Will COMEX Default on Gold and Silver?

With investment advisors like the former NASDAQ Chairman Bernard Madoff being prosecuted for fraud, it is natural for people to begin to seek stores of wealth that are not subject to counterparty risk. The precious metals have been relatively safe stores of wealth for the past 10,000 years. Many people are going back to basics, turning back to the precious metals, as places to put their money, in these uncertain times.

Gold and silver were once the most stable of all goods. Extreme volatility, however, is now a part of their nature. It comes from being made a part of the commodities casino, known as the American futures market, where speculators are allowed to use margin to control 14 times as much metal as they actually have money to buy. When the price drops a little, the “stop loss” orders of these leveraged players are triggered, and that amplifies the price move such that the price collapses on the futures market. Similarly, when gold fever begins, the prices can shoot into the sky, as the leveraged longs begin buying again. That is why the price for futures based gold and silver is still very low compared to March, 2008, even though the real world investment demand for both metals is higher than it was, back then (higher than ever before in history, actually), mining supply for gold is down by 5%, and the mine based supply of silver has utterly collapsed.

It should be noted that precious metal volatility is a short and sometimes medium term phenomenon. Since 1913, when the Federal Reserve was created, the dollar has depreciated by 97% against gold. The dollar has depreciated by about 90% against silver in that same 95 year time period. Gold has also appreciated tremendously in price as compared to 8 years ago, 2.5 times against the Euro and 3 times against the dollar. Rational people, therefore, cannot deny that, using a multi-year or, even more, a century long point of view, gold and silver are the best stores of wealth. When looking at long term family legacies, therefore, a large position in gold and silver should be a part of every estate plan. That is especially true now, given that demand currently substantially exceeds supply, the imbalance has every likelihood of becoming more severe in the near future, and the “futures” exchange prices are now very low compared to the real market.

In the last decade, central banks selling and leasing made up the long time shortfall between supply and demand. But, given the financial crisis, and the fear that the U.S. dollar will eventually collapse, central banks no longer want to hold all their exchange reserves in U.S. dollar cash, U.S. dollar denominated bonds and other investments. They are also unwilling to hold everything in other paper currencies, like the Euro. Some governments, including those in Europe and the USA, still have large gold hoards. But, China wants to buy 3,600 tons of additional gold for its reserves. The only way that this demand can be fulfilling without exploding the price is through a “privately negotiated” off-market sale of IMF gold. European banks don’t want to continue selling what gold hoards they still have left, after 20 to 30 years of participation of selling and leasing gold.

In the case of silver, almost all government stockpiles are now gone. The only ones left are in Russia and China, and China restricted the export of silver last year. The U.S.A., for example, has already expended every last ounce of its strategic silver reserves years ago. The U.K. and all other western nations exhausted their supplies even before the U.S.A. Newly mined supplies have never been sufficient, and demand continues to increase. The imbalance between supply and demand is becoming especially severe, and, in the case of silver, is going to increasingly be a difficult industrial use issue in the next few years.

Because of the severe shortages, retail dealers are charging hefty premiums for both gold and silver. This is dissuading many people from buying, but it shouldn’t, because there are ways to buy the metals without paying any premium at all. Gold and silver are selling cheaply, without premiums, on the American futures markets. Most futures contracts allow buyers to demand delivery of the metal, so the futures market is an excellent way to obtain comparatively cheap precious metals. This has already been noticed by astute investors. In the past, most traders used futures markets solely for purposes of speculation. Normally, delivery demands average less than 1% each month. Now, however, because of the premiums available in the real market, buying a futures contract and demanding physical delivery upon maturity has become a cheap method of obtaining substantial quantities of physical gold and silver. With respect to the December contract, for example, exchange records show that more than 5% of people holding open standard sized (100 ounce) gold futures contracts, and about 10% holding open silver futures contracts (5,000 ounce) demanded delivery. The delivery demands are happening even more often among deliverable mini-contracts (33.2 ounce gold/1,000 ounce silver) purchased on the NYSE-Liffe exchange.

Some speculate that clearing members of the exchanges, who have sold gold and silver short on the futures market, will eventually be bankrupted by these delivery demands. According to these skeptics, the gold and silver consists mostly of fake claims to vaulted supplies that do not exist. They say that futures contracts are nothing more than “fake paper gold” and most refuse to buy on the futures markets, opting, instead, to pay huge premiums at retail gold and silver dealers. The skeptics may be right about the failure to keep adequate supplies of vaulted metal, but it doesn’t really matter. If you buy gold and silver on the futures exchanges, you will get your metal, whether or not the short sellers are trying to defraud you, and I’ll now explain why.

The Commodities Futures Trading Commission is charged with the responsibility to monitor and regulate American futures markets. In spite of this, the futures markets have morphed from a legitimate place to hedge the risk of commodities, into a worldwide casino, which has a gaming commission that claims all of games of chance are really “investing”. This is nonsense. The exchanges are mostly used as gambling halls, with banks as casino operators, and speculators serving in the role of casino guests. All types of bets, from taking odds on interest rates to taking odds on the volatility of the stock markets (with no underlying security except the VIX!) are allowed, and are available to anyone who enjoys games of chance. If the CFTC ever bothered to enforce its own enabling act, and associated regulations, most of these games of chance would be quickly closed. For example, CFTC regulations require 90% of all deliverable commodity contracts (including gold and silver) to be covered by stockpiles of the real commodity, and/or real forward contracts from real producers (like miners). In practice, however, CFTC has never done a spot audit of even one vault. We really have no idea whether or not short sellers really have the gold or silver that they claim to have. We can assume that they probably don’t, given that the number of futures contracts issued has often exceeded the entire known supply of silver, for example, in the entire world.

Indeed, in spite of rampant speculation as to their identity, in truth, we don’t even know who the short sellers are. Other countries, like Japan, have full disclosure of identities and positioning, in open and transparent futures markets, but this is not true of the much larger futures markets based in America. American futures markets are mostly opaque, because the CFTC keeps the information secret. Lack of transparency always is a recipe for fraud and corruption. The likelihood of widespread violations, occurring at exchanges regulated by CFTC, is very high. Logical people, therefore, can make some reasonable assumptions. It is quite likely that the sellers on COMEX do not have 90% of their silver contracts, for example, backed by stockpiles of the metal.

Yet, adherence to Federal regulation is an implicit provision in the terms and conditions of every futures contract. If COMEX and/or NYSE-Liffe short sellers are entering into naked short contracts, they are violating market rules, falsely presenting their contracts to the public, and doing all this with a premeditated intent to defraud buyers. Knowingly making false assertions and promises is fraud in the inducement. Violation of the market rules is also “fraud upon the market”, and a federal and state felony level crime that can result in a long jail sentence. The vast majority of short positions in gold and silver appear to be held by only 2 – 3 American banks, so, it would be extraordinarily easy to pinpoint the perpetrators. Potentially, they could be prosecuted for market manipulation, common law fraud, state and federal RICO actions, as well as other counts.

In other words, a large scale default on COMEX or NYSE-Liffe would not only trigger the paying of money damages, but would also involve criminal liability. Even if a few individuals within the federal government are complicit, as has been alleged, and the U.S. Justice Department refused to prosecute, there are enough politically ambitious state prosecutors to take up the baton. Futures market short sellers would pay a heavy price if there were ever a big default. Because of this, they will spend whatever money is needed to make sure it never happens.

If a clearing member of an exchange fails to deliver, the futures exchanges are legally liable on the debt. If a clearing member goes bankrupt, performance becomes the obligation of the exchange. If a short position holder cannot or does not deliver, the exchange must either deliver, or pay in an amount equal to the difference between the contract price, and the amount of money needed to buy the physical commodity in the open market. Generally speaking, contract holders are allowed to purchase silver or gold on the spot market in a reasonably prompt manner, and all costs of doing so must be reimbursed.

Contrary to the claims of some sincere but misguided metal aficionados, while gold and silver may be occasionally in so called “backwardation”, both are readily available at the right price. That price, of course, may be considerably higher than the reported prices on futures markets. Precious metal will continue to be available so long as the price is “right”. If short sellers on COMEX are really as naked as some claim, the only result of technical “default” at the COMEX will be a huge “short squeeze”, sending precious metals prices to the roof. During this squeeze, movement of the U.S. dollar, up or down, will be irrelevant. If delivery demands exceed supplies in futures market warehouses, metal will be purchased on the spot market. Short sellers or the exchange will be forced to make good on whatever price is paid.

Here’s how it would work. Let’s say you buy a futures contract for February delivery of 100 ounces of gold at $800 per ounce in December. In February, spot gold is selling for $1,000 per ounce, and you deposit the full cash cost of your futures contract into your account, instructing your broker to issue a demand for delivery. The counterparty can’t deliver because the COMEX warehouse runs out of “registered” metal. There is a huge short squeeze as short sellers run around the world physical market, trying to buy gold. The short seller misses the last day to deliver. Because everyone starts hearing about the missed deliveries, by the next day after the last possible delivery date, spot gold in London starts selling for $1,359 per ounce. Your commodities broker must take the money you deposited and buy the commodity on the spot market for $1,359. The broker will be reimbursed by the short seller and/or the exchange in the amount of $55,900, plus any expenses you incurred in buying physical gold on the spot market. In the end, you get your gold or silver at the price you paid for the futures contract, regardless of the default.

A number of well intentioned, but misinformed, precious metal commentators have claimed that exchanges will escape from this obligation by a declaring a co-called “force majeure” event. Force majeure is a legal doctrine which says that compliance with a contract is excused if an “act of God” makes it impossible to comply. Formal force majeure provisions exist in many NYMEX contracts, including gas and oil contracts, for example. After recent hurricanes in Louisiana, a NYMEX committee declared force majeure, and an extension of time for delivery of natural gas pursuant to the contracts. Unlike gas, however, which is produced from the ground, or must be moved long distances under sometimes difficult conditions, gold and silver are commodities that normally reside in vaults, and are easily transported. It should be noted that, as of this date, no formal written force majeure provision exists in the specifications of COMEX gold and silver contracts. Admittedly, force majeure is a legal doctrine that is implied in every contract, and need not be written down. However, higher gold prices and/or failure to comply with the 90% cover rule are not acts of God and will not excuse contract performance.

Let’s say, as some claim, that short sellers have enmeshed themselves in a web of fake contracts, wherein third parties are contracted to deliver metal to them, even though both the short sellers and the third parties know that these contracts are fake, and there really is no metal to deliver. This web of lies assumedly is designed to protect against claims that they are selling “naked” shorts. The existence of such contracts doesn’t matter to the concept of force majeure. The obligation to deliver cannot be changed by a mere failure of “third” parties to deliver. Failure of contracts owed to short sellers are not acts of God. Failure of third parties to honor their contracts does not excuse performance of the short seller’s obligation to deliver to the final contract holder. It certainly does not alter the obligation of the exchange to guarantee delivery.

Some are still skeptical. What if the entire COMEX and NYSE-Liffe exchanges fail? I doubt that will happen. First, let me say that I do not agree with bailouts. Companies, whether in the financial district or in Detroit, should fend for themselves. No one should be allowed to become parasites who feed on the taxpayers, as the big banks and automakers have now become. If companies make mistakes, behaving in an inefficient and/or outright stupid manner, they and their executives should pay the price. The process of creative destruction is essential to prosperity in a capitalist system. Bad actors and inefficient operators should be swept away to make room for innovation and steadier hands. But, my views are not shared by the U.S. government or most other governments around the world. A large number of the clearing members of both COMEX and NYSE-Liffe have already been bailed out by their respective governments. Huge institutions like JP Morgan (JPM), Citigroup (C), Morgan Stanley (MS), Merrill Lynch (MER), Goldman Sachs (GS), Bank of America (BAC), UBS and Credit Suisse (CS) are considered “too big to fail.”

Can you imagine the exchanges not being too big to fail, when their individual members are? What chance do you think there is of the Federal Reserve allowing the entire COMEX or NYSE-Liffe exchange going bankrupt? In my opinion, the chance is close to zero. A massive failure to deliver is highly unlikely, but, if it did happen, and if the exchanges were unable to comply with their legally binding guarantee, the government will step in and provide gold from Fort Knox and enough money to buy silver in the open market, no matter what the price. The end result will merely be a huge price increase, and an end to the assumed legitimacy of futures market prices, not a default.

Summing things up, if you want to buy gold and silver, but don’t want to pay high premiums, buy them on futures exchanges. First, open a futures account with a commodities broker. Make sure it is a real commodities broker and not an imitation. Stock brokers, like Interactive Brokers, ThinkorSwim, MBTrading, and a number of others claim to be “futures brokers.” In truth, they are not. They can only offer you speculation, and not hedging services. They will not deliver, and will forcibly sell you out of your positions, even at great loss to you, if it comes too close to the delivery date. So, instead, make certain that you open your account with a real commodities broker, like RJOFutures.com, PFGBest, lind-waldock.com, MF Global, e-futures.com or any other broker willing to arrange deliveries. You can speculate just as easily, using a commodities broker, as you can using a stock broker that dabbles in futures. But, if you want delivery, you must have a real commodities broker. Steer clear of stock brokers unless you want to buy stocks.

Middle class families, looking for safety in precious metals, but who don’t have enough money to buy 100 ounce contracts, can buy deliverable mini-gold and mini-silver contracts on the NYSE-Liffe futures exchange. The mini-contracts require delivery of as little as 33.2 ounces of gold and 1,000 ounces of silver. If you want delivery, however, make sure you do not buy COMEX based miNY gold and/or miNY silver contracts. These COMEX mini-contracts are cash settled. The standard contracts, however, on both the COMEX and the NYSE-Liffe (consisting of 100 ounces of gold and 5,000 ounces of silver) are all deliverable.

The highly leveraged nature of gold and silver futures contracts create high levels of volatility. That should be kept in mind when you decide to put a large portion of your investment assets into precious metal. Big price rises and deep dips are commonplace. Most of these market movements occur without much regard for the forces of supply and demand in the real world market. If you need the money tomorrow, steer clear. But, if you want to preserve your family legacy with something that will take you safely through depressions and hyperinflations, over years and decades, gold and silver are good choices.

If you demand delivery and just put your bars in a safe place, you don’t need to worry about the volatility. The price is sure to rise in the longer term because of the fundamentals. Remember, as you watch the dizzying roller coaster of so-called “official spot” prices, that you are buying for the long term and/or for emergency use. Day to day price fluctuations should be ignored.

By way of disclosure, I hold interests in GLD, IAU and SLV as well as
physical gold.

Comments

[OnWallStree...:]

The futures exchanges could declare an emergency action in the spot contract and force trading for liquidation only, not delivery, meaning that each long & short will offset each other as there is ALWAYS one contract offsetting another, known as the open interest. Saying that, a short squeeze is easily facilitated vs. the then failure of COMEX back in 1980 silver to decide same with the Hunt brothers until it reached the $50@oz level.

As for phony warehouse gold stocks, worst case scenario is that, as a matter of public policy, contract specs could be changed, ex post facto, to include both in-ground proven gold reserves and additionally designated "hidden/secret" refined mega amount gold depositories worldwide, e.g., particularly in the Philippines & some in Indonesia. [You didn't think the USA has so many military bases & facilities in the Philippines to PROTECT the Philippines, did you?]

2008 Dec 22 08:39 AM

[NOWHEREMAN:]

Just a few years ago, I would have said "conspiracy theory" radical. Now, I tend to look into every nook and cranny.

I have believed that the price of gold has been manipulated for decades because of the Fed's changes to PPI and CPI calculations.

Therefore, nothing can be said to be impossible, just hard to prove. IMHO

2008 Dec 22 09:37 AM

[ABG:]

Declaration of "liquidation only trading" does not prevent people from taking delivery. It only affects traders. Delivery is a contractual right that cannot be taken away from contract holders.

When CFTC declared "liquidation only", in the silver markets, back in 1980, it simply meant that traders were unable to buy new positions in silver. This allowed short sellers to buy back the contracts and liquidate their short positions. The declaration of "liquidation only" trading does not affect old positions, and if the Hunts wanted to, they could still have stood for delivery.

Taking delivery is a contractual right, and in the absence of a real force majeure, it is protected by the Commerce clause of the U.S. Constitution. The CFTC can regulate trading, but cannot make rules that retroactively impair the right of contract.

As unlikely as the CFTC is to make an attempt to blatantly support silver and/or gold fraud, if such an "emergency order" (to stop deliveries) were made, it would be quickly invalidated by the courts. The end result would be that defaulting short sellers would owe a larger sum of damages (because the price will have risen) and the CFTC would owe huge sums of money for the attorney's fees of the victims who act to invalidate the regulations.

CFTC is not actively enforcing its own regulations, right now, but that does not mean it is actively supporting the alleged fraudsters, except by failing to act affirmatively against them. In any event, the agency cannot alter the right of contract, nor would it dare to try. It is not very likely that CFTC would enact trading rules to support of fraudsters.

You must remember that the short sellers were the victims back in 1980.
The Hunts were attempting to "corner" the silver market on the long side. That is market manipulation of the opposite sort that short-selling banks are now being accused of. Collusion by longs, who wish to create a falsely higher price, by constricting normal supply is just as wrong as attempting to periodically crash the market using the weaknesses of leveraged longs.

On top of this, the gold market is far deeper than the silver market, and is traded all over the world. COMEX prices currently have a heavy influence on spot prices because they are assumed to be legitimate. The fact that the COMEX standard contracts are deliverable, leads people to use the futures markets for price discovery. But, the end of trading on COMEX will end the moral authority of the futures exchanges to influence the spot price, and will not collapse the price, in the current market. If, in fact, there is downward manipulation, and end to it will result in a huge increase in price. Back in 1980, the Hunts were engaged in upward manipulation, using the futures exchanges as a key part of their plans. An end to trading there, caused the end of the upward manipulation, and, therefore, a crash in the price.

In short, once again, a delay in fulfillment of COMEX delivery will not stop contract holders from getting their gold and silver. Instead, it will simply cause a huge price rise because, if there really is a conspiracy to reduce prices, it will be ended, then and there. The futures markets are a great place to buy physical gold and silver.

Dec 22 08:39 AM ComexCow wrote:

> The futures exchanges could declare an emergency action in the spot
> contract and force trading for liquidation only, not delivery...

2008 Dec 22 10:19 AM

[bold4gold:]

Nice to hear the TRUTH !!!

2008 Dec 22 10:40 AM

[timhope:]

Interesting article Avery. Can you clarify where the counterparty risk lies for the investor. If one goes through a legitimate broker and and the short seller fails to deliver to the broker, is the broker then legally obligated to purchase the gold at the spot price and make good on the delivery? That would seem to imply that an investor's counterparty risk is ultimately with their broker, not the short seller. And if there is a large scale delivery breakdown, how many brokers are well capitalized enough to deal with that situation? I would imagine a vast majority could easily be forced into bankruptcy. Is this generally correct? Thanks.

2008 Dec 22 12:40 PM

[secmaven:]

It would seem to be only a matter of time for the tiny percentage of outstanding dollars necessary to be presented to the COMEX for delivery of precious metals to cause its stocks to be exhausted. Why the folks sitting on billions in zero interest Treasury bills don't see the relative advantage of gold given its strong investment performance while every other investment known to man has cratered is beyond me. But maybe that's why I am not among those fortunate folks. Do they know something the rest of us don't know?

2008 Dec 22 02:12 PM

[Jack Walker:]

Avery,

This is an excellent and informative article.

Is it correct to conclude in the event of a real short squeeze the bullion banks will ultimately be bailed out by the US taxpayers?

As you say,

“The vast majority of short positions in gold and silver appear to be held by only 2 – 3 American banks…,”

Do you know if the SPDR Gold Shares ETF (GLD) is permitted to lease gold holdings to the bullion banks who then us it as margin for shorting or is it all being held long and unencumbered in a depository?

Jack

2008 Dec 22 02:13 PM

[ABG:]

The counterparty is the exchange and short seller, not the broker. The broker is merely your agent, carrying out your trades.

There is always some temporary counterparty risk with the clearing broker, because they store your cash during the transaction. Notable is the fact that commodity brokers (and stock brokers who are acting as futures brokers) are not covered under the SIPC insurance scheme.

But no major futures clearing broker ever has gone bankrupt, to the best of my knowledge. It is a very profitable business.

There is no law on this, because the event has never happened, but, theoretically, best execution regulations would require the broker to buy the gold promptly, on the spot market for you, to carry through the trade to its natural conclusion of delivery. The exchange would be under an obligation to reimburse you (and, therefore, the broker) on all costs. The broker should have no problem in taking whatever short term loans it needs to carry through the transactions.

Keep in mind that your short selling counterparty is probably one of the biggest banks in the world, like JP Morgan, HSBC, Goldman Sachs, etc. They are obligated to carry through the transaction, so the likelihood that your broker will actually need to go to the London spot market to buy is VERY small. It will almost assuredly be done by the short sellers to save face.

Remember, these banks all have complete access to the federal trough, and feed at it regularly, so money won't be a problem for them. Contrary to the visions of some metals aficionados, gold is very available, provided that the price paid is high enough. In short, I think the counterparty risk is minimal, especially if you buy a contract for the next available expiration date, and take delivery that month.

2008 Dec 22 02:21 PM

[ABG:]

GLD is not permitted to lease gold to the best of my knowledge. However, if short sellers hold shares of the COMEX gold trust (IAU), they are allowed to pledge those shares to meet the "cover" requirement. IAU and GLD allow withdrawals by shareholders, provided that the shareholder owns a "basket" worth of bullion. A basket consists of several million dollars worth of gold. To get the exact numbers, you need to get the prospectus for IAU. At any rate, assuming that some of the banks millions of dollars worth of IAU shares, or buy them in anticipation of a delivery problem, they can cash the shares into bullion, and deliver that bullion. Hence, the amount of gold available to short sellers at COMEX is probably larger than appears on the surface, though probably not nearly enough to meet all delivery obligations if, let's say, 20% of the holders of the February contract demanded delivery.

> Do you know if the SPDR Gold Shares ETF (GLD) is permitted to lease
> gold holdings to the bullion banks who then us it as margin for shorting
> or is it all being held long and unencumbered in a depository?

>
>
> Jack
>
>

2008 Dec 22 02:27 PM

[Donatella:]

Having lived through every imaginable commodity scenario in my 30+ years in the commodity business, I can say that the information listed above is confused. Sorry to say. It suggests that the onus of preventing defaults on physical deliveries on the commodity exchanges is in the hands of the CFTC. It is not. It is controlled by the exchanges themselves. It is incumbent upon the exchanges to use a series of measures to limit spot month positions when deliverable supplies are not available. I would suggest that you read the Delivery rules in the Exchange rulebook, posted on the CME website under COMEX. The rules are as follows. Sellers must have deliverable stocks in exchange liscensed warehouses the day prior to the delivery. If these are not available, the seller will be forced by the clearing member (financial institution which is a member of a clearing house). The exchanges responsibility is to prevent spot month futures positions from becoming so large in relation to the physical supply available for delivery that they will adjust the margin on positions as they get closer to delivery. In the past, the exchange (for platinum) has charged significantly over 100% of the value of the physical metal on futures positions in the spot month to prevent disruptive market conditions from taking place. Also, the clearing members (financial institutions which comprise the clearing house) are responsible for accepting clients and have stringent requirements for doing business with "speculators" and trade houses and are the ones which will be responsible for any defaults. It would be useful for you to read the rules on defaults and how the clearing house structure handles potential defaults. What clearing members do NOT want are clients which could potentially default on deliveries and will not deal with them having positions in the spot month if they do not have the material at hand. In the history of COMEX there was one default -- in the early 80s, Volume Investors, and the loss was made up by the clearing members, leaving all players on the exchange and every position whole. The exchange endured the Hunt mess, the 9/11 attack (which left millions of ounces in the basement of the exchange in the Mocotta Metals warehouse facility ultimately intact.) Believe me, if you are looking for CDS or Subprime type cloak and dagger scenarios at the COMEX, believe me they have lived through everything and the checks and balances and transparency in this process is so clear that there is no way the precious metals Aramgeddon you describe would happen. They would charge 150-200% margin to eliminate large spot months positions first if the clearing members were reckless enough to take such business in the first place.

2008 Dec 22 04:39 PM

[Jason Hamlin:]

Central Gold Trust (GTU) and Central Fund of Canada (CEF) hold physical gold and silver in allocated vaults. Unlike GLD and SLV, it is audited and they do not lease it out to be shorted. Furthermore, these funds outperform GLD and SLV, so I don't understand why anyone would hold them (unless they are unaware of GTU/CEF).

2008 Dec 22 05:58 PM

[NOWHEREMAN:]

CEF is not a pure Gold play. Is GTU?

Thank you, I've never heard of GTU.

2008 Dec 22 06:38 PM

[ABG:]

I do not believe that COMEX will default. That is why I recommend that people buy gold and silver, for physical delivery there. I merely intend to explain why it will not happen even if, as appears obvious, the exchanges and CFTC have allowed the 90% cover rules to be violated. If you bother to read the article, you will learn that. In a worst case scenario, the exchange itself will be the counterparty.


On Dec 22 04:39 PM Donatella wrote:

> Having lived through every imaginable commodity scenario in my 30+
> years in the commodity business, I can say that the information listed
> above is confused. Sorry to say. It suggests that the onus of
> preventing defaults on physical deliveries on the commodity exchanges
> is in the hands of the CFTC. It is not. It is controlled by the
> exchanges themselves. It is incumbent upon the exchanges to use
> a series of measures to limit spot month positions when deliverable
> supplies are not available. I would suggest that you read the Delivery
> rules in the Exchange rulebook, posted on the CME website under COMEX.
> The rules are as follows. Sellers must have deliverable stocks in
> exchange liscensed warehouses the day prior to the delivery. If
> these are not available, the seller will be forced by the clearing
> member (financial institution which is a member of a clearing house).
> The exchanges responsibility is to prevent spot month futures positions
> from becoming so large in relation to the physical supply available
> for delivery that they will adjust the margin on positions as they
> get closer to delivery. In the past, the exchange (for platinum)
> has charged significantly over 100% of the value of the physical
> metal on futures positions in the spot month to prevent disruptive
> market conditions from taking place. Also, the clearing members
> (financial institutions which comprise the clearing house) are responsible
> for accepting clients and have stringent requirements for doing business
> with "speculators&q... and trade houses and are the ones which
> will be responsible for any defaults. It would be useful for you
> to read the rules on defaults and how the clearing house structure
> handles potential defaults. What clearing members do NOT want are
> clients which could potentially default on deliveries and will not
> deal with them having positions in the spot month if they do not
> have the material at hand. In the history of COMEX there was one
> default -- in the early 80s, Volume Investors, and the loss was made
> up by the clearing members, leaving all players on the exchange and
> every position whole. The exchange endured the Hunt mess, the 9/11
> attack (which left millions of ounces in the basement of the exchange
> in the Mocotta Metals warehouse facility ultimately intact.) Believe
> me, if you are looking for CDS or Subprime type cloak and dagger
> scenarios at the COMEX, believe me they have lived through everything
> and the checks and balances and transparency in this process is so
> clear that there is no way the precious metals Aramgeddon you describe
> would happen. They would charge 150-200% margin to eliminate large
> spot months positions first if the clearing members were reckless
> enough to take such business in the first place.

2008 Dec 23 12:06 AM

[ABG:]

GTU is not a wise investment because it sells at an extraordinary 21.7% premium to its net asset value of gold in storage. In other words, you will pay a whopping 22% premium, which is higher than even most physical gold dealers are charging.

There may be certain long term capital gains advantages because, but this is memory only, that they do not allow withdrawals of gold, and, therefore, it is not taxed as a collectible. But, emergency withdrawal and use is one of the essential reasons people own gold. On top of that, under Obama, I believe the lower rung of the capital gains tax will be eliminated. So if this advantage does now exists, it will not exist for long.

Like GLD and IAU, which erect high barriers to withdrawal, an interest in GTU does not function as an emergency store of ready wealth in the event of disaster. In short, because of the disadvantages, especially the high premiums, GTU is not a viable alternative. CEF has many of the same shortfalls, and invests in both gold and silver, so it is not a pure gold play.


On Dec 22 05:58 PM Jason Hamlin wrote:

> Central Gold Trust (GTU) and Central Fund of Canada (CEF) hold physical
> gold and silver in allocated vaults. Unlike GLD and SLV, it is audited
> and they do not lease it out to be shorted. Furthermore, these funds
> outperform GLD and SLV, so I don't understand why anyone would hold
> them (unless they are unaware of GTU/CEF).

2008 Dec 23 12:21 AM

[Merigolden:]

I think that is the hundred dollar question. What in the world are hoards of people doing sitting on "billions in zero interest treasuries"? Do you think it is the "herd mentality"? Most anyone I talk to, including sophisticated investors, laugh at the idea of holding physical gold. I think I am either a radical pessimist or a realist, because to me it seems ridiculous to hold instead a promise from a government that is so flat out it cannot pay interest, and one so obviously drowning in its own greed and corruption.


On Dec 22 02:12 PM secmaven wrote:

> It would seem to be only a matter of time for the tiny percentage
> of outstanding dollars necessary to be presented to the COMEX for
> delivery of precious metals to cause its stocks to be exhausted.
> Why the folks sitting on billions in zero interest Treasury bills
> don't see the relative advantage of gold given its strong investment
> performance while every other investment known to man has cratered
> is beyond me. But maybe that's why I am not among those fortunate
> folks. Do they know something the rest of us don't know?

2008 Dec 23 12:47 AM

[ABG:]

I would also note that you are not making an effort to understand the allegations of the conspiracy theorists. That is a mistake no prosecutor should make, when a victim, however confused, comes for help. Conspiracy theorists are saying that a few of the clearing members, themselves, are engaged in the alleged fraud. Allegedly, they take positions for their own account, to manipulate the market - not merely on behalf of clients.

The accused short-sellers, and their short position, are in the commercial category, NOT the speculative. Therefore, whether or not clearing members have controls on the type of speculators they accept in their prime brokerages, for example, is irrelevant.

I take a practical view. I think that conspiracy theory should certainly be properly investigated, which it has never been. However, conspiracy theories should prevent people from gaining the practical benefit of buying their gold and silver at wholesale on COMEX and NYSE-Liffe. That being said, contrary to what you are implying, CFTC certainly has the responsibility to enforce its own rules.

Other cheap no-premium markets, like the London Bullion Exchange, are closed to small investors. They make it very difficult for people to buy from them, because of incredibly high minimum purchase requirements, and a dearth of consumer-oriented information.

The futures markets, in contrast, corrupt or not, have become excellent places to buy cheap and force delivery upon the short sellers. They are completely open to middle class investors. Right now, there is no better place to buy precious metal, so long as the buyer does not succumb to the siren song of speculation fever.

As a side effect, if the conspiracy theorists are correct, mass demands for physical delivery will end alleged gold and silver pricing fraud more quickly than any CFTC investigation.


On Dec 22 04:39 PM Donatella wrote:

> Having lived through every imaginable commodity scenario in my 30+
> years in the commodity business, I can say that the information listed
> above is confused. Sorry to say. It suggests that the onus of
> preventing defaults on physical deliveries on the commodity exchanges
> is in the hands of the CFTC. It is not. It is controlled by the
> exchanges themselves...

2008 Dec 23 01:01 AM

[silver-bullet:]

This is an instance when Buy and Hold strategy comes into play.

- Buy an extra-large safe and
- Dollar Cost Average (don't bet the farm) into your Pre-Determined position (1 to 50% of portfolio? You have to decide).

See you on the other side of this crisis.

2008 Dec 23 01:19 AM

[ABG:]

One more point on counter-party risk. When you buy gold or silver or anything else, on futures exchanges, your trade is guaranteed by 1) the counter party short seller which will often be a huge bank; 2) the clearing house who executes the trades of your broker; 3) the exchange itself. There is every reason to believe that a minor delay in delivery, coupled with a huge price increase in the metals, will be the only result of a so-called "default" by short sellers. You, the delivery demanding buyer, will almost assuredly get your gold at the price you paid, and not a penny more.

2008 Dec 23 03:46 AM

[ABG:]

Oh, yes, and, also, the clearing house of the counter party short seller will also be guaranteeing the trade.

2008 Dec 23 03:47 AM

[Donatella:]

do not believe that COMEX will default. That is why I recommend that people buy gold and silver, for physical delivery there. I merely intend to explain why it will not happen even if, as appears obvious, the exchanges and CFTC have allowed the 90% cover rules to be violated. If you bother to read the article, you will learn that. In a worst case scenario, the exchange itself will be the counterparty."

"

No, not in the worst case scenario. In EVERY scenario. Every day, the exchange calculates and collects original margin, a good faith deposit and variation margin, i.e. it settles up daily. The exchange is the counterparty to every transaction. Yes I did read the entire article.
What is the Exchange when we say it guarantees every transaction? It is the Exchange Clearing House. What is the Exchange Clearing House? It is the group of Clearing Members, the financial institutions who put up a bond and agree to the full capitalization of their companies to pay for a default. The exchange clearing house comprised of these institutions which accept orders from customers is individually and collectively responsible for performance is the counterparty. If a gold seller defaults, the institution which "cleared" that clients trade is responsible for paying the loss. If this loss overwhelms the clearing member, it then goes into the guarantee fund (each clearing member puts up a bond) then it becomes paid for on a pro rata basis by each financial institution. These financial institutions are highly motivated to follow all the rules of the clearing house to protect themselves and the entire system. Who do you think the exchange is? I did read the article and it is confused. The exchange will not default.

2008 Dec 23 08:41 AM

[Long Silver...:]

The whole system is based on "TRUST" and "honesty" which are in short supply these days. Even the federal government reneged on the gold certificates issued before 1934. Read the Supreme Court "gold cases" to see how the highest Court simply sidestepped the "ironclad" promise to redeem the certificates in gold coin. As a lawyer, I can tell you there's no rule that can't be bent or circumvented once the lawyers get into the act. It's a joke. Take physical delivery now so you don't have to trust anybody.

2008 Dec 23 01:40 PM

[ABG:]

Yes. I agree. I cannot agree with Donatella that the clearing members of the exchange are above reproach, nor that the allegations made against some of them by conspiracy theorists should be dismissed out of hand. Some of the conspiracy theorists, like James Sinclair, for example, are persons of high intelligence and business acumen. What they are saying cannot be dismissed without a thorough investigation, which has never been done.

However, it will be extraordinarily difficult for private actors, like clearing members of COMEX or NYSE-Liffe, all of whom are guaranteeing trades on the futures exchanges, to default, as compared to the U.S. government's gold default back in the 1930s. The government can hide behind eminent domain and related legal theories. The private actors cannot. They face potential criminal liability, and a huge increase in civil liability, upon any default, so, absent a "end of the world" scenario, they aren't going to do it.

Don't ignore the opportunity to buy gold and silver at incredibly cheap prices, without the 20-30% premiums in the real market. The main point is that, even if the conspiracy theorists are correct, and they may be, people should still buy precious metals on the futures markets, as long as they don't get caught by the siren song of speculation, and have the cash to pay, and do pay, for their purchases up front.


On Dec 23 01:40 PM Long John Silver wrote:

> The whole system is based on "TRUST" and "honesty" which are in short supply these days. Even the federal government reneged on the gold
> certificates issued before 1934. Read the Supreme Court "gold cases"
> to see how the highest Court simply sidestepped the "ironclad" promise
> to redeem the certificates in gold coin. As a lawyer, I can tell
> you there's no rule that can't be bent or circumvented once the lawyers
> get into the act. It's a joke. Take physical delivery now so you
> don't have to trust anybody.

2008 Dec 23 03:02 PM

[ABG:]

Oh, yes, Donnatella, one more thing. You are technically correct that the exchange is always the legal "counter party". However, when we speak about "counter-party risk", we must talk about all the real counter parties to the transaction. The counter party to you is your own broker and its clearing house. The counter party to your clearing house is the exchange. The counter party to the exchange is the short seller clearing broker. The counter party to the buyer is his broker's clearing house. The propensity and ability of all these parties must be considered when discussing "counter party risk", not just the exchange.

2008 Dec 23 03:27 PM

[Donatella:]

Yes, you are right, but the "exchange" or the clearing house of the exchange is comprised of the clearing brokers - they are the aggregate risk takers of the exchange and they are the ones exposed on any defaults.
Anyway, good luck with buying gold wherever you decide to do it.

2008 Dec 23 05:29 PM

[roy piper:]

I am so tired of hearing about how GLD is "not audited" and "lends out" it's gold. In fact, they are audited twice a year by Deloitte & Touche and twice by GLD's managers. And they have no derivitives and do not lease out their gold. People need to do more reading of their prospectus and stop listening to Mr. Turk and others who have a vested interest in gaining GLD's shareholders for their own enterprises.

2008 Dec 23 11:43 PM

[Dokk:]

An interesting video which I would be interested to know what others think. I dont agree that the metals are going down but i like how he shows the relationship to oil prices.

www.youtube.com/watch?...

Any comments?

2008 Dec 24 11:40 AM

[waldipup:]

I agree that Comex is the way to go to take delivery , in mini contract form if necessary for smaller players.

This is the most economical way to buy , especially with current dealer markup premiums.

But I think it should be done quickly , without long term exposure to the futures market position , and not taken in certificate form but in actual metal .



Despite my agreement per the rational analysis of the articles concepts ,

I nonetheless believe that there is a reasonably high percentage chance that smaller players will have their delivery request positions compromised
as demand increases and available supplies decrease .

What is my analytical basis for saying this?

I can only tell you how you will (may) end up getting screwed after the fact , at which time knowing really wont matter anyway.

2008 Dec 24 12:09 PM

[User 326798:]

Great take of this recent topic. I know of one investor who is buying futures,and taking delivery. I am curious to the incidental charges: Delivery fees, Ins. etc. As I think I may just sell my eagles now at a premium,and order a few bars after I hear how it works for him.
As to the legal particulars, we only need look to the Madoff scandal to see how the smartest money in the room are caught with their pants down. This house of cards only worked while it was relatively stable. It should be interesting real soon as the tide recedes from the bond market,and the next shoe drops.
Per my own anecdotal evidence: My local 3 coin shops are sold out of all silver,and only have some very high premium gold. Russia on the brink, India, Pakistan etc etc...they won't be putting all their eggs in the US$ basket...we just saw how that turns out for bagholders.

2008 Dec 28 01:47 AM

[MHslowly:]

Very interesting article which leads me to two questions.

Taking physical possession eventually necessitates having bars reassayed before being sold, does it not? How much of the money saved by taking physical delivery of gold and silver from the COMEX would then be spent in the trouble and expense of reassaying and delivering the physical material?

"If you demand delivery and just put your bars in a safe place, . . ."
Would appreciate your unwrapping that "safe place." Just where would one put this bullion?

Jan 06 12:20 AM

[Avery Goodman:]

I need to update the information in this article to reflect a recent conversation I had with the legal compliance department of NYSE-Liffe futures exchange. I had a report, from a very upset person, who had purchased three (3) 1 kilo NYSE-Liffe mini-contracts for gold. Instead of getting 3 1 kilo bars, as he expected, the registrar told him he would need to accept a single 100 ounce bar.

This is a significant development. According to NYSE-Liffe exchange rule 1408, each mini-contract is delivered by a so-called "warehouse depository receipt" or WDR. Potentially, however, the WDR can represent a 1/3rd interest in a 100 ounce bar of gold. This rule is now being enforced. It means, essentially, that a person buying mini-contracts on NYSE-Liffe may not be able to take physical possession of his 1 kilo bar anymore. He must have 3 WDRs in order to equal 1 vault receipt, and you can only take delivery of a 100 ounce bar with a vault receipt.

This indicates to me that NYSE-Liffe must have had a serious "run" on their 1 kilo bar supply, and, if one looks at the number of deliveries that have been demanded lately, it is no surprise. Just as the U.S. Mint has run out of gold to mint 1 ounce coins, it seems to me that, now, NYSE-Liffe must have run out of 33.3 ounce bars of gold.

In short, this news makes it clear that the gold supply is extremely tight. If you want to take delivery of cheap gold, through the futures exchange, you must buy at least 3 mini-contracts, so you are better off just buying one full 100 ounce contract. Given the latest shortage of 1 kilo size bars, it seems ever more likely that it is only a matter of time before the price explodes.

Jan 14 04:27 PM

[BxCapricorn:]

I appreciate the effort in feeding corrections and clarifications to your original post, and the comments on this thread are excellent. If one were a commodity investor, this article and comment page deserves a bookmark.

Mar 07 04:20 PM

[sevenmile:]

clueless as usual

another bs article

to those who take delivery on a regular basis, it does no good to trade the mini (1 kilo) contract because it was NEVER deliverable in physical !!!

the article conveniently left this out:

Settlement
Financial

link here for the mini gold contract
www.nymex.com/QO_spec....

versus the full 100 oz contract

Delivery
Gold delivered against the futures contract must bear a serial number and identifying stamp of a refiner approved and listed by the Exchange. Delivery must be made from a depository licensed by the Exchange.

www.nymex.com/GC_spec....

CRIMEX gold is a STEAL compared to premiums on coins and smaller bars

if you got da scratch, GET YOU SOME !!!

Mar 28 08:50 PM

[Philman:]

Hey, Sevenmile, the only one who is clueless is YOU!

The article is talking about delivery on NYSE-Liffe mini-gold, NOT COMEX miNY gold. The two are different exchanges! They just happen to share the same warehouses, because NYSE-Liffe is smaller than COMEX but many of the same derivatives dealers use it. The NYSE-Liffe mini contracts WERE AND ARE supposed to be deliverable.

The difference now is that they won't give you delivery on 1 contract. Before, you could get 1 kg. worth of a gold bar. Now, you must share a gold bar of 100 ounce size with 2 other people, or you need to buy 3 minis.

Get your facts straight!

Apr 09 06:19 AM