Marc Faber: Excess liquidity can slosh into commodities and push them up fast

Section:

Right In Front of Our Eyes

By Theodore Butler
www.InvestmentRarities.com
Tuesday, October 19, 2004

There were two extraordinary developments last
week. Although the connection was not made
openly, they were very much related.

The first development was the historic one-day
selloff in the base metals on October 13. It is
difficult to recall a day when metals such as
copper, aluminum, zinc, and lead fell by as much
as 10 percent, with nickel falling more than 15
percent. But what is most extraordinary is the
reason all fell like they did, when they did.

When you strip away the noise and the
after-the-fact reporting of the news (such as another
slowdown in China), prices rise and fall solely upon
the relative aggression of the buyers or sellers.
The sellers on the day of the big selloff (and
subsequently) were clearly more motivated and
aggressive than the buyers. Or so it would appear.

In reality, the sellers were tricked by the buyers
into selling, even though those sellers are still not
aware that they were hoodwinked into selling at
distressed prices.

Of course, the sellers were, almost exclusively, the
same brain-dead technical hedge funds that I write
about so often in silver and gold. I don't have a real
financial interest in the base metals. My ax to grind
here is strictly the distortion caused to the free
markets by the mechanical tech funds reacting as
one entity, and playing into the commercial dealers'
collusive bid rigging.

It was the same old game we've seen enacted
continuously in COMEX silver and gold, only this
time the main stage was the London Metals
Exchange (LME), the world's leading base metals
trading platform. The COMEX copper market was also
part of the manipulative selloff, and it is from the
soon-to-be-released copper COTs that we will be able
to confirm that it was mainly dumb tech fund selling
and crooked dealer buying that caused the selloff.
The LME is nowhere near as transparent as the
COMEX, and there are no equivalent COTs there,
to my knowledge.

I want to keep this brief, so let me make my point.
Intentional or otherwise, there is a sickness that all
of our markets have developed in the past two
decades, as a result of the emergence of these
technical hedge funds and the colluding commercial
dealers that harvest them. Even though they are
separate entities, because these tech funds are
operating on essentially the same price signals
and moving averages, their effects on the markets
are the same as if they were under the control of
one person.

I ask you to think about this new concept.

My main complaint here is that the law would clearly
preclude any one entity from buying and selling as
much as the tech funds (and dealers) collectively
transact. Yet, if the tech funds are all essentially
doing the exact same thing, at the same time, isn't
the net affect the same as if they were one entity?
In other words, what's the difference (in market
impact) between one entity buying or selling 50,000
contracts in a time-urgent manner, and 50 tech funds
transacting 1,000 contracts simultaneously?

And I don't think these tech funds even realize that
they are acting as one. They jealously guard their
secret trading formulas, when in reality it doesn't
matter what supercomputers they are using to
compute moving averages, as the end result is
essentially the same for all of them. Numbers are
numbers.

Commodity law would never allow one speculative
entity to control or transact 50,000 contracts of
anything because it's obvious that this would
manipulatively impact the price. Yet 50 unrelated
tech funds controlling and simultaneously
transacting the same amount of contracts for the
same silly mechanical reason has the exact same
manipulative effect on price. I submit that both
should be disallowed. Remember, the very purpose
of commodity law is to prevent speculators from
setting the price.

Incredibly, there exists a simple solution to this
problem of tech funds and dealers controlling the
markets and setting prices, and it's already on the
books. It's called speculative position limits and
you have seen me write about it often. These
limits, when applied with common sense and
fairness, would solve the issue of tech fund and
dealer paper trading dominance over prices. If
tech funds and dealers are going to transact
massive positions collectively and in unison,
reasonable speculative position limits should
apply to the collective position. This isn't rocket
science.

So where are the regulators, namely the
Commodity Futures Trading Commission and
the commodities exchanges? I'll tell you where
they are -- accommodating the dealer community.

You see, it is the dealer community that sets the
rules, and they would never set a rule that would
cost them money. They earn great sums harvesting
the tech funds and want to see the manipulative
game continue. There's even a hard to believe extra
kicker that the dealers reap from the tech funds. In
addition to taking the opposite side of whatever the
tech funds buy or sell (euphemistically referred to
as "market making"), the dealers actually do the tech
funds' trading for them, in the dealers' dual role as
tech funds' broker and competitor. That means that
the dealers always know the tech funds' positions
and likely behavior and actually buy and sell for the
funds while trading for the dealers' own benefit.

This is an extremely unfair advantage, similar to
being able to see the other guy's down cards in a
poker game. If that's not unfair and corrupt, nothing
is.

Unfair and corrupt. That leads us to the next
extraordinary event of the past week, New York
Attorney General Eliot Spitzer's taking on the
insurance industry. While I am sad that there is
so much wrong in America, I am glad that there
are men like Spitzer trying to right the wrong. He
is a true American hero. That is why I wrote to
him in the first place about silver and AIG. I knew
there were few men with the courage to stand up
to such a powerful corporate juggernaught.

I am going to resist the temptation of patting myself
on the back for first making the Spitzer and AIG
link and instead concentrate on analyzing the silver
connection with this latest insurance industry
scandal. But as I have written repeatedly, that AIG
has apparently departed the silver business is solely
because of Spitzer's behind-the-scenes involvement.
You don't go from being the dominant force to running
away for no good reason. I would suggest that those
new readers unfamiliar with the issue look up past
articles, as there weren't many in the last year in
which AIG was not mentioned.

There are some similarities and differences between the
silver market and the unfolding insurance scandal. One
similarity is that the practices under attack in the
insurance scandal, from bid rigging to contingent
commissions, were longstanding and widespread.
It was only after an outsider, Spitzer, looked at them
from a different perspective that they were seen by all
to be corrupt.

Similarly in silver, we have longstanding practices
that defy legitimate economic explanations, like the
concentrated shorting of more silver than exists and
the corrupt practice of leasing. Let Spitzer publicly
question those practices and the reaction will be
profound.

Another similarity between the silver manipulation and
the insurance scandal is that there exists an extensive
body of law and regulatory apparatus expressly created
to prevent the very wrongs now being revealed. And in
both cases, that body of law and regulatory apparatus
failed to deal with the wrongdoing. In silver, the CFTC
and the NYMEX actually deny any manipulation exists.
It is a denial that will prove more embarrassing and
damaging than the failures of the state insurance
agencies that were just out to lunch.

In all of Eliot Spitzer's great successes, from the Wall
Street research scandal, to the mutual fund timing
scandal, to getting AIG out of the silver business, and
to the new insurance scandal, there have been
designated regulators who were asleep on their watch.
Without him, it would surely be (crooked) business as
usual.

To his great credit Spitzer is obviously motivated by a
desire to help the regular guy. Also to his credit is his
desire to reform as opposed to just punish. He is
concerned with making the system better, not
destroying it. If he wanted to, he could have snapped
AIG like a toothpick, in either the silver matter or this
insurance issue, so compelling was their bad behavior.

Also similar are the repugnant conflicts of interest
that exist in both silver and insurance, from the insurance
brokers taking commissions from both customers and
insurance companies for the same policy to the silver
dealers taking commissions from and allocating prices
for fills for tech funds and the public alike on trades they
take the other side of, as principals.

Perhaps the most glaring similarity between the silver
manipulation and the insurance scandal was the regular
bid rigging, price fixing, and lack of real competition in
both. That I have consistently used these very terms to
describe the silver market and they are being used by
Spitzer to describe the insurance scandal is no
coincidence. Neither is the fact that one firm, AIG, is
central to both scams. Whether it is an insurance broker
creating phony bids for insurance to rig the price, or the
COMEX silver wolf pack collusively pulling bids to snooker
the tech funds, this is a distinction without a difference.

Both deeds were done to create an artificial price.

But there are some big differences between the silver
manipulation and the insurance scandal. For one, I think
the silver manipulation is more serious in that a single
price has been manipulated, as opposed to individual
insurance policies. Artificially low silver prices over the
past 20 years have bankrupted some mining companies
and caused the U.S. government to dispose of much of
its silver at unfair price levels, to cite just two examples.
It is because the silver manipulation is potentially more
serious than the insurance, mutual fund, or Wall Street
research scandals that Spitzer has chosen to work
behind the scenes in silver, rather than publicly, in my
opinion.

Another big difference is that the insurance companies
involved and others not accused, stopped their bid
rigging and conflicted commission arrangements
immediately. Silver is still a bid-rigging and price-fixing
crime in progress. Sure, AIG may be gone in silver, but
the wolf pack still dominates. It will be a great day
indeed when we can speak of the collusive bid rigging
and price fixing in silver in the past tense.

The biggest difference between the silver manipulation
and the insurance scandal, as well as the mutual fund
and Wall Street research scandals, is that the others
were unexpected and originated on basically a single
complaint or revelation. Not so in silver. In silver,
the manipulation has been openly discussed and debated
for years. More than 3,600 people, an absolutely
enormous number, have signed a petition to Spitzer
beseeching his assistance. There were no such public
pleas in the other scandals. In silver, the CEOs and
general counsels of the Silver Managers were personally
notified of their firms' involvement. In silver, the
regulators were contacted more times than can be counted,
by others and myself.

There will be no claims of ignorance when silver blows.

The main lesson from the shocking developments over
this past week is the reconfirmation of widespread
institutional financial fraud in every nook and cranny.
There can be no reasonable doubt as to the extent
financial institutions will go to make an easy buck. It
is against this backdrop of new revelations that I
raise an issue I have harped upon recently: Where
are the metal mining companies in all of this,
particularly the silver mining companies, that they
don't see what is right in front of their eyes?

Why a copper company, for instance, would remain
silent as the price of its product drops 10 percent in
a day, solely due to the tech funds being tricked
from their paper positions is beyond me. But it is the
silver mining companies, particularly Pan American,
Coeur d'Alene, Hecla, and Apex that bear the greatest
scrutiny. Silver has been manipulated for 20 years,
while copper hasn't. Their collective silence on the
silver manipulation issue defies analysis. One
company, Pan American, actually continues to attack
me as if I'm some great enemy of silver.

I had always assumed that it was stupidity, cowardice,
or just plain stubbornness that accounted for these
miners refusing to help themselves and their
shareholders by speaking out against an increasingly
obvious silver manipulation -- especially since other silver
miners have broken rank and bought silver. In light of
this week's developments, namely, the base metal
massacre and Spitzer's attack on the insurance
industry, the silver miners' continued lack of concern
is bizarre. I'm starting to agree with those that
have suggested a more nefarious motivation. Is there
some type of quid-pro-quo that we can't see?

With so many revelations concerning widespread
financial fraud in so many areas, it's getting close to
the point that if you believe that silver is not manipulated,
you must also believe that it's the exception. Given all
the facts, that's just not reasonable. At the very least,
the silver miners should be objective enough to
acknowledge the possibility of a silver manipulation.
That they fight the very idea that it's possible that silver
is manipulated raises serious questions about their inaction.
In the case of Pan American, Chairman Ross Beaty has
publicly written that gold is likely manipulated but
definitely not silver. Huh?

Make no mistake; it has been the silver miners' lack of
involvement that has prolonged the manipulation. A primary
producer questioning a continued low price carries more
weight than an analyst's complaint. The flip side is that
if events play out as I expect, great shame will be heaped
upon those miners who did nothing, and great praise on
those who did something.

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