by Keith Weiner, Sprott Money:
On Thursday, July 6, in the late afternoon (as reckoned in Arizona), the price of silver crashed. The move was very brief, but very intense. The price hit a low under $14.40 before recovering to around $15.80 which is about 20 cents lower than where it started.
Buyers of silver are rejoicing. They can now get more money (silver, like gold, is money) in exchange for their dollars than before. However, as we see from the reactions in the community, there were few buyers.
Cries of woe are heard everywhere. Those who are crying are sellers, including those who say they don’t plan to sell but who really want a high price in case they change their mind by Monday morning.
If you want to see what it looks like when everyone is thinking of buying, look at the bitcoin market when there is a price drop. The enthusiasm is palpable. Everyone is gloating about buying the dips, with faith unbroken that the cryptocurrency is on its way to shoot past $10,000 if not $1,000,000.
Gold and silver are the opposite. For now. And perhaps that is a sign that here is a good opportunity. Blood in the streets, as the expression goes.
The purpose of this article is to look deeply into the trading action at the time of the crash. First, here is a graph showing the bid and offer prices for about 50 seconds. The horizontal axis shows time, but it is ticks rather than seconds or milliseconds. So, for example, it does not show the 10-second period when CME halted the exchange.
For most of this time period, there is an orderly market as seen in the tight bid-offer spread, though even from the start we observe that on price drops the bid drops more. That becomes extreme where the bid hits $14.10 (which occurs right after the halt). From that point onwards, we see a very wide bid-offer spread. The bid looks to be held low deliberately, around $14.33, while the offer is moving around as buyers begin lifting it.
Let’s address the wide spread. The banks have been under assault for their trading practices. Among other things, they are blamed for having proprietary positions, for “leaking” information during the Fixing, for having a too-large position, etc. The net result is to push the compliance department into prominence. No longer can the bank act when the market offers a profitable opportunity for arbitrage.
Arbitrage causes spreads to tighten, as part of the process of making money.
But before a bank may arbitrage something, they must weigh their proposed trade against the new regulations. And of course, always they must be aware of the optics. It does them no good to make a perfectly legal trade that will bring resentment, more regulatory scrutiny, and possibly litigation.
For example, what is the difference between a “prop” (proprietary) trade, and ordinary market-maker arbitrage? Don’t bother trying to answer this question. Unless you are a commodities lawyer who is intimately familiar with the regulations as they existed on July 6, and also familiar with the current interpretations of the regulators, you cannot answer. Regulations can make distinctions between two maddeningly similar actions, or even identical actions in confusingly similar contexts. On one side of the distinction lies your right to earn a profit. On the other side is regulatory action, penalties, brand damage, and possibly an extended visit to prison.
With such large differences in outcomes, based on such fine lines between actions, you can bet that the banks are backing away from trades they would otherwise take. They are becoming more conservative and making less money. And leaving the market less efficient, more costly to do business in, and more volatile.