‘sticking it to the man’ and then there is bringing the whole system down. A lot of this is bluster. While r/WSB are clearly a nihilistic bunch, a bit like a chatroom version of the 80s hip hop group NWA, there is something else quite dangerous and potentially revolutionary going on here which could mark a see-change in overall attitudes to money.
- Silver is probably too cheap due to demand and supply factors. Its high conductivity makes it a key component in circuitry and it is likely to benefit from the ESG drive towards electrification and clean energy (silver is a key component in solar panels). According to the Silver Institute, 2020 production fell to 978m oz from 1.023bn oz in 2019 due to Covid-19 (many of the mines are in badly affected areas of Mexico and South America). Clearly the Comex futures set up (‘paper’ silver) has an inordinately large effect on the price of the physical metal out of all proportion to production. On 1st February 2020 alone, 325k futures traded, equivalent to 1.6bn oz of metal versus overall annual production of around 1bn oz. In 2020, JP Morgan was fined $912m for spoofing the silver futures’ price. Conspiracy, price-fixing – pick your poison. There is clearly an element of truth to all of this. But this still misses the point.
- The most interesting part of this whole silver story is people going out to buy coins and bars of silver – the actual physical metal. This is no longer a WFH do-it-on-an-app thing. What started in 2020 as a ‘dumb’ retail chasing bankrupt stocks like Hertz (HTZGQ.US) on the Robinhood trading app, has, within a year or so, almost reached the heart of the money system. Silver is one step away from gold, and gold is still the reference asset for all forms of fiat money until the last central bank sells its final ounce of gold, and that is not happening any time soon. Now all sorts of folk are hoovering up silver coins like there is no tomorrow.
- Why is buying physical silver so important? There a few things to note. The screenshot below shows the cost of a US 1-ounce silver eagle ($39.87) on the Apmex.com website. At the time of writing, spot silver is trading on screen at $27.5 and the March 2021 Comex future (SIH1) is at $27.78. Clearly physical is at a massive premium in coin form (there are widescale reports of unavailability after this recent r/WSB rush). Part of the ‘screw the banks plot’ is to buy up the physical metal (like the Hunt brothers did) and force futures higher. Perhaps this will work, but they need to buy an awful lot of physical silver to do this, and it may be that retail, however large the grouping, might not have the firepower (especially given the massive flows on the Comex futures exchange relative to physical trading).
- What does all this mean? The r/WSB mindset is a bit like the one characterised in Chuck Palahniuk’s 1996 book ‘Fight Club’, later made into a film starring Brad Pitt and Edward Norton. These are the people who feel left out or left behind by the system, who haven’t benefited from the bailouts in the way big business or Wall Street always seem to do. This is the source of their nihilism and their don’t-care attitude. That this disenfranchisement and dissatisfaction has started to find an expression in physical silver though is quite something. Whether it is luck or fate, they’ve almost got to the heart of the matter; questioning a country’s currency is questioning its ability to govern. There is no more powerful expression of dissent.
- Back in the days of commodity money (gold and silver), governments often debased the coinage to help their finances. The purity of the metal coinage was reduced, so you had more coins but with a lower value. The effect was inflationary. The government of England’s Queen Elizabeth (1558-1603) was particularly adept at doing this, which led to the term Gresham’s Law (after the Tudor financier) which says ‘bad money drives out good’. This means that people hoard the good, pure coins and try to get rid of the newly debased ones. The velocity (turnover) of money rises, and inflation is the consequence.
- So when you see a thread in an internet chatroom filled with characters with nicknames like ‘roaring kitty’ resulting, within the space of a few days, in people queuing up outside precious metal wholesalers to buy silver coins (and given the premium paid these are definitely for keeps), one might be entitled to say this isn’t a bit like Gresham’s law, it is Gresham’s law in action. These guys don’t like the system, and by implication don’t like its money, and the bad money is driving out the good.
- Do these folks know what they are doing? It doesn’t actually matter. This is not just a glib aside but a more important statement about causality of action in the economic sphere. When Northern Rock went under in 2007, savers queued up outside branches to get their money out in cash form. They wanted their savings back. Did they know at that stage that savers who deposit at banks are really creditors of the bank since the bank lends their money on (and with leverage)? Who knows? What matters is they knew exactly what to do – be first in the line to get your money back, like any sensible creditor. When newcomers hoover up silver coins and bars, does it really matter why they are doing it? Isn’t the action itself enough?
- The point here is one about debasement of the currency and the problem of inflation which follows. This kind of action (buying up physical metal, and dumping dollars, euros, pounds or whatever to do so) is Gresham’s Law in practice. Maybe it is just a fad. But the world hasn’t seen ‘proper’ inflation in developed markets for a few generations, yet it’s funny how people might be starting to act as though they were old-timers at dealing with it. What about inflation? Clearly the world isn’t really expecting an explosion of it, and bond markets are certainly not pricing it for now.
- Under the hood though, things are changing. Extracts from January’s European and Chinese PMI’s and the US January ISM are presented below. The data was all published on the 1st
FRANCE: “cost burdens rose at the sharpest rate for nearly three years”
SPAIN: “price pressures strengthened amid widespread reports of raw material shortages, increased freight costs and higher prices for key inputs such as steel. Overall input prices rose at the sharpest rate for three years”
ITALY: “Disruptions to supply chains intensified, however, with lead times for inputs lengthening to the greatest extent since May, pushing the rate of input price inflation to a near four-year high”
HOLLAND: “cost burdens rose noticeably during January, with the rate of inflation the most marked for over two years. Raw material shortages, higher transportation fees and supplier price hikes were the main drivers of inflation, according to panellists. Factory gate charges also rose, with the rate of charge inflation solid, despite easing since December”
RUSSIA: “manufacturers registered another marked monthly increase in input costs at the start of 2021. Although the rate of cost inflation eased from that seen in December, it was among the sharpest for six years”
CHINA: “stock shortages and shipping delays led to a further marked deterioration in supplier performance and added further upwards pressure on costs”
GERMANY: “There was an associated acceleration in the rate of input price inflation faced by German manufacturers to the highest since July 2018. Increased costs were largely absorbed by goods producers, however, with average factory charges rising only modestly and at a slower rate than in December”
US: Supply base is struggling to keep up with demand, disrupting our production here and there. Raw material lead times have been extended. Covid-19 continues to cause challenges throughout the supply chain. Huge logistics challenges, especially in getting product through ports and in getting containers. We are seeing significant cost increases in logistics and raw materials”
- No prizes for seeing the common theme. Bear in mind too that this is in the middle of lockdown and, if you believe the Fed’s Rosengren, still in the middle of a deep recession. Imagine what happens post-vaccine when everything opens up. Add in another $1.9tn of stimmy from Biden’s White House. Silver coin buying may turn out to be the wisdom of crowds, not the madness of crowds.
The term “RWC” may include any one or more RWC branded entities including RWC Partners Limited and RWC Asset Management LLP, each of which is authorised and regulated by the UK Financial Conduct Authority and, in the case of RWC Asset Management LLP, the US Securities and Exchange Commission; RWC Asset Advisors (US) LLC, which is registered with the US Securities and Exchange Commission; and RWC Singapore (Pte) Limited, which is licensed as a Licensed Fund Management Company by the Monetary Authority of Singapore.
RWC may act as investment manager or adviser, or otherwise provide services, to more than one product pursuing a similar investment strategy or focus to the product detailed in this document. RWC seeks to minimise any conflicts of interest, and endeavours to act at all times in accordance with its legal and regulatory obligations as well as its own policies and codes of conduct.
This document is directed only at professional, institutional, wholesale or qualified investors. The services provided by RWC are available only to such persons. It is not intended for distribution to and should not be relied on by any person who would qualify as a retail or individual investor in any jurisdiction or for distribution to, or use by, any person or entity in any jurisdiction where such distribution or use would be contrary to local law or regulation.
This document has been prepared for general information purposes only and has not been delivered for registration in any jurisdiction nor has its content been reviewed or approved by any regulatory authority in any jurisdiction. The information contained herein does not constitute: (i) a binding legal agreement; (ii) legal, regulatory, tax, accounting or other advice; (iii) an offer, recommendation or solicitation to buy or sell shares in any fund, security, commodity, financial instrument or derivative linked to, or otherwise included in a portfolio managed or advised by RWC; or (iv) an offer to enter into any other transaction whatsoever (each a “Transaction”). No representations and/or warranties are made that the information contained herein is either up to date and/or accurate and is not intended to be used or relied upon by any counterparty, investor or any other third party.
RWC uses information from third party vendors, such as statistical and other data, that it believes to be reliable. However, the accuracy of this data, which may be used to calculate results or otherwise compile data that finds its way over time into RWC research data stored on its systems, is not guaranteed. If such information is not accurate, some of the conclusions reached or statements made may be adversely affected. RWC bears no responsibility for your investment research and/or investment decisions and you should consult your own lawyer, accountant, tax adviser or other professional adviser before entering into any Transaction. Any opinion expressed herein, which may be subjective in nature, may not be shared by all directors, officers, employees, or representatives of RWC and may be subject to change without notice. RWC is not liable for any decisions made or actions or inactions taken by you or others based on the contents of this document and neither RWC nor any of its directors, officers, employees, or representatives (including affiliates) accepts any liability whatsoever for any errors and/or omissions or for any direct, indirect, special, incidental, or consequential loss, damages, or expenses of any kind howsoever arising from the use of, or reliance on, any information contained herein.
Information contained in this document should not be viewed as indicative of future results. Past performance of any Transaction is not indicative of future results. The value of investments can go down as well as up. Certain assumptions and forward looking statements may have been made either for modelling purposes, to simplify the presentation and/or calculation of any projections or estimates contained herein and RWC does not represent that that any such assumptions or statements will reflect actual future events or that all assumptions have been considered or stated. Forward-looking statements are inherently uncertain, and changing factors such as those affecting the markets generally, or those affecting particular industries or issuers, may cause results to differ from those discussed. Accordingly, there can be no assurance that estimated returns or projections will be realised or that actual returns or performance results will not materially differ from those estimated herein. Some of the information contained in this document may be aggregated data of Transactions executed by RWC that has been compiled so as not to identify the underlying Transactions of any particular customer.
The information transmitted is intended only for the person or entity to which it has been given and may contain confidential and/or privileged material. In accepting receipt of the information transmitted you agree that you and/or your affiliates, partners, directors, officers and employees, as applicable, will keep all information strictly confidential. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information is prohibited. The information contained herein is confidential and is intended for the exclusive use of the intended recipient(s) to which this document has been provided. Any distribution or reproduction of this document is not authorised and is prohibited without the express written consent of RWC or any of its affiliates.
Changes in rates of exchange may cause the value of such investments to fluctuate. An investor may not be able to get back the amount invested and the loss on realisation may be very high and could result in a substantial or complete loss of the investment. In addition, an investor who realises their investment in a RWC-managed fund after a short period may not realise the amount originally invested as a result of charges made on the issue and/or redemption of such investment. The value of such interests for the purposes of purchases may differ from their value for the purpose of redemptions. No representations or warranties of any kind are intended or should be inferred with respect to the economic return from, or the tax consequences of, an investment in a RWC-managed fund. Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns. Nothing in this document constitutes advice on the merits of buying or selling a particular investment. This document expresses no views as to the suitability or appropriateness of the fund or any other investments described herein to the individual circumstances of any recipient.
AIFMD and Distribution in the European Economic Area (“EEA”)
The Alternative Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Investment Fund Manager (an “AIFM”) to certain funds managed by it (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior to their investment in an AIF. The majority of the prescribed information is contained in the latest Offering Document of the AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.
In relation to each member state of the EEA (each a “Member State”), this document may only be distributed and shares in a RWC fund (“Shares”) may only be offered and placed to the extent that (a) the relevant RWC fund is permitted to be marketed to professional investors in accordance with the AIFMD (as implemented into the local law/regulation of the relevant Member State); or (b) this document may otherwise be lawfully distributed and the Shares may lawfully offered or placed in that Member State (including at the initiative of the investor).
Information Required for Distribution of Foreign Collective Investment Schemes to Qualified Investors in Switzerland
The representative and paying agent of the RWC-managed funds in Switzerland (the “Representative in Switzerland”) is Société Générale, Paris, Zurich Branch, Talacker 50,
P.O. Box 5070, CH-8021 Zurich. In respect of the units of the RWC-managed funds distributed in Switzerland, the place of performance and jurisdiction is at the registered office of the Representative in Switzerland.