''We know money,'' AIG ads say as company admits scamming $4 billion

Section:

By Ted Butler
InvestmentRarities.com
Tuesday, May 31, 2005

First a quick word on the structure in various markets, as defined
by the commitment of traders (COT) report, and then a follow-up on
something I wrote about last week.

The move down in gold and up in the dollar as a result of the French
vote, augments the existing structure, and the reversal, when it
comes, should be powerful.

In silver, the impressive rally, while expected, was on fairly heavy
volume and penetrated all the moving averages, suggesting
significant tech-fund buying. Almost perversely, this does increase
the odds of a tech fund selloff back down through those same moving
averages. There may be a quick, sharp selloff, although this should
matter little to long-term silver investors. Of course, when the
moment of truth arrives in silver, the COTs will lose their
significance and we will just explode in price

Last week I wrote the following about copper: "Once again there is
no legitimate economic reason for shorts not to deliver as soon as
they can, save that they don't have the material. About the best
thing one can say about the May COMEX silver delivery is that it is
nowhere near as extreme as the May COMEX copper delivery, where
there are more than 2,000 contracts open with the same two trading
days remaining. Interestingly, this number of contracts in copper is
more than all the total copper in COMEX warehouses, something I have
never seen before. This is a very extreme and unusual circumstance.
I don't know what conclusion to reach other than copper is,
obviously, very tight and that the management of the COMEX doesn't
seem quite on top of the situation in allowing such a development."

In subsequent trading over the next two days, the May copper
contract exploded in price, both on an absolute and relative basis
to other months. On the last trading day, the 26th, the May contract
closed at life-of-contract and, I believe, a historic high price for
copper of $1.6140 per pound. This price was more than 16 cents
higher than the active July contract, up 5 cents on a spread basis
on the last day alone, also unprecedented and an historic spread
differential. In addition, the price of the May copper contract
jumped more than 15 cents per pound in the last five trading days,
more than 10 percent of the copper price, a huge world market. There
was no cash market explanation for the move. A reasonable person
would consider this price action to be unusual.

Unusual, perhaps, but completely expected. It was no accident that
the big price move in the May copper contract coincided with the
cessation of trading in that contract. That's why I mentioned copper
in last week's report. You see, the last trading and delivery days
of the contract are when the rubber meets the road -- when you have
to put up or shut up.

My concern was that there was such a mismatch between open positions
in the May copper contract vs. what was in position in the COMEX
warehouses that could be delivered that it was a dangerous
situation. So I questioned whether COMEX management and the
Commodity Futures Trading Commission were on top of the situation.
That question is still unresolved.

Now some would say that my concerns were unfounded, as everything
worked out fine and there was no default. I disagree with that and
would like to explain why. I think there are some real lessons to be
learned here.

First, if there are big price moves in the last few trading days of
any commodity contract, when delivery is due, that strongly suggests
that the price of the commodity was incorrectly priced prior to
those last few trading days. In commodity circles, this phenomenon
is known as price convergence. At the very end of a commodity
contract, the price of the futures contract should converge, or come
to meet the price of the underlying cash market from which the
contract was derived. This is normal and happens in every single
commodity futures contract traded.

What's not normal is a sharp change in the price during this
convergence. As the very term implies, there should be a smooth,
gradual convergence of the futures and cash market prices. If there
is a sharp change, as there was in copper, that tells you something
is wrong. And since the sharp price change in copper was the May
contract moving sharply higher at the very end of the contract, we
can conclude two things:

First, the May contract price was artificially depressed compared to
the underlying cash market. And second, the culprits of that
artificial pricing were the shorts in the May copper contract. Only
when the shorts' feet were held to the fire of trading termination
did they relent and allow the price to be marked to free-market
levels. They had no choice.

This is not how the markets are supposed to work.

The sad thing about this copper episode was that this manipulation
was entirely foreseeable and preventable. Years ago I repeatedly
offered the only fair solution -- make sure that the shorts have
warehouse receipts on first delivery day; don't wait until the last
minute. That the COMEX is headed by a former chairman of the CFTC
and this lesson still hasn't been learned is truly shameful.

The bigger lesson here is for silver investors. Here once again you
are given proof that the very best investment is in real silver, not
paper contracts. Just as in copper (and platinum and palladium
earlier), when the crunch comes, fully-paid-for actual silver or
warehouse receipts will be the safest invesment and command the
highest price.

You can't depend upon exchange officials or government regulators to
protect you. You must take care of yourself. If you wait until the
last minute to secure real silver, you may have a problem. Once you
get your real silver, no problem.

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