• John Adams

George Soros and the Silver Moon Shot

As millions of people across the world struggle financially resulting from the economic damage caused by COVID-19 and the lockdown of economies and global supply chains, financial markets remain in continual turmoil.


In such circumstances, unique investment opportunities exist which can generate asymmetric financial returns[1] for those market participants who can identify these opportunities and can allocate capital ahead of these opportunities becoming realised.


A unique category of investment opportunities can exist in distorted markets where artificially set prices are released back to their equilibrium price when the cost of maintaining the artificial price becomes unsustainable.


Identifying distorted markets and their profit-making potential requires an understanding of:

  • some important microeconomic theoretical concepts;

  • economic history; and

  • knowing when and how to deploy capital.


In 1992, billionaire and hedge fund manager George Soros of the Quantum Fund identified such an opportunity when the British Government of John Major was no longer able to maintain an artificial price for the British Pound (GBP) against the German Deutschmark (DM) under a European fixed exchange rate regime known as the Exchange Rate Mechanism (ERM).


Soros’ allocation of capital betting that the GBP, under the ERM, was overvalued netted him and his fund investors approximately $US 1.5 billion within the space of a month – an extraordinary asymmetric capital return.


Drawing on lessons from microeconomics and Soros, a new market opportunity exists in the 2020-21 mayhem of COVID-19 that being the silver market. This opportunity has been labelled by some market participants as the ‘silver moon shot’.

The Microeconomic Theory of Price Fixing

Elementary microeconomic theory dating back to Alfred Marshall in the 19th Century, suggests that an equilibrium price in a freely traded market is established when the demand for an individual product is met with the requisite supply as shown in Diagram 1.

Diagram 1: The establishment of the ‘equilibrium price’


Elementary microeconomic theory also suggests that market distortions can be established when the price of an individual product is pegged (or fixed) at a price which is not the equilibrium price. As demonstrated in Diagram 2, when the price of a product (for example gasoline) is artificially set:

  • above the equilibrium price – supply exceeds demand meaning that a product surplus eventuates; or

  • below the equilibrium price – demand exceeds supply meaning that a product shortage eventuates.

Diagram 2: Market distortions resulting from artificial set prices


There are several mechanisms of how market prices can be artificially set including through:

  • category 1 - government laws and regulations dictating that the prices of particular products be set to a fixed price point or to a fixed price range;

  • category 2 - governments, governmental bodies (e.g. central banks) or commercial entities (e.g. financial institutions such as banks) financially intervening in markets via injections of capital influencing either market demand, market supply or both; or

  • category 3 - sophisticated market price-setting mechanisms which are easily susceptible to market manipulation or fraud.

In the case of category 1, governments use their law-making power to set the artificial prices in cases such as natural monopolies (e.g. public utilities) or to achieve a political purpose – e.g. quell public anger resulting from runaway inflation (e.g. price and wage controls).


Price fixing in this context can lead to disastrous and real consequences. For example, during the 2008 Zimbabwean hyperinflation episode food retailers were unable and unwilling to sell food to the general public (i.e. their shelves were bare) given that the legal prices for individual food items set by the Zimbabwean government were substantially lower than the market price.


In the cases of category 2 and 3, government and private sector market participants use their financial resources to distort the prices of individual markets either to:

  • achieve a political or economic policy objective; or

  • obtain a market advantage.


In many instances under categories 2 and 3, the cost of maintaining an artificial price is relatively small in the beginning, but grows substantially as economic and market conditions alter resulting in a widening price differential between the artificially set price and the equilibrium price.

These costs grow until a climactic point manifests itself whereby the entity (or entities) who are distorting the market no longer possess the financial resources to maintain the artificially set price.


In these instances, involved entities are forced to abandon their price-fixing effort resulting in a sharp and dramatic price readjustment from the artificially pegged price to the equilibrium price.


For those investors and market participants who can:

  • anticipate these price readjustments; and

  • deploy capital which capitalises on these price readjustments

are able to realise extremely lucrative asymmetric returns on capital.

George Soros ‘breaking’ the Bank of England

One of the most famous examples of this microeconomic principle was how George Soros broke the Bank of England in September 1992 when the British Government of John Major was forced to abandon the ERM.


The ERM was created in 1979 and was a key component of the European Monetary System. The ERM was entered into by a range of European countries with the goal that member countries would set the value (i.e. price) of their currencies against the DM (given that the DM was the strongest currency in Europe) within a target bandwidth.


By fixing the value of their currencies against the DM, participant countries sought to:

  • secure monetary stability and thus lower rates of inflation; and

  • minimise exchange rate fluctuations

in order to give economic agents greater exchange rate certainty and thus better facilitate trade and investment flows.


In order for the ERM to work effectively, member countries would either use their foreign exchange reserves or interest rates to maintain the value of the peg relative to the DM.

The British Government of John Major joined the ERM in October 1990. The ERM was the flagship centrepiece of the government’s economic policy agenda in its fight to reduce inflation and lift productivity.


The Major Government argued that devaluing the GBP to provide uncompetitive British firms an advantage in international trade was unsustainable and that British firms would, as a result of the ERM, need to reduce business costs, especially wages, if they wished to compete domestically or export on a profitable basis.


Upon entry, the ERM was set at 1 GBP to 2.95 DM with a trading range of 6% either side (i.e. a trading range of 2.78 to 3.13 DM)[2].


During 1991, the ERM had proven to be a successful policy tool as it assisted in:

  • stabilising the value of the GBP;

  • driving the rate of UK inflation to a 3 year low;

  • lowering British inflation expectations; and

  • lowering interest rates (or yields) on long-term British government and corporate bonds.


However, structural problems began to emerge with the ERM when the German Bundesbank (i.e. the German Central Bank) raised interest rates by 2.75% in the first half of 1992 sending the GBP to its lowest point against the DM since joining the ERM and raising financial market fears that the GBP would not be able to hold its value within the established ERM trading range.


Such fears were not assisted when:

  • Bundesbank officials rebuffed calls from British officials to lower interest rates in early September 1992[3];

  • the Major Government announced in early 1992 taking a 7.2 billion GBP foreign exchange loan to defend the value of GBP[4]; or

  • Bundesbank president, Helmut Schlesinger, had told the Wall Street Journal on 9 September 1992, and openly stated, that the Bundesbank would not intervene to the save the GBP.

Anticipating that the Major Government would be forced to abandon the ERM and that the GBP would readjust back to its equilibrium price on foreign exchange markets, Hedge Fund manager George Soros via his Quantum Fund sought to take advantage through a tripled layered bet.


This bet as shown in Diagram 3 was factored on the following three events occurring:

  • Event 1 – the GBP would depreciate once released from the ERM;


  • Event 2 – European Bonds (especially German and French) would rise in price (consequently resulting in bond yields (or interest rates) falling) resulting from an appreciation of the DM and French Franc versus the GBP;


  • Event 3 – the value of equities on the London Stock Exchange would appreciate resulting from the depreciated GBP.


Diagram 3: George Soros’ 1992 Triple Bet


In the lead-up to 16 September 1992 (or became known as black Wednesday), Soros’ Quantum Fund had built a short position against the GBP to the tune of $US 1.5 billon. This position was increased to $US 10 billion[5] on the morning of 16 September 1992 (through the use of substantial debt) and was joined by other currency speculators once they had discovered Soros’ position[6].


This action resulted in the value of the GBP trading close to the lower acceptable trading range as mandated by the ERM.


Once the markets had opened in London that morning, British officials initially attempted to rescue the value of the GBP by depleting their foreign exchange reserves to buy the GBP on the open foreign exchange market. However, this action had no impact on the value of the GBP.


The Government was then, within the space of hours, forced to defend the GBP by raising interest rates:

  • initially by 2% from 10% to 12%; and then

  • by another 3% from 12% to 15%.

However, these radical policy manoeuvres did not convince currency speculators that the Major Government would maintain its commitment to the ERM and continued to short the GBP.


Such was the market pressure on the GBP that the Major Government, on the evening of 16 September 1992, was forced to abandon the ERM[7].

Upon release from the ERM:

  • the GBP depreciated by 15% against the DM and 25% against the United States Dollar;

  • German and French bonds rallied by more than 3%; and

  • equities on the London Stock Exchange rallied by more than 7%.

Given the speculative positions entered into and anticipating the actions of the British Government and the Bank of England, Soros netted an asymmetric profit of $US 1.5 billion within the space of a month. A colossal amount of money for the times.

The ‘Silver Moon Shot’

Importantly, the microeconomic principles of arbitrary disequilibrium price-fixing and price readjustments are not only relevant when discussing George Soros, but also carries significance for today.

As noted in recent articles:

  • The undeniable manipulation of the silver market[8]; and

  • COVID-19 exposes gold and silver price manipulation[9];

the current internationally recognised price of silver does not reflect the underlying physical demand and supply fundamentals of the silver market. Rather, the price of silver is being actively suppressed by the actions of the New York based COMEX futures market as well as the London Bullion Market Association (LBMA) and its member organisations (in particular the bullion banks and bullion refiners).


Accordingly, the physical demand and supply fundamentals of the silver market would suggest that the price of silver should be north of $AUD 600 per ounce, not the current approximate market price of $AUD 26 per ounce[10].

As outlined above, price equilibrium theory would suggest that such a discrepancy between the artificially set price and the equilibrium price would result in a market shortage of available silver. In the current COVID-19 context, market shortages have manifested themselves since February 2020 whereby:

  • significant delivery delays occur in obtaining possession of physical silver bullion; and

  • the price of an ounce of physical silver bullion is now significantly higher than the internationally recognised London OTC market price.


More broadly, market participants, as outlined in my previous articles:

  • COVID-19 exposes gold and silver price manipulation; and

  • Beware of synthetic gold and silver products[11]

have been using, over an extended period of time, a range of techniques to limit the extent of any market shortages including:

  • using naked short futures contracts or Exchange for Physical (EFP) contracts where physical silver is not exchanged;

  • employing rehypothecation tactics via leasing arrangements; or

  • supplying the market with synthetic silver products such as unallocated or pooled allocated silver accounts, Exchange Traded Funds or silver backed cryptocurrencies;

which all are designed to limit the demand for physical silver bullion.


From an economic standpoint, price suppression in this context is equivalent to an arbitrary setting of the price of silver at a price inconsistent with the equilibrium price. As noted above, this form of price fixing can continue until the costs of maintaining the artificial price for the entities involved become financially unsustainable.


As noted in ‘Will COVID-19 collapse gold and silver price manipulation’[12], this occurrence has already been observed in the context of precious metals when the London Gold Pool (LGP) became financially unsustainable in March 1968 resulting in central banks withdrawing their participation from the LGP and the price of gold being released from its artificial peg of $US 35 per ounce.


Within the parlance of the silver market, the moment at which market participants at the COMEX and the London OTC market can no longer maintain the current artificial pegging of the silver price resulting in a radical price readjustment is referred to as the ‘silver moon shot’.


Thus, drawing on principles from microeconomics and the 1992 case study of George Soros breaking the British Government and the Bank of England, the opportunity to generate asymmetric capital returns currently exists for those silver market participants who can position themselves appropriately before the ‘silver moon shot’ occurs.

When will the ‘silver moon shot’ occur?

The critical question remaining is when will the ‘silver moon shot’ occur?


While identifying the precise moment remains difficult to forecast, recent market developments suggest that the silver moon shot may occur sooner rather than later.


As noted recently in ‘Will COVID-19 collapse gold and silver price manipulation’, significant disruptions occurred in the gold market on 23 and 24 March 2020 resulting from:

  • a surge in demand for physical gold bullion; and

  • a lack of physical gold to meet EFP delivery requirements.

These disruptions resulted in several financial institutions losing significant sums of money such as HSBC losing $US 200 million[13] and the Canadian Imperial Bank of Commerce (CIBC) losing $US 64 million[14] both within one day trading.


Moreover, throughout April, May and now June 2020, additional developments have surfaced which add weight that the silver moon shot may be soon approaching including:

  • bullion banks withdrawing from the COMEX as demonstrated by a sharp fall in the open interest (i.e. the number of COMEX contracts outstanding)[15];

  • the Bank of Nova Scotia (a LBMA market maker) announcing their withdrawal from trading in the precious metals market in early 2021[16];

  • a significant surge in demand for gold and silver EFTs such as GLD and SLV[17];

  • increased Bank for International Settlements activity within the gold market via gold swaps and gold related derivatives reaching a 3 year high in May 2020[18]; and

  • an unprecedented surge in physical gold and silver being deposited at COMEX depository warehouses in June 2020 in response to a record number of COMEX futures contracts standing for physical delivery[19].


If the trajectory of these developments:

  • continue in the coming weeks and months; and

  • result in a chronic shortage of physical silver to the point at which the COMEX is unable to meet all requests for physical delivery,

then bullion banks, who actively participate in setting an artificial disequilibrium silver price, will be forced to allow the silver price to readjust towards the equilibrium either in a controlled fashion or uncontrollably.


Importantly, the current direction of global macroeconomic policy of ever-increasing rounds of fiscal and monetary stimulus given:

  • the state of the global economy;

  • the scale of the current global debt bubble; and

  • the fragility of capital markets and of large corporations (including financial institutions)

indicates that a greater global demand for physical gold and silver is more likely in the coming years meaning that the silver moon shot is ultimately inevitable.

Conclusion

Microeconomics shows us that the artificial pegging of prices at points of disequilibrium can cause significant market distortions whether they be excess supply (i.e. surpluses) or excess demand (i.e. shortages).


Governments and large-sized corporations have the ability to maintain artificial price pegs for a considerable amount of time.


Over this duration, the cost of maintaining an artificial price peg mounts for the entities involved as the scale of the market distortions grows larger.


The history of economics indicates that market distortions grow until a point in time where the cost of maintaining an artificial price peg becomes unsustainable for the entities involved.


At such a point, the artificial peg is released resulting in a dramatically sharp readjustment of price from the pegged price towards the equilibrium price.

Investors who can:

  • identify market distortions resulting from artificially set prices;

  • anticipate the point at which market distortions become unsustainable; and

  • deploy capital to take advantage of dramatic price readjustments before they occur

are able to earn very lucrative asymmetric capital returns.


George Soros is one famous investor who was able to handsomely profit to the tune of $US 1.5 billion in September 1992 following the withdrawal of the GBP from the ERM.


In 2020-2021, the most attractive investment opportunity to profit from a readjustment of price following the collapse of an artificial peg is the silver market, given that arguably the current price of silver is furthest away from its market valued equilibrium price based on physical demand and supply fundamentals.


John Adams is the Chief Economist for As Good As Gold Australia

[1] An asymmetric capital return is an investment opportunity where the opportunity to realise a very large capital gain has a high probability whereas the downside risk is relatively very small. [2] https://www.thebalance.com/black-wednesday-george-soros-bet-against-britain-1978944 [3] https://warwick.ac.uk/fac/soc/pais/people/kettell/research/erm.pdf [4] See footnote 2 [5] In increasing his position that morning, Soros borrowed large sums of GBP and was selling them on foreign exchange markets. [6] https://theeconreview.com/2018/10/16/how-soros-broke-the-british-pound/ [7] By abandoning the ERM, the British Government experienced a loss of 3.3 billion GBPs. [8] https://www.adamseconomics.com/post/the-undeniable-manipulation-of-the-silver-market [9] https://www.adamseconomics.com/post/covid-19-exposes-gold-and-silver-price-manipulation [10] See footnote 6. My article ‘The undeniable manipulation of the silver market’ outlines the methodology for how this calculation can be achieved. [11] https://www.adamseconomics.com/post/beware-of-synthetic-gold-and-silver-products [12] https://www.adamseconomics.com/post/will-covid-19-collapse-gold-and-silver-price-manipulation [13] https://www.bloomberg.com/news/articles/2020-05-13/hsbc-lost-about-200-million-in-one-day-on-gold-market-turmoil [14] https://www.reuters.com/article/us-cibc-gold/canadas-cibc-lost-64-million-in-a-day-on-paper-in-gold-market-turmoil-idUSKBN2343K9 [15] https://www.reuters.com/article/us-health-coronavirus-gold-cme-exclusive/exclusive-bullion-banks-prepare-cme-pullback-after-virus-snarl-idUSKBN23424L [16] https://www.reuters.com/article/us-metals-bank-of-nova-scotia-exclusive/exclusive-scotiabank-to-close-its-metals-business-sources-idUSKCN22A2ZC [17] https://www.bullionvault.com/gold-news/gold-silver-etf-060320201 [18] http://www.gata.org/node/20214 [19] See the following discussion between Chris Marcus and David Kranzler at the Arcadia Economics YouTube channel: https://www.youtube.com/watch?v=MSzH8maPneg

© John Adams Economics 2020. All Rights Reserved.