Precious Metals and Inflation - Part 3

precious metals Apr 21, 2021

Is 2021 the Year Silver and Gold Prices Skyrocket?

Part 3 - Market Manipulation

Have you heard people talking about a silver short squeeze? Maybe you’ve seen a news headline. Maybe someone said something in a “small talk” conversation. Maybe everyone agreed that precious metal prices are about to explode.

Does this kind of water cooler conversation mean much? What are they talking about anyway?

To understand how market manipulation can affect precious metal prices we need to understand the difference between buying physical gold and silver and paper ETFs. We also need to understand about short selling and a how the markets work.

What is an ETF? – Electronic Traded Fund

Investopedia tells us that “An exchange traded fund (ETF) is a type of security that tracks an index, sector, commodity, or other asset, but which can be purchased or sold on a stock exchange the same as a regular stock. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.”

An ETF can be a representation of a particular commodity. However when you own the ETF, you own a share of the company. As an owner of a piece of that company, you own a part of what the company owns. Owning silver or gold physically is therefore very different than owning part of a company that owns silver or gold.

If you want to invest in gold or silver without actually having to deal with transaction and storage costs, an ETF is how you can do that. There are Exchange Traded Funds that were created for that purpose. GLD is an ETF created in 2004 and reports to own 33.12 in assents (gold) SLV is an ETF created in 2006 and reports to own 6.5 billion in net assets (silver).

Investing in the ETF is more like investing in the stock market. Because the asset of the ETF is what gives it its value, the ETF usually goes up or down with the commodity it holds. So when a person invests in either GLD or SLV their investment should go up or down along with the spot prices of gold or silver.

What is short selling and a short squeeze?

The GameStop Short Squeeze story.

What if you believe that a particular stock is going to go down in value? How would you make money on such a stock? You short the stock. Investopedia says “Short selling is a fairly simple concept—an investor borrows a stock, sells the stock, and then buys the stock back to return it to the lender. Short sellers are betting that the stock they sell will drop in price. ... The difference between the sell price and the buy price is the profit.”

Short selling can be a very risky. If the stock goes down they make money. If the stock goes up they lose money. There is an unlimited risk because the stock can go up an unlimited amount.

Did you hear about GameStop stock in January?

A hedgefund had bought a large amount of “short” GameStop stock. The hedgefund was betting the price would go down. A group of independent investors joined together to bet against the hedgefund. They bought as much of the stock as they could.

What happens when people buy a lot of a particular stock? It goes up in price. As the price rose dramatically, the hedgefund had to buy the stock to stop its losses from going even higher which raised the price of the stock again.

The law of supply and demand kept raising the prices until GameStop stock skyrocketed almost 2,000% in a few weeks! On January 4th 2021 the stock closed at $17.25 per share. On January 28th 2021 the stock closed at $347.51 per share.

The hedgefund lost 13.1 billion dollars and went bankrupt. Many of the independent small investors who participated in this “short squeeze” made a huge profit on their investment. (Today’s price is around $170 per share, which would still be a very good (nearly 1,000%) profit if you bought when it was $17.25 per share.)

This was a “David vs. Goliath” story. It was the little investors beating the big investors at their own game. It also illustrates what short selling is. And what a short squeeze is. And how different investors can profit or lose money depending on how they invest. When someone makes money in the stock market, usually someone else has lost money.

The silver (SLV) short squeeze story

So that conversation you heard at the water cooler about silver prices exploding? The story you might have heard is that the investors that caused the GameStop stock to skyrocket were about to do the same thing to silver.

How can you do short sell or short squeeze silver? You can only do that with the paper silver – an ETF. The Exchange Traded Fund, SLV, is how this was going to happen. They saw that some were short selling this ETF. The investors felt they could buy SLV and make it explode like GameStop Stock did.

Silver was supposed to go from the $25-$27 range to over $300 an ounce. After what happened to GameStop stock there was a lot of fear and excitement surrounding silver for a few weeks.

It turns out that really almost nothing happened. It caused a 6% change in the price, barely noticeable by most investors. January 4th the price for a share of the ETF representing silver, SLV was $25.35. On February 1st, 2021 SLV closed at $26.76. April 9th it closed down at $23.41 a share. Evidentially things were different with the Exchange Traded Fund (ETF) SLV than they were with the stock GME (GameStop stock).

Manipulation of the markets.

Manipulation of the markets is illegal. You aren’t supposed to take insider information and profit from it in the market. You aren’t supposed to do things that manipulate the price of a commodity. You aren’t supposed to engage in “spoofing”.

According to Wikipedia finance, “Spoofing is a disruptive algorithmic trading activity employed by traders to outpace other market participants and to manipulate markets. Spoofers feign interest in trading futures, stocks and other products in financial markets creating an illusion of the demand and supply of the traded asset. In an order driven market, spoofers post a relatively large number of limit orders on one side of the limit order book to make other market participants believe that there is pressure to sell (limit orders are posted on the offer side of the book) or to buy (limit orders are posted on the bid side of the book) the asset.”

In recent years major banks have been fined for engaging in this activity. These include JP Morgan Chase & Co, Deutsche Bank, Union Bank of Switzerland, and HSBC (Hongkong and Shanghai Banking Corporation). These fines were 920 Million in 2020 and 46.6 million in 2018. These are some of the biggest international buyers and sellers of precious metals. This tells us that that market manipulation does occur.

How does this affect those of us buying gold or silver as a long term investment? Very little. It seems that the manipulations only cause short term price changes. However, the for the longer term investor they don’t make that much of a difference. Market demand and inflation have a bigger impact on overall precious metal prices.

Conclusion – 2021 precious metal prices.

While learning about stock market investing and ETFs can be fascinating. It is very different than buying actual gold or silver from your favorite dealer.

Market manipulation seems to have a short term impact on prices. A market manipulation like a short squeeze on an ETF or a big bank spoofing might change the price for a day or a week. But the overall annual prices going up or down in the market has more to do with the market demand and inflation.

So back to the question we originally asked about precious metal prices in 2021: Will silver and gold prices skyrocket?

Some experts seem to believe prices will double in 2021 for silver in particular and possibly gold. Other experts think that there will be almost no change in the precious metal prices this year.

Now that you have read all 3 parts of these blog series, what do you think?

In part one, we learned that inflation is a very real concern with what is happening with the devaluation of the dollar this year. In part two, we learned that there is a definite increase in demand for precious metals right now. Here in part three, we have learned that while market manipulation is real, it is probably not going to have as big an impact on prices as inflation or market demand.

After considering all of the complexity of the silver and gold markets, we can admit that we don’t know the future of prices with 100% certainty. There are too many factors. But it does seem reasonable to prepare for a price increase in both silver and gold this year. That increase might be substantial. It might be small. Either way if you are able to buy and hold more gold or silver this year, it sure seems like a good idea. Don’t you think?