China's Silver price capping.

China's Price Capping Of Silver Is Ending

Keep big purchases off-market and control the price those transactions refer to. That has been China's strategy: No longer!

In recent decades, China, which ranks fifth in global silver reserves, has not only mined approximately 3,500-4,000 tonnes annually but also imported large quantities of silver doré for refining. Less well known is the People's Bank's role in managing silver reserves, which many people in China still regard as a monetary metal. China was on a silver standard only ninety years ago.

Today, gold is the primary monetary metal, and silver is widely regarded as an industrial metal only. However, since 1983, in addition to gold, the PBOC has overseen the accumulation of the nation's silver bullion reserves. The key to this policy has been price management. This article shows how it achieved this.

Introduction

About twelve years ago, I was speaking in New York at a conference attended by about a dozen silver mining and exploration companies. At that time, conspiracy theories about JPMorgan's dealings in the silver market were rife. But when Blythe Masters, then Head of Global Commodities at JPMorgan, went on CNBC, she made JPMorgan's position clear:

Speculation is [rife], particularly in the blogosphere, about this topic, and I think the challenge is that speculation represents a misunderstanding of the nature of our business. As I mentioned earlier, our business is client-driven, where we execute on behalf of clients to achieve their financial and risk management objectives. The challenge is that commentators don't see all that activity at once. For example, we store significant amounts of commodities, such as silver, for our customers. We operate vaults in New York City, Singapore, and London. And often, when customers store that metal in our facilities, they hedge it on a forward basis through JPMorgan, which in turn hedges its position in the commodity markets. If you only see the hedges and our activity in the futures market but aren't aware of the underlying client position, then hedging it would suggest inaccurately that we're running a large directional position. In fact, that's not the case. We have offsetting positions. We have no stake in whether prices rise or decline. Rather, we're running a flat or a relatively neutral… [interviewer interrupts].[i]

Silver bulls rushed to condemn her, calling her a liar and worse. But I was convinced that a senior executive of her undoubted ability, in her position, would be telling the truth. Furthermore, I suspected that Masters conducted the CNBC interview specifically to quash the wild rumors about JPMorgan's silver dealings, rather than ignore them.

So, what was JPMorgan's true role in the market? Clearly, it acted as an intermediary for clients and didn't take one-sided positions on its own account. As the Masters revealed, the bank took derivative positions only to hedge its client dealings.

The conference in New York gave me a chance to dig a little deeper. I asked the dozen or so silver companies present to describe how they turned their silver at the mine into cash to cover costs. They all stated that the process began with an assessment of the silver doré's value by a specialist assessor, typically from Glencore, who then arranged for payment and shipment to a refiner. None of the miners admitted they knew where the doré was shipped to for refining – it was no longer their concern. But the common assumption was probably China.

Glencore is a large commodity trader that acts on behalf of both large mining corporations and smaller miners, as I was informed during my interview. They obviously worked with a major bank on the payments side, which is where JPMorgan would come in. As soon as the doré was shipped, the cashflow-hungry miner would be paid by JPMorgan based on the assessor's valuation. Likely, it would ship FOB Origin, meaning the doré enters Chinese possession at the point of shipment.

Presumably, China (via the PBOC) instructed JPMorgan to hedge the silver price on the Comex or London market, timed to suppress the price. Note that this is not JPMorgan acting as a principal, but rather acting on behalf of the Chinese as a client.

As a major miner herself, China was refining substantial amounts of imported doré as some Western refineries closed due to environmental and cost concerns. So, the hedging book with JPMorgan would have been sufficient to manage the price. We can take this even further, within the context of a typical dealer-client relationship. As dealer and client work together, the dealer can be given some discretion alongside the dealing objectives.

So what might those objectives be? As a major buyer of doré, China would have had an interest in keeping the price as low as possible. Shorting derivatives would have been China's means of accumulating substantial silver reserves for monetary purposes, as it had already done with gold. In this context, the original 1983 Regulations on the Control of Gold and Silver, appointing the People's Bank of China, state:

Article 4. 

• The People's Bank of China shall be the State organ responsible for controlling gold and silver in the People's Republic of China.
• The People's Bank of China shall be responsible for the control of the State's gold and silver reserves; responsible for the purchase and sale of gold and silver; work in conjunction with the authority responsible for commodity prices to formulate and administer a purchase and sale price for gold and silver [my emphasis]

Note the PBOC's responsibility for controlling silver prices.

We know or should know that in the period 1983-2002, when the Shanghai Gold Exchange finally came into existence under the control of the PBOC, the PBOC was able to secretly accumulate vast quantities of gold, which was in a substantial bear market, fuelled by American and European financial communities liquidating their bullion holdings in favor of dollars. I believe that during this period, China secretly acquired as much as 20,000 tonnes, hidden by spreading it among various state bodies.

These easy conditions for accumulating gold did not generally apply to stockpiling silver in the far larger quantities required, as reflected in the price relationship between the two monetary metals. The PBOC had to use different tactics. The practical way to accumulate massive quantities of silver was to become the world's refiner and manage the price – in other words, keep it suppressed principally by selling as a covered bear in paper markets.

Blythe Masters had no need to lie about JPMorgan's role. With Glencore and China as customers, JPMorgan would be central to achieving China's desired outcome.

Another aspect of this puzzle is rarely mentioned. Note that under Article 4 of the Regulations appointing the PBOC, no distinction is made between gold and silver. For the purposes of the regulations, silver is considered as valuable as gold, serving as a reserve to be controlled by the central bank as general backing for the currency.

China was on a silver standard as recently as 1935. Ordinary people accumulated silver as wealth, and banks maintained silver reserves. For the Chinese population, silver was their money as much as gold was in the West. There is every reason to single out silver in the Regulations and give it the same status as gold.

Will China continue to suppress prices? Those days are probably over. Almost certainly, China has accumulated substantial silver reserves, more than enough to support a monetary role alongside gold. The state's monetary silver reserves are likely to be segregated from industrial production, which has become an uncontrollable source of demand.

Clearly, the PBOC understands the role of monetary metals, which is ultimately to secure the value of credit. They know that the values of gold and silver are generally stable, and that it is credit that declines. Their very public disposal of dollars for gold indicates that they are no longer suppressing the price of gold. What applies to gold must also apply to their silver policy.

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