TexasTruBlu's Blog

Here’s a story from the past, but it bears some eerie similarities with what we are seeing in today’s market. Replace the word “silver” with “oil futures” and you have a very close twin to what happened over thirty years ago. Two lessons to take away from this-people who have money are allowing the market to drop so that they can buy more shares in stocks of American companies and in commodities futures AND eventually the prices will drop leaving someone’s economic situation in disarray. If you know traders that are playing fast and loose buying Light Sweet Texas Crude at high market prices, you would be better off in for the short haul rather than the long haul if history is any guide. I wonder why the FTC isn't seriously and rigorously seeking to find out what groups or shell corporations are setting us up for what amounts to an economic takeover. Anyone who has a 401K should be asking some serious questions. And everyone should be emailing, phoning and faxing their Congressional reps to see if they are holding the FTC's feet to the fire.

“In 1971, the US completely abandoned the gold standard. The US defaulted on its promise to foreign central banks that paper dollars could be redeemed in gold. The original default on the dollar really occurred in 1913 when the Federal Reserve was created, allowing the Federal Reserve to print more Federal Reserve Notes than physical gold was in the US Treasury. Alternatively, the default occurred in 1933 when President Roosevelt said that US citizens could no longer redeem their paper dollars for gold and that US citizens were not allowed to own gold.

The Hunt brothers were the sons of a wealthy oil billionaire. They started investing in silver as a hedge against inflation. When they started buying silver, it was still illegal to own gold. They chose silver as their inflation hedge.

The Hunt brothers realized that the dollar was now worthless unbacked paper. They famously said "Any fool can run a printing press!" They decided to convert their paper wealth to physical silver. When they first started buying silver, the price was under $2/ounce. Recently, silver was quoted at $18/ounce. Over 30 years, a gain of 9x is equivalent to an annualized return of 7.6%. If the Hunt brothers were able to buy-and-hold their silver, they would have made a respectable rate of return….

 
If the Hunt brothers merely invested a bunch of their own money in silver, they would have profited immensely. However, they got greedy *AND* they got screwed over by the Federal Reserve and the rules of the commodities exchange (CFTC).

After investing their own money in silver, driving up the price, the Hunt brothers started seeking other people to invest in silver with them. They convinced some Arabs to invest oil money in silver along with them. You're a fool to invest in an asset *AFTER* someone else has made a huge purchase, driving up the price. The Hunt brothers were seeking other silver investors to drive up the silver price even more. This made the Hunt brothers' initial silver investment even more profitable.

The Hunt brothers took physical delivery of their silver. They hired sharpshooters to protect them as they transported their silver to their warehouse.

The Hunt brothers said repeatedly, "Our goal is not to corner the silver market. Our goal is to be long-term buy-and-hold investors in silver." The problem is that the Hunt brothers were using extensive leverage. Whenever you have a leveraged investment, you risk being bankrupted during the next bust phase of the business cycle. Unfortunately for the Hunt brothers, they were *NOT* financial industry insiders. The financial industry insiders changed the rules of the game after the Hunt brothers had bought a large amount of silver.

Even though the Hunt brothers said "We are not trying to corner silver.", their actions were the same as someone attempting a corner. In a commodity market, cornering the market means buying so much of the commodity that you have a virtual monopoly. Monopolizing the supply, you can set the price at which you sell.

As you begin to corner the market in a commodity, the price naturally skyrockets. Suppose the price of silver is $18/ounce. You decide to invest $1 billion in silver, maximizing your leverage. You use 20x leverage, so you actually can buy $20 billion in silver. You have $20 billion in silver and a debt of $19 billion. HOWEVER, your purchase of silver has driven up the price. Suppose you were able to drive up the price 3x to $54/ounce. Now, you have $60 billion in silver and a debt of $19 billion. If you tried selling your silver, you would drive the price back down to $18. However, that's not the way margin rules work. Margin rules value your silver at the CURRENT PRICE. You only invested $1 billion, but your account now has $41 billion in equity ON PAPER. According to margin rules, you can use this equity to borrow more and buy even more silver! Anybody who tries to corner a commodity is taking advantage of this positive feedback cycle.

Real interest rates are negative, so this is a great deal! Your profits aren't free; they're paid by everyone else as inflation. Suppose inflation is 10% but the Fed Funds Rate is 5%. As you hold onto this position, you will benefit IMMENSELY from inflation.

That is the real reason "cornering the market" in a commodity is considered illegal/immoral. The real culprit is Federal Reserve negative real interest rates, combined with margin usage. As your attempted corner drives up the price, the margin rules mean that you can borrow more and buy more! Negative real interest rates mean that you profit immensely from using leverage. Money supply inflation is greater than the interest rate you are charged, and you will profit if you can hold onto your position long enough.

The Hunt brothers were exploiting the defect of negative real interest rates combined with margin rules. If real interest rates were not negative, but instead market-determined, this would not have been a profitable trade. If margin rules were based on liquidation price instead of current price, they would not have been able to drive up the price of silver so much.

At one point, the Hunt brothers had 77% of the world silver supply, either physically held or in the form of futures contracts. The Hunt brothers had substantially driven up the silver price.

The Hunt brothers were making a HUGE bet that the price of silver would continue to rise. At the same time, financial industry insiders started making a HUGE bet that the price of silver would crash. Guess who won the conflict?

The Hunt brothers were buying all the silver futures contracts they could, using leverage. Financial industry insiders were naked short selling all the silver futures contracts they could. There was no way all this silver could be physically delivered. There was a real risk that there would be a default on the silver futures contract.

Suppose you owned futures contracts for 1 billion ounces of silver while the world silver supply was only 200 million ounces. The futures exchange would be forced to default on its promise to deliver silver. As a commodity exchange, a failure to deliver is the most serious disaster you can have. The commodity exchange would collapse in default/bankruptcy. Large financial companies assume liability for the trades. They would be also forced into bankruptcy, because they would also be responsible for the commodity clearing default. …

It was important to bankrupt the Hunt brothers. People who speculate in gold or silver are betting against fiat money. Bankrupting the Hunt brothers made the dollar look strong in comparison. When the price of silver crashed, it created the false impression that the dollar had appreciated in value….

The bottom line is that if you aren't a financial industry insider, you aren't going to profit borrowing to buy assets. If the Hunt brothers had taken an unleveraged long position in silver, they would have made a nice profit, and there's nothing the financial industry could have done to screw them over. Without using leverage, the Hunt brothers wouldn't have been able to push up the silver price that much, and they wouldn't be exploiting negative real interest rates and defects in the margin rules. The financial industry insiders will *ALWAYS* be bailed out by regulatory changes or by the Federal Reserve. In this case, the financial industry insiders had huge short positions. The insiders were bailed out regulatory changes and by the Federal Reserve jacking up interest rates, causing a temporary money supply crash.”

http://fskrealityguide.blogspot.com/2008/02/hunt-broth
ers-silver-corner.html