Early in 2018, there is some prospect that gold and silver prices could become extremely volatile, maybe even to the degree such as happened with the price of Bitcoins in 2017.
While receiving very little media coverage, the settlement of maturing contracts on the New York COMEX over the past few months has taken a strange turn.
When maturing COMEX gold futures contracts are called for delivery of the underlying metal, the party on the short side of the contract has four options: delivery of the physical metal from registered inventory in a COMEX warehouse, payment in cash, delivery of corresponding shares in a gold exchange traded fund, or what is called “exchange for physical.”
Exchange for physical means that the contract is settled by delivery of some cash plus a contract for an equivalent amount of gold on the London Bullion Market Association exchange. This form of settlement was established by the COMEX in 1974 as what was expected to be only an emergency option. The reason for that is that making settlement in this manner would actually cost more than the current gold spot price. Obviously, if the party on the short side were in a position to deliver the physical metal, cash, or shares in an ETF, that would cost less than doing an exchange for physical.
Consequently, over the decades, settlement by exchange for physical was little used. However, that has changed in recent months. Researchers Koos Jansen, James Turk and Harvey Organ have been tracking the number of maturing COMEX gold contracts being settled by exchange for physical. During October and November, they report that the average daily volume of gold contracts settled by exchange for physical amounted to 850,000 ounces (850 contracts). Early last week, Harvey Organ reported that volume settled in this manner had jumped in early December to an average of 1.4 million ounces per daily.
There is a problem with a COMEX contract being settled with some cash plus an equivalent contract in the London market – there is virtually no physical gold available at the London exchange. Parties seeking to receive delivery of physical metal are having to wait, recently, an average of 13 weeks to get delivery. In fact, the firms trading on the London market are refusing to accept orders to deliver large quantities of physical metal simply because they cannot fill such orders on a timely basis.
In theory, both the COMEX and London markets should be able to deliver physical gold immediately. That certainly isn’t true in London, and it is suspicious that may also be true on the COMEX. At the close on Dec. 11, 2017, the COMEX reported only 879,624 ounces of registered gold inventories in all of their vaults combined (go to http://www.cmegroup.com/clearing/operations-and-deliveries/nymex-delivery-notices.html and click on “gold stocks” for current data). There were another 8,102,519 ounces of Eligible inventories in COMEX warehouses that day, but those are not automatically available to deliver against a maturing contract unless the owners agree to convert them to Registered inventories.
Obviously, with COMEX registered gold inventories lower than what it would take to fulfill one day’s worth of delivery demands at current demand levels, the gold market is primed to experience a major supply squeeze.
At the close on Dec. 11, there were 344,282 open gold futures contracts on the COMEX, representing 34,428,200 ounces of gold. Only a small percentage of these contracts will ultimately be held for delivery at maturity. Most owners are investing in the price rather than wanting to own the actual commodity. Therefore, most owners will sell off their long position before maturity. If they want to maintain a paper investment in gold, they would then buy another long contract with a maturity further into the future.
But there is always some percentage of these contracts where the owners do ask for physical delivery upon maturity. What happens when investors sense that there is a shortage of physical metal for delivery is that they become more inclined to request delivery rather than roll over contracts into others with later maturity. Such a shift results in a supply squeeze that can quickly force up prices. This happened at the end of April 2011 for silver and in September 2011 for gold, for instance. It could definitely occur again in early 2018.
When the gold or silver markets experience major supply squeezes, that tends to encourage investors to acquire the other of these two metals in hope of making a greater percentage profit once lagging demand matches the first of these to soar in prices.
If you are interested, researcher Harvey Organ sent a Dec. 11, 2017, letter to J. Christopher Giancarlo, the chairman of the Commodity Futures Trading Commission, asking him to publicly comment on the developing shortage of physical gold in the COMEX futures market. You can read a copy of this letter at his blog at https://harveyorganblog.com/2017/12/11/dec-11-letter-to-commissioner-of-the-cftc-giancarlo/.
Patrick A. Heller was the American Numismatic Association 2017 Exemplary Service and 2012 Harry Forman Numismatic Dealer of the Year Award winner. He was also honored by the Numismatic Literary Guild in 2017 and 2016 for the Best Dealer-Published Magazine/Newspaper and for Best Radio Report. He is the communications officer of Liberty Coin Service in Lansing, Mich., and writes “Liberty’s Outlook,” a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Some of his radio commentaries titled “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 a.m. Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com).
This article was originally printed in Numismatic News. >> Subscribe today.
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