There’s an old investment saying that says, “Never marry a loser.” When the ego gets in the way, the trade becomes more about being right, than about being profitable. When J.P. Morgan used Federally backed funds to acquire Bear Stearns in March of 2008, it seemed like the steal of the century. They bought Bear Stearns at $2 a share and the Federal Reserve guaranteed Bear’s illiquid debt and counter party risk allowing J.P. Morgan to step in and take immediate control of Bear’s trading operations.
Apparently, part of Bear Stearn’s proprietary portfolio included a rather large short position in the silver market. J.P. Morgan, rather than liquidate the position at a loss, clean up their new balance sheet and pocket the profits decided they were smart enough to trade their way out of it using the profits accrued from Bear’s acquisition to sustain the ongoing trading losses. Thus, they’ve continued to add on to their short position selling more silver futures to increase their average price the entire way up. It has been reported by the UK’s Guardian that J.P. Morgan may now be short the silver futures market to the tune of 3.3 BILLION ounces. As a comparison, the total outstanding deliverable interest in the silver futures market is 320 million ounces and annual global supply is approximately 900 million ounces.
Short positions in the futures market can only be settled in two ways. First, the contracts can be repurchased at the current market price, which in J.P. Morgan’s case would be a losing trade. The second way out is to physically deliver the silver itself. This would make the people who bought the silver from J.P. Morgan, whole.
J.P. Morgan has the ability to hire some of the top minds in the trading game and over the last two years, they’ve been working hard to try and trade their way out of this mess. Their primary strategy thus far has been to take advantage of the limited trading in the overnight electronic markets to manipulate the market prices. The basic plan they’ve been following is to place large orders to sell more silver which make the overnight markets appear to have an abundance of sellers. When normal market players come in and need to get their own silver sold, their own human instinct takes over and they make their offer at a lower price than what they’re seeing on their screens. Once J.P. Morgan feels that enough sell orders have piled up under their own bluff of an order, they come in and buy up the lower priced offers and withdraw their large bluff sitting over the market. They have been under investigation by the Commodity Futures Exchange Commission for their manipulation of the silver market for the last year.
Clearly, J.P. Morgan has a problem. They owe the market more silver than the world produces and their previous attempt to unwind their position is under investigation. So, what’s the next logical move? They’re currently attempting to corner the copper market from the long side. They are essentially, creating a hedge. The idea is that they’ll make in the copper market what they’re losing in the silver market. Over the last three months as silver as silver has gone from $19 an ounce to more than $30 an ounce, J.P. Morgan has been managed to accumulate between 50 and 80% of the copper traded on the London Metals Exchange. It’s no coincidence that they also announced their plans to offer an Exchange Traded Fund backed by physical copper. Clearly, they’re hoping to recoup some of their losses through price appreciation in copper while the generating a new revenue stream, as well.
Time will tell how this plays out on their balance sheet. History has shown that traders who lock into one idea, like selling the silver market, typically go broke before they are proven correct. J.P. Morgan’s dominant purchases in the copper market reflect their fear of outright loss in the silver market. Considering the notional amount (3.3 billion ounces) they are short relative to the size of the silver futures market and the global supply of physical metal, it will be interesting to see how they manage to divorce the loser they’ve inexorably hitched their wagon to.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
