The King of Silver and Gold Flees

J.P. Morgan Sees the Pitchforks and Torches Coming

Written by Adam English
Posted July 29, 2013

J.P. Morgan has finally bowed to the masses and will abandon its throne of silver and gold.

Bearing the modern equivalent of pitchforks and torches, a handful of outspoken whistleblowers, investors, and journalists have begun shedding light on the highly questionable manipulation of markets and commodities by J.P. Morgan and the other megabanks.

The whole fiasco is the result of a lousy patchwork of half-baked laws.

The wall between banks, investing companies, and commodities was dismantled when the Glass-Stegall Act was dismantled in 1999. As a result, Morgan Stanley (as it was called at the time) and the Goldman Sachs Group, Inc. aggressively moved into both sectors. At the time, the law allowed them to keep their commodity businesses — as long as they were in place before 1997.

The Federal Reserve made the situation worse in 2003 by broadening the rules. The Fed thought commodity trading was complimentary to financial activities and, as a result, a logical sector for banks to enter.

The results have been disastrous, with the evidence against the banks and this law piling up higher by the day.

The Fed began reviewing the implications of its decision last week.

The unintended consequences and implications of misguided laws and regulations have become the defining aspects of the commodities market. Politicians can no longer ignore this situation, and are now openly questioning in Congressional and Senate meetings why banks are in the commodities market in the first place. 

Just last week, I was compelled to point out the manipulative exploits of J.P. Morgan in the silver market. HSBC and Goldman Sachs were also mentioned.

All of the megabanks have jumped into commodities futures, warehousing, and high-frequency trading of paper gold and silver. This is in addition to holding shipping companies, operating power plants, and managing pipelines, electrical grids, and other basic infrastructure. Any market large enough to distort was turned into a profit center.

But the track record of the banks has been abysmal. J.P. Morgan in particular is behind a number of misdeeds and a good deal of deception...

Repeat Offender

One look at J.P. Morgan's resume, and you have to wonder who in their right mind would let them near commodities to begin with.

Of course, this is an article and not a book, so we'll just stick to recent history...

We'll start when J.P. Morgan inherited a massive amount of silver shorts priced between $20 and $21 from the Bear Stearns bankruptcy deal the U.S. Treasury Dept. approved. Together with HSBC, the two megabanks covered 85% of all silver shorts.

If the free market was allowed to set the price of silver during unprecedented monetary easing would turn the acquisition into one of the worst deals in its history... So J.P. Morgan made sure that didn't happen.

By maintaining the massive short position and utilizing high-frequency trading, JPM could buy up silver at a discount and artificially induce others to sell and keep the price low. Same with gold.

However, that started to change this year, and J.P. Morgan threw gold investors under the bus to further its strategy... 99.3% of the physical gold sales at the COMEX between the beginning of February and the end of April was from J.P. Morgan alone.

At the time, it looked like just another power play in the market to capture gains and force others to panic sell until a better entry price was available.

Since then, selling has not subsided. J.P. Morgan even removed 66% of its COMEX-eligible gold from the market a couple weeks ago, leaving just 46,000 troy ounces when it had over three million in the market two years ago.

Now things look a bit different — but just as manipulated. This massive reduction, coupled with COMEX-eligible gold for delivery across the board and massive demand from Asia, is driving a huge wedge between the reality of physical gold prices and paper trades through exchanges.

The physical gold J.P. Morgan will retain after removing it from the sale rack is poised to skyrocket in value. If it is getting out of the market, it might as well bolster its holdings in the process. If it destroys the market at the same time, so be it.

The Warning Shots

In the last month, we've seen a massive fine handed to J.P. Morgan and renewed interest in revoking the rules that allowed J.P. Morgan and the megabanks to dominate commodities.

The $400 million fine for giving false information to state power grid operators and collecting money for not running power plants was the first real hit J.P. Morgan has taken for manipulation in years.

Reuters just reported that the Department of Justice has sent letters to at least two firms seeking information for a preliminary inquiry into complaints that companies involved in metals storage may have inflated prices earlier this week.

Bart Chilton, head of the Commodity Futures Trading Commission, has even publicly stated that silver prices are subject to "fraudulent influences," and the parties behind it should be prosecuted. On July 25th, he said:

This whole area of banks owing the physical, warehousing and delivery mechanisms of commodities is one that policy makers need to thoughtfully consider, and soon. Banks getting back to being banks and making loans to businesses and individuals seems like the best course of action. Perhaps that will happen without any policy changes, although I have definite doubts.

You and I have heard plenty of talk from legislators in the past, and we're starting to hear it again about this situation...

We have no reason to think it'll come to anything (consider the number of the bankers jailed for causing the Great Recession...) when they rattle their sabers in front of a camera. But when J.P. Morgan positions itself to get ahead of the curve, well, that's different.

The company's move shows that it believes the politicians won't like what they see. There is no other reason for them to abandon what has been a source of massive profits.

The 10 largest Wall Street banks generated about $1 billion from physical commodity units in 2012, and about $5 billion from commodity derivatives and financing.

J.P. Morgan has the daunting task of unwinding $6.7 billion in total positions.

Going Forward

If everything goes as planned (or as publicly stated), J.P. Morgan will be out of the commodities business within a couple of years.

And we'll know within weeks or months if the other megabanks will follow the first rat off the sinking ship.

What that means for you and me could be a whole new world... It could also be nothing different.

The U.S. government can only legislate and control a portion of the global markets, and it has a terrible track record rife with unintended consequences. If the move is entirely voluntary, the demand for legislation will subside and it's likely nothing will happen. The door will stay open for the megabanks as well.

One thing we can count on is tightened liquidity in commodity markets. It could be negligible if J.P. Morgan and the other megabanks just spin the business into new firms. If they sell their commodities desks and positions to other firms or close up shop, it'll sap the market of liquidity for months or years.

In my opinion, we should welcome the potential for short-term pain if it means a truly free market.

We'll all be better off without being subject to the whims and decrees of the self-appointed kings of commodities — along with the heavy taxes they collect from us through their schemes and manipulations.

Take care,

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Adam English

follow basic @AdamEnglishOC on Twitter

Adam's editorial talents and analysis drew the attention of senior editors at Outsider Club, which he joined in mid-2012. While he has acquired years of hands-on experience in the editorial room by working side by side with ex-brokers, options floor traders, and financial advisors, he is acutely aware of the challenges faced by retail investors after starting at the ground floor in the financial publishing field. For more on Adam, check out his editor's page

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