Counterparty Risk May Lead to Potential Squeeze in Gold Market

Gold rallied sharply last week and was up nearly 9% despite continuing uncertainty and a very mixed performance in stock markets. The US dollar index fell some 4% on the week and it looks increasingly likely that the dollar may have topped out and may soon resume its bear market. For the year, gold is now up by more than 4% in dollar terms and by much larger amounts in euros (+11.7%) and pounds (+40.4%).

Gold rallied sharply on the open in Asia and has remained elevated as oil is stronger (up some 4%) and the dollar remains weak.

The FT reported late Friday on the potential for squeeze in the gold market by year end which would see prices rise materially.

The FT’s Chris Flood reported that:

Traders have been hearing talk that the gold market could face a potential squeeze at the end of this year if market participants with futures position on New York's Comex exchange decide not to roll over their positions, because of concerns about counterparty risk and opt for physical delivery instead.

But dealers dismissed the threat of a squeeze, pointing out that Comex gold stocks stand at 8.5 million ounces, well above the five-year average of almost 6 million ounces. ..."

The 8.5 million ounce figure cited by the FT is actually the total Comex gold inventory which includes gold that belongs to customers who are storing it on the exchange which is not available for delivery. The amount that is registered to dealers, and therefore available for delivery, is only 2.846 million ounces. The delivery notices that have been issued so far in December total 1.26 million ounces, which is 44 percent of the available deliverable gold. There is also the possibility that some of the gold may be encumbered in lending/swap operations.

According to the Gold Anti-Trust Action committee (GATA), the Comex authorities themselves have been alerting various futures firms about the potential of a squeeze on the December contract . The Comex is allegedly advising the $840 December shorts to exit their remaining open positions. There have been 12,636 notices of delivery. The shorts have until December 31 to make delivery. Normally they deliver early to take in cash and earn the interest.

This represents about 43 percent of the gold available at the Comex. Some speculate that concerned futures players could buy the February gold contract and then spread into December, which would shock the shorts and lead to a massive short squeeze sending prices markedly higher in a short period of time.

Former Federal Reserve Governor Says Fed’s Gold is Important Asset

Another bullish development for the gold market was former Federal Reserve Governor, Lyle Gramley reassuring that the Federal Reserve’s solvency was not at risk (due to its rapidly deteriorating balance sheet). Gramley denied such concerns were valid as he said the Fed has significant assets in the form of undervalued government gold certificates.

Interviewed Monday last week on the "Trading Day" program of the Business News Network in Canada, Gramley hinted that a big upward revaluation of gold may figure heavily in the Fed's attempt to rescue the U.S. economy. Gramley, now senior adviser at Stanford Group in Houston, was asked about the seemingly grotesque expansion of the Fed's balance sheet in recent months by the program's guest host, Niall Ferguson, an author and history professor at Harvard.

Ferguson asked:

I've heard it said that the Fed has turned into a government-owned hedge fund, leveraged at 50 to 1. Do you feel nervous about what this might actually do to the Fed's reputation?

Gramley reponse was:

I think you have to reckon with the fact that one of the Fed's assets is gold certificates, which are priced, as I remember, at $42 an ounce, and if we were to price them at market prices, the Fed's leverage would look a lot less than it is now.

More signs that gold is increasingly being viewed as the potential savior of central banks internationally from the global deflation gripping the world. The Federal Reserve is one of the largest holders of gold in the world with most of its foreign currency reserves in gold. A devaluation of the dollar and revaluation of gold may help the U.S. government and the Federal Reserve to protect their solvency and inflate their way out of a Depression.

Source: Wikipedia

Comments

[waldipup:]

"if market participants with futures position on New York's Comex exchange decide not to roll over their positions, because of concerns about counterparty risk and opt for physical delivery instead."

I agree, but would point out that many dont have the cash for that , and only play the futures market based on margin trading -

Unless we are talking about a point in time per delivery month when full value has been required to remain in a position?

2008 Dec 16 09:06 AM

[bearfund:]

You do your readers no favours by breathlessly promoting gold. Rumour, innuendo, and appeals to nebulous authorities are all pointless. Gold isn't an investment and it isn't going to "explode higher".

Here are the facts:

1. Gold is the only meaningful store and standard of value. The US dollar is a convenient medium of exchange - for now, at least - but is not a store of value. Accordingly, the "price of gold" is really nothing but the inverse of the real price of the dollar.

2. Price and value are related in theory only. While price must eventually converge to value, there can be no assurance that it will do so on any particular timeline, or that it will not overshoot.

3. The value of the US dollar is equal to the discounted present value of all current and future US production divided by the total number of US dollars in existence.

4. US production is falling.

5. The number of US dollars in existence has increased by approximately 190% in the past 12 months.

6. Therefore the value of the US dollar has fallen by about 66% in that time.

7. The market price of the US dollar has fallen by about 7% in that time.

Traders must wonder whether the US dollar was artificially depressed a year ago or is artificially expensive today. A first-order look would suggest the latter; the world is in the midst of a dollar short squeeze right now, which has propelled its price higher in absolute terms as well as relative to other financial assets. But it's entirely possible that 1/850 ounce of gold is actually a reasonable price for the dollar /assuming no further increase in supply were to occur/.

Place your bets, if you wish. For the rest of us, gold remains a very simple asset: a store of value. The price of the dollar is almost completely irrelevant. The value of the dollar is interesting only in making trades. Please don't go suggesting shadowy conspiracies and latent squeezes to get people excited about "buying" gold. People who think of it that way don't understand the purpose of gold and more importantly they mistakenly think the dollar is a store of value. That's why they keep score in it, and why they think they've "won big" when they "buy gold" and it "explodes". In fact all it means is that a portion of their portfolio retained its value while the rest dropped like a rock. If that makes them feel good, so be it, but they're not profiting and you're not helping them. Instead, please help people understand what gold and the dollar (and other assets) are for, what they do, how they work, and why someone might or might not want to own them. Rumours are delicious but facts are where profits come from.

2008 Dec 16 11:04 PM

[Theo68:]

Bearfund,

Your point on conspiracy theories is well-taken. Making investment decisions on rumor rarely pans out. However, many of your facts (number of dollars increasing while production is decreasing . . .etc) seem to support the opinion that gold is a prudent investment.

Although I own gold, I truly hope we don't see it at $10,000/ounce as that would mean the probable collapse of society. A slow steady advance to $2000/ounce over the next couple of years is fine with me.

2008 Dec 17 03:03 AM