05/03/2011 08:18 pm ET | Updated Jul 03, 2011

Silver and Derivatives Dislocation

In the past couple of days I have received a number of calls about currency weakness and commodities volatility -- especially that of silver.

The aggressive policies pursued by the American government and other debtor nations to debase their currencies have awakened speculation in "hard assets" such as silver, gold, other precious metals, oil, etc. As the prices of these commodities are fear driven, not demand driven, there is no analytical case to be made for either boom or collapse.

There are, however, technical reasons to be cautious. Historically, when currencies become worth less and less, politicians try to offload the blame on the "speculators." Nixon put currency controls in effect. Roosevelt prohibited gold ownership. Currently delivery of the ten ounce bar of gold has ended and is replaced with a "dollar settlement" substitution. When in enough trouble the political "saviors" institute confiscatory treatment against those left with some form of assets. History is replete with such activity.

Another observation often made is that these markets have little to do with the underlying asset as the derivatives markets in these assets constitute many, many fold the availability of the "underlying" asset. We saw in recent history what happens when one or more of the derivatives bankers, brokers or speculators are improperly capitalized or hedged. Witness the mortgage crisis! Witness the Hunt silver bubble and subsequent debacle!

To sum up, the recent run-up in hard commodities has little to do with demand for productive economic consumption. It is driven by fear or simple trading exuberance. Whether the run-up has discounted the likely continued depreciating value of most currencies is not measurable. Politicians punish the winners in times of extreme. The winners are the scapegoats. Their capital and capitalistic rights are often trod upon. The banks, brokers and many speculators are never well enough capitalized or hedged in these volatile derivatives markets. The system is at risk at times of high volatility.

It would not be a surprise but would, indeed, be sad to see the "hard asset" derivatives markets as the source of the next economic emergency.