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The China Syndrome

Xi Jinping

Are we witnessing an epochal shift? Are the COMEX and LBMA losing their roles as precious metal market price maker for the entire world as influence and control shift to China? Maybe. Frankly, it's too soon to know. But things certainly appear to be trending in that direction.

And what would a shift in the balance of pricing power to China mean? The western Fractional Reserve and Digital Derivative Pricing Scheme has persisted for nearly 50 years. If the price begins to be driven by eastern physical demand instead of western paper supply, what might be the impact?

Perhaps we're already seeing that. Over the past week alone, the price of physical silver in Shanghai has risen by nearly 15% from $30/ounce to $35/ounce, closing Monday, May 20 at $35.30. The London/NY bullion banks risk losing copious amounts of metal in a physical arbitrage if they don't allow the COMEX price to keep pace. As such, the price of the Jul24 COMEX silver contract has moved up by almost the identical percentage.

may 21 silver price chart

This move broke the COMEX price out of its nearly four-year trading range and will almost assuredly draw in fresh speculative money. Recall that COMEX gold surged $100 in one week after breaking out of its own multi-year price range back in March.

may 21 silver price chart

But in reality, the bullion banks had no choice but to let the price rise, despite the most recent Commitment of Traders report that revealed them to be collectively net short over 37,000 COMEX silver contracts or about 190,000,000 ounces of silver. If the COMEX price had remained below $28 while the Shanghai price moved to $35, the resulting arbitrage of $7 per ounce might be profitable enough to prompt a significant drainage of the COMEX vaults. Caught between the proverbial "rock and a hard place", The Banks had no choice but to let the COMEX price rise.

may 21 silver price chart

So, as I type on Monday morning, May 20, the spread between New York and Shanghai is about $3/ounce. Is that thin enough to maintain COMEX pricing relevance and forestall that vault-draining arbitrage? Maybe. But what happens if physical shortage in China and elsewhere in The East leads to even higher prices? If Shanghai is posting physical silver at $40/ounce by later this week or next, how does the COMEX price not move to $37? But at $37, that nearly 200,000,000-ounce net short position gets another $1,000,000,000,000 in potential losses hung on it. Talk about a short squeeze! OUCH!

Out of anticipation and concern, is this why the heads of precious metal trading of four separate bullion banks all took turns stopping by Shanghai in March and April? This can't be coincidence. Were they pleading for mercy and Chinese intervention to control price?

•              https://en.sge.com.cn/eng_news_News/10001908 

may 21 silver price chart

So this begs the questions that I posed to Dave Kranzler in a podcast recorded last Thursday. Is the COMEX losing its monopolistic control of price? Can physically delivered contracts in Shanghai wrest control of price from London and New York? Does the COMEX ultimately become a "price taker" instead of a "price maker"? Listen to that podcast. It's free and not behind any paywall.

Years ago, my good friend Ned Naylor-Leyland coined the phrase "the futures market tail wags the spot market dog", and until very recently, this had been precisely the case. The globally recognized price of gold and silver was primarily determined through the trading of derivative and futures/forward contracts. But no more. At least not this week. The physical price in Shanghai is now "wagging" the futures price in New York.

If this continues, then we truly have a paradigm shift, and while this does not mean that precious metal prices will now go straight up and "to the moon", it does mean that physical metal trading is finally resuming its rightful place in the global price discovery process. Given the leverage, hypothecation, rehypothecation, and overall shenanigans inherent to the current pricing scheme, any shift back toward a physical metal influence on price should be very much appreciated by all precious metal and mining sector enthusiasts.

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About the Author

Our Ask The Expert interviewer Craig Hemke began his career in financial services in 1990 but retired in 2008 to focus on family and entrepreneurial opportunities.

Since 2010, he has been the editor and publisher of the TF Metals Report found at TFMetalsReport.com, an online community for precious metal investors.

*The author is not affiliated with, endorsed or sponsored by Sprott Money Ltd. The views and opinions expressed in this material are those of the author or guest speaker, are subject to change and may not necessarily reflect the opinions of Sprott Money Ltd. Sprott Money does not guarantee the accuracy, completeness, timeliness and reliability of the information or any results from its use.

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