Silver Derivatives

*Definition - A derivative instrument is a contract between two parties that specifies conditions under which payments, or payoffs, are to be made between the parties. It’s like a side bet. Futures, options, swaps, leases etc are all derivative contracts.

The concept behind derivatives is to allow a company to hedge their risk. For example to hedge a credit risk of a bank loan a lender can purchase a Credit Default Swap contract that will payout if the borrower defaults. Hedging risk is a good thing right? Not always. In reality the risk of default does not go away but rather is transferred to another party and a new risk is created in the form of a counter party risk of the CDS issuer defaulting. The issuer of that CDS can hedge their new risk by purchasing a CDS from another issuer and so on. Although the initial concept of a derivative is to hedge your risk, the more and more derivatives that are created off the first transaction greatly increase the total risk is to the overall market.

In the last 20 years derivative contracts have ballooned into the hundreds of trillions of dollars on a notional value basis. In 2008 the inherent danger in this growth in overall risk became painfully apparent with the global crash of the financial markets.

Warren Buffet was correct in identifying derivatives as "WEAPONS OF MASS FINANCIAL DESTRUCTION".

If there was any one person to blame for the 2008 financial crisis it was a woman named Blythe Masters out of the JP Morgan "Financial Products Division" in London. She was the creator and promoter of the Credit Default Swap market and built it up over 15 years into a monstrous 50 Trillion dollar market by 2008 when it all fell apart. The destruction this amount of "risk hedging" ended up costing the world was almost incalculable. Today, even after all the losses and bankruptcies, the Credit Default Swap market stands at over 30 trillion dollars.

So what ever happened to this woman who destroyed the world’s financial markets with derivatives…

1) Blythe went from running the gigantic CDS derivative market to running the gigantic commodity derivative market for JPM.

2) COMEX open interest means nothing. The price of silver is determined on a trade by trade basis. The amount of daily volume on the COMEX is staggering. Based on the COMEX daily silver volume averages over 120B ounces of silver derivatives will trade in 2011. 120B ounces! Stunning number considering there’s a total of just over 700M ounces mined every year. AND THIS IS JUST ONE EXCHANGE!

3) The LBM will settle over 50B ounces of (supposedly physical) silver this year. These are net ounces counted at the end of each day. During the day many multiples of this amount trade hands. I’m conservative and I’ll say 5x the amount.

4) Including all markets and unreported OTC derivatives I estimate that the total worldwide silver derivative contracts traded in 2011 will amount to 500B ounces. 500B ounces!

5) Let’s say that 500M oz of the 700M oz mined every year have silver derivatives attached to them for some reason. That equates to silver derivatives totaling 1,000x the underlying commodity. There is no legitimate market function of silver derivative trades for the 1,000x derivative leverage. In the March 2010 CFTC hearings commissioner Gensler asked Jeffery Christian a very important question at the very end of that hearing. That question was "What are the billion banks hedging on the other side?" His answer clearly didn’t satisfy Chairman Gensler. The answer was "a tremendous amount of things". He then went on to list "forward purchases from mining companies"(not many hedged silver mines these days but ok), "forward purchases from refineries"(ok, I’ll give you one there), "metal leased to electronics manufacturers, catalysts and jewelers"(not that I agree that leased metal should be consumed but I’ll give you that one too). So that’s 3 when put on the spot. That’s only 3! Can he name a thousand for each and every ounce of silver mined this year? Of course not because the vast majority of these 500B ounces of silver derivatives aren’t hedging anything!

6) The truth is that the price discovery mechanism for silver has been destroyed by a mountain of silver derivatives. Remember that "Quaint Little Physical Silver Market" we talked about earlier? It means absolutely NOTHING when it comes to discovering the true Fair Market Value of silver as long as the silver market riggers are allowed pile on 500 billion ounces of silver derivatives every year.

7) Just like the Credit Default Swap bubble that burst and almost destroyed the global financial system in 2008 the silver derivative bubble is an accident waiting to happen.

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The latest from Bix today…

FIREPOWER COMES TO THE CFTC & CHRISTIAN DOES IT AGAIN!

The CFTC just announced that Mark Wetjen's nomination was confirmed and he has now taken Commissioner Dunn's spot.
Statement of Chairman Gary Gensler on Mark Wetjen's Confirmation as CFTC Commissioner

http://www.cftc.gov/PressRoom/SpeechesTestimony/genslerstatement102111

The timing of this couldn't be more perfect. Dunn cast the deciding vote on Position Limits and now he is out! Dunn was a joke of a Commissioner but Wetjen is the REAL DEAL! Along with Gensler he wrote the commodity law portion of the Dodd-Frank Law.

Looks like everything is in place.

Buckle up!!!!

Bix Weir
www.RoadtoRoota.com

PS - Just listened to Jeffery Christian's presentation at the Silver Summit and came away with 2 DOOZIES. 1) He has upped is previous "faux pas" of admitting 100-1 gold trading leverage on the LBM to 400-1 but he says it doesn't matter! 2) Christian claimed that the "Drive By Shooting" in May was caused by a change of trading positions on the COMEX....WHICH IT WAS! Of course, under US Commodity Law it is ILLEGAL for prices to be SET on the COMEX! The futures and options contracts can only be a "price discovery mechanism" and not a "price setting mechanism"!

Thanks again for your valuable insight Jeffery!