Potential COMEX Gold Fail

FUTURES AND FORWARD CONTRACTS

Many commodities trade via forward or futures contracts. A forward contract is is an agreement between two parties to buy or sell an asset at a specified point of time in the future. A futures contract is a standardized contract to buy or sell a specified commodity of standardized quality at a certain date in the future, at a market determined price (the futures price).

REGULATION AND COUNTER-PARTY RISK

Both futures and forward contracts introduce counter-party risk, which depends on the financial ability of the counter-party to perform and may result in a failure to deliver. The calculated counter-party risk of futures contracts are assumed to be lower than forward contracts because they are traded on commodity exchanges. This is because generally governments must provide a common insurance or regulatory standard, such as the Commodity Futures Trading Commission (CFTC), and some release of liability, or at least a backing of the insurers, before a commodity market can begin trading.

COMMODITY MARKET SIZE

As a result of this increased confidence, the size of futures contracts has grown tremendously. The major commodities exchanges in the United States were the COMEX and NYMEX which merged under the New York Mercantile Exchange and Commodity Exchange, Inc. (NYMEX) name on 3 August 1994.

The notional value outstanding of OTC commodity derivatives contracts increased 27% in 2007 to $9.0 trillion. OTC trading accounts for the majority of trading in gold and silver. Overall, precious metals accounted for 8% of OTC commodities derivatives trading in 2007, down from their 55% share a decade earlier as trading in energy derivatives rose.

BACKWARDATION

Because of the large aboveground stockpiles of the monetary metals therefore gold and silver should never enter backwardation. Backwardation would be evidence of the market’s increased apprehension of counter-party risk and the increased probability of a failure to deliver. The brief gold backwardation or the recent black swan of nine weeks of silver backwardation in the London Bullion Market Association (LBMA) forward markets revealed the extreme fragility of the worldwide financial and monetary system.

click to enlarge

Mr. Avery Goodman, a securities attorney and a member of the roster of neutral arbitrators of the National Futures Association (NFA) and the Financial Industry Regulatory Authority (FINRA), has also written extensively about whether the COMEX will default on gold and silver, how the NYSE ran out of gold bars, the evidence that the ECB bailed out Deutsche Bank preventing a failure to deliver of gold on the COMEX and a follow up article on the ECB’s saving of the COMEX from a gold default.

Then there are other commentators like Jason Hommel, the creator of the satirical silver CFTC appreciation medallion above, who alleges regulatory culpability. Still others like the Gold Anti-Trust Action Committee (GATA) who has met with CFTC officials bring considerable intellectual firepower to the allegation of a central bank gold price suppression scheme where Mr. Robert Landis, a Harvard trained attorney, asserts “Any rational person who continues to dispute the existence of the rig after exposure to the evidence is either in denial or is complicit.”

TOOLS OF SPECULATION

Due to the size of the derivative contracts traded on the commodity exchanges and the counter-party risk the contracts are impregnated with therefore a bankruptcy of either the counter-party, the exchange or both could happen. Due to the increased liquidity of these exchanges many of those buying or selling the contracts for speculative purposes neither want possession of the underlying commodity nor possess the underlying commodity and have the ability to physically deliver.

While there are some legitimate measures such as oil or gold companies that sell forward their production, and the number of gold companies has increasingly withered, in many cases when you buy these gold derivatives you are buying from a speculator who is shorting gold and that gold speculator does not actually own any physical gold.

MECHANICS OF AN EXCHANGE BANKRUPTCY

Let us assume for the sake of argument that gold prices go ballistic and you decide you want your gold by taking delivery on the contract. What if gold prices go up dramatically in one day such as a thousand dollars an ounce. Is it possible? Of course. Is it probable? Not really.

But that means the person who shorted gold is in a very precarious position and could have possibly lost everything or more. Perhaps they had a stop but the market is fast and gaps and as a result they cannot get out of their position. What would happen?

Let us assume this speculator had ten thousand dollars in their commodities account and they were short a gold contract. Suddenly, perhaps overnight, the Chinese press the issue because the International Monetary Fund failed to deliver on their gold sales and needed a line of credit, gold prices rapidly jumped and this speculator lost a hundred thousand dollars overnight. Now the brokerage firm has to attempt to collect on this ninety thousand dollar margin call in the form of an unsecured debt. What if they cannot collect and what if there are hundreds or thousands of speculators in similar situations?

With this failure to deliver and violation of margin requirements what if the exchange, because they do not have adequate capital or liquidity, cannot get the currency to settle the contracts? Then the exchange goes broke unless there is a government bail out but what good would that fiat currency do in purchasing the physical gold or silver bullion?

COUNTER-PARTY RISK MATERIALIZING

This is what happened with the American Insurance Group (AIG). The reason AIG went bankrupt is because they were the other side of many speculative contracts. When the flock of black swans they had insured against descended AIG could not perform because they did not have the cash. The government bailed them out at the cost of hundreds of billions if not trillions of dollars.

This means if you buy silver or gold on the COMEX via futures contracts, there is a huge move up, the COMEX goes bankrupt and the government does not bail them out then you are not going to be able to cash out your epic gains from the casino. Like the auto maker’s bond holders you will not realize and enjoy the profits you thought you would.

This is precisely what happened with people who were short a bunch of oranges and other interesting things via hedges with Lehman Brothers and even though they ‘made’ millions of dollars on their positions they lost everything. Why? Because Lehman Brothers went under and did not perform on the contracts. This is counter-party risk.

CONCLUSION

At all time and in all circumstances gold and silver remain money. For the conservative investor the reason to own them is as insurance for when everything else fails. These issues of counter-party risk are important when considering how to buy gold or silver through third parties. There are third-parties, like GoldMoney, that not subject to counter-party risk because of the way ownership is titled and the ability to demand physical delivery at any time.

As I explain in my book The Great Credit Contraction capital is burrowing down the pyramid into safer and more liquid assets. The safest and most liquid of them all are gold and silver. Why? Because the world reserve currency the FRN$ is merely an illusion that can become worthless while gold and silver are money and will always buy something.

Consequently, the conservative investor will determine what their gold standard is considering there are 140 ounces of paper gold for every ounce of physical gold. Then they will take appropriate actions, such as buying gold in a vending machine, to remove the layers of risk between them and their purchasing power in an effort to preserve and safeguard their capital.

Comments

[kohalakid:]

Salt was once used as a medium of exchange. The Yap Islanders used huge round stones as a store of wealth. Money doesn't require some intrinsic value to be a medium of exchange, it just needs to be accepted as a medium of exchange. What has run the dollar down is not merely that it's printed on paper, but that too many are printed. That you can use a printed paper dollar to buy goods and services virtually anywhere on the planet makes it a medium of exchange. What is screwed up is how many the government prints to finance the biggest growth industry of all: government.


On Jun 19 09:07 PM Market Sniper wrote:

> Things to keep in mind. IF the value of your labor is subject to
> manipulation by central bankers who can add deposits out of thin
> air, thus creating inflation. How is your labor to be valued? You
> get paid say $100. That $100 costs 2 cents to print. Ever wondered
> what happened to the other $99.98? Sure, it is good for exchange
> for things you need and want. But since the "invention" of the Federal
> Reserve System in 1913, they have inflated away 95% of the value
> of a "dollar". We are now just working on that last nickel. How can
> you have a just and equitable society when the "money" is subject
> to such manipulation? Answer: you can't. That is why we are in a
> sorry state of affairs today we find ourselves in and it shall only
> get worse. Much worse. This is the largest fraud ever perpetuated
> on The People. We have been so flim-flammed and bamboozled we do
> not even know which end is up anymore having lived our entire lives
> in a fiat fairyland.

Jun 19 10:36 PM

[Market Sniper:]

Here, here! First step: Abandon Empire. We are no good at the Empire business. Second step: abolish the Federal Reserve and return to sound money that The People control. Third step: we desperately need to form The Restitution Party whose platform seeks the resititution of The Republic and a RETURN to constitutional government. Then maybe, just maybe, we can unwind this mess by getting back to work.


On Jun 19 10:27 PM kohalakid wrote:

> But they can't vote themselves the public fisc if government keeps
> to what the Founders intended for the Federal government. I don't
> see in the Constitution where it says the Federal government should
> be responsible for my retirement plan or my health care.
> If the Federal government did only what the Constitution gives it
> a mandate to do, we wouldn't have 99% of our budget problems.
> Like I said, it's the implementation of bad (unconstitutional) ideas
> that cause the problem, not the basis system.

Jun 19 10:41 PM

[Market Sniper:]

Well, most of history is not Yap Island history (they had NO metal deposits to begin with). Gold is money. It is deaf and listens to no one. Paper listens to everyone. Especially central bankers and craven politicians. Without a metals standard, there is no known way to reign in politicians buying votes with deficit spending. Or bankers from creating "money" out of thin air by use of the modern fractional banking system. Paper ALWAYS fails for the above reasons. Gold has been money since the dawn of time and will remain so until we are gone as a species. Might want to get Nathan Lewis' book..Gold: the Once and Future Money. Best treatise on the subject I have found.


On Jun 19 10:36 PM kohalakid wrote:

> Salt was once used as a medium of exchange. The Yap Islanders used
> huge round stones as a store of wealth. Money doesn't require some
> intrinsic value to be a medium of exchange, it just needs to be accepted
> as a medium of exchange. What has run the dollar down is not merely
> that it's printed on paper, but that too many are printed. That you
> can use a printed paper dollar to buy goods and services virtually
> anywhere on the planet makes it a medium of exchange. What is screwed
> up is how many the government prints to finance the biggest growth
> industry of all: government.

Jun 19 10:48 PM

[Moon Kil Woong:]

In most commodities the contracts are over written and have many speculators. It is true there can be sortages or run ups. This can happen with any commodity.

The simple fact is gold and silver are safer for some to write contracts on because governments and central banks have plenty of it to help them out of their predicament if this should happen. Bailing them out by supplying them with precious metal helps them convey the illusion that inflation is less than what it really is.

As with all markets, they are dominated by self interest. Don't count governments out of adhering to this mantra.

Jun 20 07:45 AM

[gollwoods:]

Just got an idea, since the default would cause a systemic risk to our financial security wouldn't that mean that under the proposed new regulations that the fed could regulate anyone holding gold must deposit it in an account at the fed to stabilise our fine financial structure. ore some such clever way of exchanging thier short position for your gold especially the GLD fund.

Jun 20 09:05 AM

[Long Silver...:]

Roosevelt tried outlawing the holding of more than a small amount of gold. Didn't work, as everybody just dug a deeper hole for their stash. All I know is that earlier this year, archeologists in Jerusalem dug up a cache of ancient gold coins. They had held their value. By contrast, when I go to my neighborhood coin dealer, they have cases full of old paper currency that became worthless. Even the clear redemption promise on the $50 Gold Certificates (Grant's picture on them, no less), were reneged upon by the Supreme Court in the "gold cases" of 1937. Gold and silver physical holdings give you self-sufficiency. No need to trust anybody.

Jun 20 10:57 AM

[john12345:]

I didn't know where this article and blog was headed but it seems to have pointed to the federal government as the root of the problem. A friend of mine is circulating a proposal with an interesting twist. Think about it before you reject it. His idea is a constitutional convention with only one item on it's agenda -- term limits. This is the best way to improve governance at the national level -- provide a convenient way replace the incumbents who aren't getting the job done. This also provides a path for interested citizens to gain public office since many are frozen until some long term Senator or Congressman dies, thus allowing governors, mayors, attorney generals and others an opportunity to rise up the ladder to higher office. Another benefit of the idea is that you don't even need to call Washington to implement it. No national office holders have any control or say in the process. It's the states that control constitutional amendments. The agenda for the convention would be term limits only, thus avoiding partisan, social, economic, and other issues which may make the result worse than the present situation.

Jun 20 11:07 AM

[Trace Mayer:]

kohalakid, Exactly. Perhaps you should study your Constitution a little more.

Article 1 Section 8 Clause 5: "To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;"

Article 1 Section 10 Clause 1: "No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."

I explain and outline the arguments here:

Constitutional intrepretation: www.runtogold.com/2009.../

Define the Dollar Or Else:
www.runtogold.com/2009.../


On Jun 19 10:27 PM kohalakid wrote:

> If the Federal government did only what the Constitution gives it
> a mandate to do, we wouldn't have 99% of our budget problems.
> Like I said, it's the implementation of bad (unconstitutional) ideas
> that cause the problem, not the basis system.

Jun 20 12:35 PM

[D. McHattie:]

If the price of something is artificially inflated it will attract excessive investment. Like the housing bubble.

If the price of something is artificially suppressed there will be insufficient investment to meet real demand.

I'm not sure they'll ever lose control of the price of gold. But if they do it will do an absolutely moonshot.

Jun 20 02:29 PM

[MGA_1:]

Question - does comex guarantee contracts if the counter party fails?

Gold certainly is interesting. I've been reading a lot of fairly incriminating stuff pointing to artificial suppression of gold price by specific government agencies. If this is the case, then it can't last forever, and gold will start to rise again.

Jun 20 02:39 PM

[CC_Gold:]

If you do not own at least 2,500 dollars in physical gold or Silver, be prepared to be annihilated. Owning Gold and Silver is not about investing or wealth preservation. It's about survival! I have 4 children that will need to eat. Green or blue worthless fiat currency is not going to feed them. I love reading the comments section on here. Everyone seems to be an expert. If your posting crap on here, you are not an expert. The only thing you have is an opinion and it's probably gonna be worth more than those fancy reserve notes sitting in your pocket. If you think Gold or Silver is worthless, please package all the physical you can muster and send it to me. I will pay spot for it plus shipping. I will give you all the green worthless crap you want for it. I've following Trace for a while and his articles are usually spot on. If you doubt that the Comex will default, get your head out of the sand. It has near defaulted twice in the last 6 months. Why did the ECB bailout Deutsche Bank when it defaulted on it's short gold position? Where is the missing gold from the Royal Canadian Mint? Why did the German government demand delivery of it's gold from the USA? Why is Dubai demanding delivery of their gold from London Bullion Banks? When was Fort Knox last audited? Look at the recent Commitment of Traders report for Gold and Silver. The commercials have a concentrated naked short position that if called could never be delivered. Oops. Yes, it can. It's called the ETF's GLD and SLV!

Jun 20 03:44 PM

[H. T. Love:]

On Jun 19 09:07 PM Market Sniper wrote:

> Things to keep in mind. IF the value of your labor is subject to
> manipulation by central bankers who can add deposits out of thin
> air, thus creating inflation. How is your labor to be valued? You
> get paid say $100. That $100 costs 2 cents to print. Ever wondered
> what happened to the other $99.98? Sure, it is good for exchange
> for things you need and want. But since the "invention" of the Federal
> Reserve System in 1913, they have inflated away 95% of the value
> of a "dollar". <snip>

All you say is correct. Just in case others don't know, the CB was not invented in 1913. Under other names it has been around in many jurisdictions for many hundreds of years. And had also existed previously in this country, being abolished by Abraham Lincoln, leading to a long, uninterrupted, non-cyclical, prosperous economy.

Anyway, I encourage all to google for "history of banking" and other phrases, like "central bank history", etc. Lots of good information out there and even some well done and, afaict, accurate videos.

The CBs do not exist to serve the citizens and governments of the countries in which they operate, but to serve the private institutions that own them.

HardToLove

Jun 20 05:00 PM

[kohalakid:]

CC_Gold----

The COMEX got nowhere near a default on the ECB/Deutsche Bank deal. DB was short April contracts and made delivery the first couple days of April. They had until April 29 to make delivery or roll the contracts forward. The article by Avery Goodman was completely wrong in its assumption that a default was averted.
If you have any question how COMEX works, and when delivery must be made, and when any default would occur, go the the NYMEX website and read the notice and delivery rules for COMEX.
I sure wish Avery had. Would have saved him a lot of time and effort.

Jun 20 06:03 PM

[kohalakid:]

I'm well aware of the Constitution's statements on what is legal tender. And I know that the change to that policy was implemented long before I was born. All I can do is vote for candidates who advocate a return to fiscal sanity and an end to ever-growing entitlements AND make sure I have enough of my asset base in metals. No argument there.


On Jun 20 12:35 PM Trace Mayer wrote:

> kohalakid, Exactly. Perhaps you should study your Constitution a
> little more.
>
> Article 1 Section 8 Clause 5: "To coin Money, regulate the Value
> thereof, and of foreign Coin, and fix the Standard of Weights and
> Measures;"
>
> Article 1 Section 10 Clause 1: "No State shall enter into any Treaty,
> Alliance, or Confederation; grant Letters of Marque and Reprisal;
> coin Money; emit Bills of Credit; make any Thing but gold and silver
> Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex
> post facto Law, or Law impairing the Obligation of Contracts, or
> grant any Title of Nobility."
>
> I explain and outline the arguments here:
>
> Constitutional intrepretation: www.runtogold.com/2009.../
>
>
> Define the Dollar Or Else:
> www.runtogold.com/2009.../

Jun 20 06:15 PM

[Jimbo:]

John12345, I completely support your idea of a constitutional convention ( it is provided for in the Constitution). But the rent seekers in Washington and New york would be utterly terrified and would do anything, legal and otherwise to stop it. I feel deeply alienated from our government. I have just read that Senator Kennedy had put a provision that the proposed national health scheme. The plan would NOT apply to Congress!! Of course their plan would be superior. They also don't pay Social Security Tax, which incidentally covers millions of people on disability and dependents. Never underestimate the ability of Congress to screw the people.

Jun 20 08:03 PM

[adan:]

i think this is the first article i've read that helps me better understand how it might be possible for a default via the clearing houses could actually even occur -

good stuff to think about, thanks!

Jun 21 12:19 AM

[texanpilot1:]

We do not need a constitutional convention nor do we need to re-write our constitution. What we need is every eligible voter in the USA to exercise their right to one man one vote. if anything PACs and corporate lobbying should be outlawed in the USA!


Gordon
Connecticut

On Jun 20 11:07 AM john12345 wrote:

> I didn't know where this article and blog was headed but it seems
> to have pointed to the federal government as the root of the problem.
> A friend of mine is circulating a proposal with an interesting twist.
> Think about it before you reject it. His idea is a constitutional
> convention with only one item on it's agenda -- term limits. This
> is the best way to improve governance at the national level -- provide
> a convenient way replace the incumbents who aren't getting the job
> done. This also provides a path for interested citizens to gain public
> office since many are frozen until some long term Senator or Congressman
> dies, thus allowing governors, mayors, attorney generals and others
> an opportunity to rise up the ladder to higher office. Another benefit
> of the idea is that you don't even need to call Washington to implement
> it. No national office holders have any control or say in the process.
> It's the states that control constitutional amendments. The agenda
> for the convention would be term limits only, thus avoiding partisan,
> social, economic, and other issues which may make the result worse
> than the present situation.

Jun 21 09:51 AM

[balois:]

CC_Gold I am with you:

“...Owning Gold and Silver is not about investing or wealth preservation. It's about survival! I have 4 children that will need to eat...”

...but only to a certain extent, in a more or less functioning world.

I assume that you are assuming when you need your Gold there is still somebody out there fair enough to give you a fair shake. I beg to differ. A catastrophe is about survival of the fittest. Count on lots of hungry people with hungry children, too. And a few guns. And nothing to lose. Beside your smarts, an emergency stockpile and good defense is probably your best bet. And when things improve, have something ready to barter. Mobile goods that people can immediately recognise and evaluate.

Frankly, what shall I do with your Gold coins you want to give me for my sack of potatoes? Are the coins genuine? How many? What s the price? Even if I have mercy, maybe I ll take all the coins you have for a few pounds of my tubers. It is risky and I do not know how and when I can get rid of the coins. And you may scream to heaven if I hand over an entire sack of potatoes to the next fellow who offers me a few bottles of red wine instead. At least in my neck of the woods, people would give a king s ransom if they are short of the stuff...

Have a good day

Jun 21 01:11 PM

[CC_Gold:]

Balios good point, but when I start buying city blocks with my gold and silver coins and let you live there for your sack of potatos. Who will be thanking who? If you think that can't happen, look at Chicago during the Great Depression. I prefer not to use guns for argument sake. Just about everyone will have guns. How many people will have Gold or Silver? How many people ate with guns during the great depression besides hunters? If it comes down to stealing or using weapon to obtain food, the government would no longer exist.

Jun 21 05:46 PM

[cameroni:]

When that moonshot day comes McHattie I will bet "dollars to donuts" that the same folk who suppress gold now will have filled their own sorry boots first. When the price of gold takes off it will be because the guys behind the curtain have already decided it is the best bet to hold.


On Jun 20 02:29 PM D. McHattie wrote:

> If the price of something is artificially inflated it will attract
> excessive investment. Like the housing bubble.
>
> If the price of something is artificially suppressed there will be
> insufficient investment to meet real demand.
>
> I'm not sure they'll ever lose control of the price of gold. But
> if they do it will do an absolutely moonshot.

Jun 21 09:58 PM