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Gold, Silver Distorted Markets, Financial Sophistry, and Moral Hazard

Commodities / Gold and Silver 2015 May 17, 2015 - 08:06 AM GMT

By: Jesse

Commodities

There was intraday commentary here that included an interesting perspective from the audacious one percent and their enablers.

And there was another about the current state of political discussion in Britain, a recent awkwardly stated reflection by the Prime Minister that may have revealed the mindset of their powerful, and its possible relationship with the continuum of politics and 'statism' here.

Oddly enough, both seem to have some implications for another question that was raised by a reader who shared this from another site. It was in reference to a posting earlier this week at Le Café that showed that the number of potential claims on actual available gold at the Comex was back to a record high.


And it is further related to a familiar theme about the relationship between a thing masquerading as a market, The Bucket Shop on the Hudson, and THE marketplace for precious metals in Asia and the Mideast. And the potential longer damages implicit in their protracted divergences.

"It is not meaningful that there are 107.7 claims per registered ounce. you should consider that the ratio between paper SPY and real SPY is infinity.

You are making the fundamentally flawed assumption that you need a physical commodity to determine price. You do not.

It doesn’t matter how many physical ounces there are per claim. It can be 1 or 1000 or 107.7 or infinity and it simply doesn’t matter.

The purpose of commodity markets is not to trade commodities, it is to determine price. There are zero SPY physical contracts and the market works just fine.>

I was a commodities broker and part of the test is to ask the function of commodity markets. Every commodity broker understands you don’t need a physical product.

It’s not a broken system, it’s existed in one form or another for a longer time than currency in any form. But to use it you have to understand it and you do not.

Everyone who owns physical gold or silver bought it with paper. There is no difference, they are fungible. The only difference is the price you are willing to take or to give. Physical and paper are exactly the same.

Saying that financial markets are manipulated is about as meaningful as saying the sun rises in the East. Well, duh?"

What this person is saying is that price really has nothing to do with actual supply and actual demand for a physical thing. And much worse, they seem to have a remarkable disregard for risk and leverage. I was originally going to ignore this since it smelled like teen spirit. But when they came back and announced their expertise, how could I resist using this as an occasion of some education.

Futures are derivatives, bets. They are wagers that are indicative of where professionals think that price is going, should be going, given a set of known and unknown factors with certain assumptions and other factors, including fraud and gaming the system with bluffs, etc.

These types of futures markets began as a means for people who actually used and supplied things like commodities to factor in the risk in the 'future' and to essentially spread the risk around.

The 'futures market' is not the market. No derivatives market is the market. It is a reflection of THE market, and that reflection or representation varies in its quality and efficiency from market to market and over time. This is why we have rules and regulations and enforcement.

A derivatives market is a creature of risk arbitrage, and leverage, and it is a reliable indicator of price to the extent that risk is correctly perceived and priced, leverage managed, and these exchanges are REGULATED against the short term gaming that speculators are often wont to do.

I really do not blame the guy who thinks these things in his statements above since he knows what he has been taught, and what the financiers think these days are distorted by moral hazard.

The notion that the paper markets can set prices as they will without regard to risk or leverage is a not uncommon assumption held by those in the pursuit of unearned wealth. That is why we have market crises and crashes.

This willfulness of paper is at the heart of some interpretations of Modern Monetary Theory that enthrones the principle of fiat in determining value above all other considerations, including the willingness of actors in the physical marketplace to accept it at a stated value. At its worst it is a reflection of a kind of statism.

This flawed assumption of the extensible power of fiat is the basis of every black market and currency crisis in history.

Commodities are different than stocks, because a stock is itself a derivative wager, a share in the future profits, dividends, and losses of a company. How can any broker fail to know that? Pretty basic stuff. That is the difference between buying bullion and a mining stock. A futures contract is a promise to buy and sell a thing at some future date. It is not the thing itself, but it is based on the promise that you CAN do what you say you do.

Like the famous short seller Daniel Drew once said, 'He who sells what isn't his'n, must buy it back, or go to prison.' But it is not always just a matter price to someone who might really wish to have the thing with they think they are purchasing.

I understand the mindset. I really do. It is the same mindset that Kyle Bass calls out in his video below about the Comex about why he chose to take delivery of his gold out of a sense of fiduciary responsibility.

Commodities are by definition a real thing, and are not totally fungible with paper money at any and all times at a set price. I think this is the MF Global school of thought, and it is fraught with injustice and moral hazard. And it is nonsense to think that paper can paper over any and all action or any excess, except in a nation of willful thugs acting in a web of lies that come crashing down periodically.

If you believe in the pricing of things without reference to supply, demand, time, and risk, I invite you to go for a very long and solitary walk into the Sahara Desert, with only the price of a couple of gallons of water and a hotel room in New York in paper dollars in your pocket.

Enjoy the refreshing and thirst quenching crunch of paper and your comfortable bed of sand.

It is a broken system in which these types of wagers can set price without reference to a realistic set of expectations based on supply, demand, leverage, and risks. This is where bubbles are born and frauds dwell.

Leverage is a component of risk, but given the state of things, I feel the need to call it out separately since it seems to be fashionable now amongst 'market professionals' to believe that leverage is irrelevant to the point of infinity. Maybe it is when you are playing with other people's money, and there are no consequences for your actions.

Such a self-referential system does not properly allocate capital for future investment in supply. It does not inform the planners of changes in consumer interest, and the state of their own needs and conditions. It does not give consumers the surety that they can actually obtain what they need and when they need it, and not be forced to accept some substitute at a dictated 'price.'

This sort of nonsense used to be relegated to the intraday antics, in which markets are just a voting machine, but you could rely on markets on the longer term to obtain some greater efficiency. The breakdown is that the grift has completely taken over, thanks to the policy errors of the Fed and the regulators.

The financial markets are an enabler, and not an end unto themselves. And when they lose their proper place in the bigger scheme of economic things where the real markets and people exist, it is because of the moral hazards of an outsized and over-leveraged financial sector.

It may take some time to catch up with us, but we know that at some point there will be hell to pay in the real world. And there are those who simply do not care, who are sure they can just take their loot and blithely walk away, if they ever bother to think that far ahead.

How can we not see this lesson now, after all that we have seen and been through over the past twenty years?

We seem to be relearning that lesson about every seven or eight years, and then forgetting. And until the consequences of their actions are visited on these infantile masters of the universe, I suspect we will have to keep relearning them because they are certainly not going to stop on their own.

This is the point of madness to which the sophists of finance have brought us, for any variety of motives. I don't really care to discuss it any further with these sociopaths and willful fools at this late stage and after the carnage they have created. It makes me sick to even think any longer about it and where it may be bringing us.

If you do not get this by now, then you probably will not 'get it' until you are searching in the rubble for your face after the next financial crisis.

Have a pleasant weekend.

By Jesse

http://jessescrossroadscafe.blogspot.com

Welcome to Jesse's Café Américain - These are personal observations about the economy and the markets. In providing information, we hope this allows you to make your own decisions in an informed manner, even if it is from learning by our mistakes, which are many.

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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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