Regulators have frowned on the extreme market moves in stock prices of firms that had been suffering from the pandemic. Traders using social media platforms to share views have gone after short-sellers such as hedge funds. 

(Updated with fresh price action, adds Singapore regulator's comments.)

Social media traders who last week prompted big swings in the share price of US games retailer GameStop – hitting short-sellers in the process – have turned fire on silver, triggering a sharp rise in the precious metal. 

In New York, futures prices for the metal settled at their highest point in eight years (source: Wall Street Journal, 1 February). The most actively traded futures gained 9.3 per cent to $29.42 a troy ounce, the highest for almost eight years, and briefly went over $30 at one point. Analysts have noted that earlier attempts to corner the silver market have led to crashes, and that this is a notoriously volatile commodity. In overnight trading,  prices subsequently fell by 1.96 per cent after the CME Group hiked trading margins by about 17.9 per cent on silver futures contracts. The exchange said that the decision was based on “the normal review of market volatility to ensure adequate collateral coverage.” (Source: Deutsche Bank).

The extraordinary market moves of recent days have prompted the main US financial regulator and UK watchdog to warn about consequences for retail investors. The Monetary Authority of Singapore also issued a cautionary note on the saga yesterday.

Users of the Reddit platform bought silver to squeeze out short-sellers - the same tactic they used to hit those shorting GameStop and AMC, the cinema chain. Silver eased off its highs in London trade yesterday, touching $29.52 per ounce, having started the day at $28.45, according to BullionVault, a precious metals trading platform.

Melvin Capital Management, the US hedge fund that was hit hard by the soaring stock prices of heavily shorted stocks, reportedly lost 53 per cent on its investments in January (source: WSJ, 31 January, quoting unnamed sources).

In a 29 January statement, the Securities and Exchange Commission, said it was “closely monitoring and evaluating the extreme price volatility of certain stocks’ trading prices over the past several days.”

“Our core market infrastructure has proven resilient under the weight of this week’s extraordinary trading volumes. Nevertheless, extreme stock price volatility has the potential to expose investors to rapid and severe losses and undermine market confidence,” the SEC said. The statement was signed by acting chair Allison Herren Lee; commissioner Hester M Peirce; commissioner Elad L Roisman, and commissioner Caroline A Crenshaw. 

The volatile activity will be a big test for former Goldman Sachs banker Gary Gensler, nominated by President Joe Biden to take over as SEC boss. If the saga hurts retail investors, the SEC will want to be seen as protecting millions of investors’ portfolios. Gensler's post has yet to be confirmed by the US Senate.

In its statement late last week, the UK’s Financial Conduct Authority said: “Buying shares in volatile markets is risky and you may quickly lose money. These losses are unlikely to be covered by the Financial Services Compensation Scheme. Broking firms are not obliged to offer trading facilities to clients. They may withdraw their services, in line with customer terms and conditions if, for instance, they consider it necessary or prudent to do so. Firms are exposed to greater risk and therefore more likely to need to take such action during periods of abnormally high transaction volumes and price volatility.”

“We will of course take appropriate action wherever we see evidence of firms or individuals causing harm to consumers or markets,” it added. 

Singapore's MAS said yesterday: "The public should be aware that certain individuals may exploit this interest for their own benefit through “pump and dump” activities that can amount to market misconduct under the Securities and Futures Act."

Silver
Comments on the silver market began circulating on Reddit forums last week, reports said. One comment read that the “Silver Bullion Market is one of the most manipulated on earth. Any short squeeze in silver paper shorts would be EPIC.” Another post on the forum stated that “inflation-adjusted silver should be at $1000 instead of $25. Why not squeeze $SLV to the real physical price. Think about the Gainz. If you don’t care about the gains, think about the banks like JP Morgan you’d be destroying along the way.” (Source: Daily FX).

Adrian Ash, research director BullionVault, said: “We've seen people try to corner the market in silver before, but the size and speed of the Reddit Ramp is off the charts for silver. The billionaire Hunt brothers took a decade to build their position in the 1970s, and Warren Buffett built his mid-1990s' holdings over a couple of months. Both helped drive the price higher, but nothing like as fast as the 'hive mind' of Reddit has spiked silver 20 per cent since Wednesday night [last week].”

“The flood of new interest in silver has emptied coin shops, but there's plenty of metal in wholesale storage, and any talk of a 'shortage' will in truth refer more to trucking and handling capacity rather than physical stockpiles,” he said. 

Attack on shorting
The attack on short-selling is against a practice used by hedge funds to profit by taking a negative view of a market, or to hedge against downside risks and, as such, is a widely-used wealth protection tool. But at certain times, during the 2008-09 financial crash for example, the practice of shorting has been politically attacked as making market falls more severe than they would otherwise be. 

“As always, the Commission will work to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate capital formation. The Commission is working closely with our regulatory partners, both across the government and at FINRA and other self-regulatory organisations, including the stock exchanges, to ensure that regulated entities uphold their obligations to protect investors and to identify and pursue potential wrongdoing,” the SEC said in its statement. “The Commission will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities.”

“In addition, we will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws. Market participants should be careful to avoid such activity. Likewise, issuers must ensure compliance with the federal securities laws for any contemplated offers or sales of their own securities,” it said. 

BullionVault’s Ash warned that silver is a notoriously volatile metal, and that market participants who try to make it more volatile as part of a campaign were playing with fire.

“While short-term spikes and dips in price are great for trading platforms like BullionVault, we hope the long-term case for precious metals investing becomes clear to silver's sudden flood of new buyers. Fact is, however, anyone buying silver should know that it's called `the devil's metal’ for a reason. Volatility can be swift and violent, and it can be hard to miss the long-term uptrend in prices if you suddenly find yourself sitting on a loss,” he said. 

Gensler stepped down from leading the Commodity Futures Trading Commission in early 2014. Since then, he has taught finance at the Massachusetts Institute of Technology and written about financial-technology innovation, such as the rise of bitcoin – another volatile entity.

Not a “one-off”
The events of recent days aren’t isolated, Patrick Ghali, managing partner at Sussex Partners, an alternative investments advisory firm, said. 

“We don’t think this is a one off but rather something that has been going on for a while now to different degrees. This is clearly creating unwanted volatility for managers, especially market neutral and fundamental strategies, as companies with questionable fundamentals are suddenly rallying and this is leading to dislocations in portfolios. Eventually fundamentals should prevail but in the meantime this can lead to losses for managers despite them being correct in their analysis,” he said. 

“Understanding flows, and retail investor behaviour, has become very important in this environment and has led to sometimes significant distortions in equity prices. It feels like some of these platforms have in effect turned parts of the markets into a version of legalised gambling, with retail investors that are stuck at home due to the pandemic passing their time by playing the markets,” Ghali said. 

“Fundamentals should win out in the end, but nobody can predict how long this may take and in the meantime this can certainly force managers to close out positions due to unforeseen losses. Low liquidity stocks are obviously more vulnerable to such moves,” he continued. 

“It has already started to spread to Asia though to a smaller extent. I think there are a couple of points to remember. Firstly, company fundamentals will have to prevail in the end. A company that isn’t making money isn’t going to make money just because the valuation increases. Secondly, it is too simplistic to look at hedge funds as this Goliath you want to attack. People should remember that many hedge funds manage investments for public and other pensions etc, and so attacking them means that ordinary people will suffer losses in their pensions etc. Hardly a noble goal,” he added.