Are Silver Investors Favoring Physical Metal After MF Global?

February 05, 2012

BY: Robert Hallberg, Topics: Silver

By now anyone remotely connected to the world of finance have heard about the MF Global collapse, were customers lost their funds in supposedly safe segregated accounts. Once the accounts were emptied they were transferred to other brokerage firms but without a cash balance, margin calls were issued, not because of a trade that had gone bad, but because the funds to cover margins were no longer available. As a consequence customers were forced to either closeout their positions or wire additional funds to the new brokerage firm to cover margins.

Nevertheless, many of the larger firms with connections high up in the financial world had more insight of the market and realized that something wasnt right and moved out of MF Global right before they collapsed, leaving the smaller individual traders holding the bag when the company went down. The turmoil that followed the collapse shook the confidence in the futures market, and many traders have withdrawn from futures altogether vowing never to trade again.

It is the responsibility of the commodity exchange to ensure that brokerage firms structure its trading practices so that money held in segregated accounts are protected. Before the MF Global disaster, it was understood that futures traders had never lost money due to bankruptcy, fraud, or theft. That myth is now shattered. Up until this point no acceptable justification has been given as to how MF Global were able to misplace $1.2 billion in client funds, with both the firm's former CEO John Corzine and the bankruptcy trustee saying they dont know where the money went.

Moreover, the Commodities Futures Trading Commission (CFTC) is the body responsible for regulating MF Global and other brokerages. The exchange is headed by Gary Gensler, a former coworker of Mr. Corzine at Goldman Sachs. A highly suspicious detail about the regulatory environment of MF Global is that the firm became a Primary Dealer in 2011, giving the firm the ability to buy and sell US Treasuries at auctions. Yet unlike other primary dealers MF Global was not regulated by the Fed.

Furthermore, all brokers operating in the futures market are obligated to have a Series 7 license, but Mr. Corzine, the former Governor of New Jersey had been out of the financial industry for 12 years prior to taking over MF Global and did not have the required license. Instead, he was given a waiver by FINRA. This is of importance because the trade that led to the firms collapse was orchestrated by none other than Mr. Corzine himself.

The trade that caused the company to collapse was a $6 billion bet that European debt would be a safe investment. Many industry insiders believe that this bet was leveraged 35 to 1. The collapse of the firm was so quick that Corzine didn't even have time to do a fire-sell of the company before running out of money so that he at least wouldnt be barred from trading again or possibly prosecuted.

Meanwhile, thousands of farmers and small independent traders lost their money in what they believed were protected accounts, while institutional player and hedge funds were largely unharmed by the collapse. The exchange has not stood behind its clients and up until this day traders have not been given a 100% refund. As a consequence many former traders have lost confidence in the system.

This fiasco with MF global has hurt the futures market price discovery mechanism and a preference of physical silver over paper derivatives seems to appear among investors as a result. The trend towards a preference to physical metal was already in place before the MF Global incident, but the firms collapse seems to have hastened that trend. If this trend continues it may not be much longer before supply and demand of physical silver determines the price and not derivatives on the Comex. The chart shows the demand for physical silver and other silver derivatives.

Furthermore, investors that buy physical silver are not likely to sell quickly, rather they hold on to their metal for years or even decades. Buyers of American silver eagles in particular have been known to hold on to their metal for very a very long time. So as the weak hands and speculators have been washed out of the market the strong hands are left standing, putting a floor in the market and creating a base for higher prices silver in the future.

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