Comment Text:
My understanding of the silver, and other exchange traded markets, is as follows. Hedgers transfer risk to speculators. Speculators accept risk from hedgers. Speculators also speculate against each other, up to the current 5000 contract position limit. Another point, the known supply of physical silver has limits. The supply of futures contracts (a derivative) does not. A hypothetical open interest of say, one trillion contracts in silver vs its known physcial supply, should raise questions. Speculator position size plays a large role in what I call the derivative-underlying, price disconnect. In a normal market arbitrageurs are supposed to come into the market and prevent the derivative and underlying price from getting out of line by facilitating the convergence of the two. But with leverage, low margins, and high position limits, arbitrageurs are asking why should I do an almost risk free, but low reward trade when I can -- and here's the point -- keep adding contracts on the bid or ask, as the case may be, and make more money? Why beat 'em when I can make more money by joining 'em? This behavior, which we are now seeing more of, causes an "extreme" divergence between derivative pricing and the underlying asset. This is the disconnect (uncoupling) I mentioned above. The derivative market assumes a life of its own (ie. its own supply and demand features) and bears less and less of a relationship between the forces of the underlying's, supply and demand features. I can rember when the Saudi Oil Minister said, "I don't know why oil is $160.00 a barrel. It only costs us $60.00 to produce." One would think he would know a thing or two about world supply. And by the way, total market demand doesn't go up two hundred percent in say three months and fall faster. In other words, fundamental determinants of price didn't change that much. We are seeing more and more of this "uncoupling" phenomenon these days. Prices paid by the little guy (me) are based on the derivative price and not the underlying. In a normal market setting this would be fine, but "excessive position limits" cause price divergence from the fundamental supply and demand forces that determine price, which is/can be disruptive. I don't know what the ideal position limit should be. The answer might be the position limit where markets would "uncouple' less. I don't have enough formal training to suggest that a position limit in silver of say 1500 contracts is better than say 2000 like others have said. On the other hand, and for the reasons stated above, I believe 5000 contracts is ripe for silver market mischief -- uncoupling (aka speculative excess).
