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“Liquidity” is what makes the world go round. “Liquidity” if you recall, was (still is) the primary tool that was applied to “fix” the world after the 2008 Lehman event.  Yes, it was absolutely necessary to flood the system; otherwise we would have seen a default cascade.  And no, “liquidity” did not fix anything.  It only kept the system going and prolonged the end game.

Well, we are again seeing a big problem right now behind the scenes when it comes to liquidity.  Not with stocks, not with bonds…but with commodities.  I spoke today with the owner of a large supplier to Miles Franklin and he told me that “liquidity” is drying up for the ability to hedge precious metals.  I will try to explain the best that I can, it is somewhat above my pay grade as I am a horseman with street smarts, not a computer geek esoteric rocket scientist.

When you call a coin dealer to purchase (or sell) in any sizeable quantity, the dealer will then call their supplier.  The supplier will then take the order and call their dealer; in the meantime there will be 2-4 days before the metal arrives so this dealer must protect themselves against market movement.  They will call an “aggregator” to lay off the risk.  An aggregator deals in OTC contracts and will write a contract down to the exact ounce.  They take the opposite side of the trade in other words, for a small premium which of course is built into the original price of the trade and is ultimately paid for by the end client.

The above is super simplified but please understand that this is how the world turns in ALL markets.  Risk must be, and is hedged through these aggregators with ECP’s (eligible contract participants).  We heard on the 20th that Morgan Stanley was exiting this market, then on the 25th it was JP Morgan’s turn and now this week it is others.  These firms are “ECP’s” who ultimately take on the risk.  I should rephrase that…they WERE the ones who took on the risk as they are now exiting the business.

So I asked, “How can you still do business without hedging?” to which I found out that so far this week almost ALL of the hedging has been done through Europe, particularly for silver.  There is liquidity…just not any coming from the US.  He also told me that between 2:00PM and 5:00PM this week he was not able to do any silver hedging at all because there was nowhere to hedge as Europe is sleeping.

Oversimplified?  Yes of course it is and I hope someone else (smarter than me) picks up the ball and runs with it because this is really big news.  As I have always said, the world runs on “credit” and without it everything stops.  Now this is not credit so to speak, this situation is one of “swaps” (derivatives) used as insurance to hedge risk.  Without it, flow slows down, risk increases along the supply chain and the risk of supply disruption increases.  In layman’s terms, this would be like the trucking industry having to call Europe to get cargo insurance because no US based companies will write the coverage.  Will a trucker haul an uninsured load?  Maybe…maybe not, but flow slows down and all that is associated with it.

So what does it mean?  First off, something has changed or is changing in the precious metals (and base metals) arena for sure.  We already knew that inventories are being drawn down and the lower prices have created unprecedented demand.  We also have evidence that the Bank of England has bled out 1,300 tons of gold over 4 months’ time which equates to more than half of the entire world’s production.  And now this?

My simple take?  They don’t want to take the other side of the trade, period.  The Goldman’s and Morgan’s of the world know how to make money, lots and lots of it and rarely pass up an opportunity to make more.  They are plugged in and are “in the know” yet now they don’t want to write OTC derivatives insuring against volatility (upward) in gold and silver.  This should tell you something, no; this should SCREAM something at you!  They do what they do to make money, not lose it and by their actions are telling you what they think (probably know).

Please understand that this market is only a microcosm of what is out there.  Jim Sinclair has been pounding the table at anyone willing to listen to the OTC derivatives would one day blow up and take the system with it.  Everyone owes everyone in this daisy chain and all of the “insurance” is worth NOTHING.  When the smoke finally clears, no one will know who owes who or who owns what.  It has all worked because it “did” and no one was called on to “perform.”  THIS is systemic.  It is how the world operates in all markets, all locales and industries.  Break the chain anywhere…it breaks everywhere!

Lastly, what does this mean to you?  It means that you have to be out of the system.  Hold your certificates, hold your metal outside of banks and brokers…get OUT!  It also means that when the music does stop as it most surely will, you will be locked into whatever you had when the music stopped.  Do you really believe that your ATM or credit card will work or your broker will “sell or buy” for you once this chain breaks?  Do you really believe that your coin dealer will be able to get your metal delivered to you?  In the state of Minnesota a new law for coin dealers is in place that regulates shipping requirements, but who is regulating this in other states?   If your coin dealer can deliver, you will send your money first, give them an order possibly having no idea what price you will ultimately pay and then get your metal in a couple of months…or more.  This is akin to calling an insurance company AFTER the hurricane came through and asking for coverage or putting your seat belt on AFTER hitting the bridge abutment!  Derivatives are more than a $1 quadrillion market and I’m afraid that they just pulled the pin on this grenade.  Please do what you need to do…yesterday!