We have covered the rapidly declining COMEX gold inventories in previous articles, and the story seems to be getting old, but COMEX gold continues to drop with registered gold inventories hitting their lowest levels ever. Additionally, total COMEX gold has now dropped under 7 million total ounces or by almost 40% since the beginning of the year (we started 2013 with around 11 million total ounces).
This is something that should be very relevant to investors who own physical gold and the gold ETFs (GLD, PHYS, and CEF) because any abnormal inventory declines may signify extraordinary events behind the scenes that would ultimately affect the gold price.
As you can see on the chart above, both registered and eligible gold stocks have been declining significantly since the beginning of 2013, and they continue to decline at rapid levels. We will take a closer look at these numbers but let us first explain the COMEX a little more for investors who are unfamiliar with it.
Introduction to COMEX Warehousing
COMEX is an exchange that offers metal warehousing and storage options for its clients. The list of their silver warehouses can be found here and their gold warehouses can be found here. In the case of silver and gold, the metal is stored at these official warehouses on behalf of banks and their clients and can be used to settle futures contracts, transferred between clients, or withdrawn from the warehouse. This offers large holders of precious metals a convenient way to store their metal with minimal storage fees - very convenient indeed if you hold large amounts of gold or silver and you don't want to store them in your basement.
Silver and gold stored in these warehouses can fall into two categories: Eligible and Registered.
Eligible metals are those that conform to the exchange's requirements of size (1000 ounce bars for silver and 100 ounce bars for gold), purity, and refined by an exchange approved refiner. Eligible metals are stored at COMEX warehouses on behalf of banks or private parties, but are not available for delivery for a futures contract.
Registered metals are similar to eligible metals except that these metals are also available for delivery to settle a futures contract. COMEX issues a daily report on gold, silver, copper, platinum, and palladium stocks, which lists all the metal that is currently stored in COMEX warehouses and how much eligible and registered metal is present.
This information allows investors insight into how much metal is currently backing COMEX futures contracts, what large gold and silver owners are doing with their metals, and how many clients are requesting delivery of their metals. There is a lot more to glean from this information but for the purpose of this article we will focus on the gold drawdown.
Gold Continues to Leave the COMEX
Before we look at the numbers we have to give a plug to the folks at troyozgold who provided important data that helped to contribute to this article. Their site is free to use and provides investors with terrific information about COMEX inventories, ETF inventories, and a lot of other data about everything related to the gold and silver markets - investors should check it out.
Let us now take a deeper look at the gold draw-downs being seen in the COMEX warehouses.
As you can see in the chart above, we have been seeing consistent declines in gold inventories for the last six months and last week continued this decline. In the reporting week ending on 7/19, gold stocks dropped by 120,723 ounces for the week which left COMEX inventories at a new yearly low of only 6.99 million ounces - the lowest it has been since the beginning of 2006.
But what may be more important to investors is that registered gold stocks have dropped to their lowest levels since data has been published - pre-2002 levels.
Keep in mind that registered gold is the only gold available for delivery at the COMEX - eligible gold is stored but is not available for delivery. This means that COMEX participants are demanding more gold for delivery, even as other COMEX gold holders are preventing their gold from being eligible to fulfill delivery on settled gold contracts.
As we have mentioned before, we do not know why gold is leaving the COMEX - but we do know it is still leaving in ever increasing quantities. The steep and sustained nature of this decline suggests that it is not a haphazard event - multiple players are withdrawing their gold in large amounts and there must be a significant reason why they are doing it.
Debunking the Negative Gold Sentiment Explanation
Some may suggest that gold stock declines are due to negative investor sentiment about gold. The argument is that investors are no longer interested in gold so there is no need to own or keep it at the COMEX - they can just sell it on the market and move their investment dollars elsewhere.
The first problem with this argument is that the declines started way before the gold price started to drop. Why wouldn't we have seen the start of this decline in 2011 after the $1900 gold high? Why not in 2012 when the gold price dropped 20% from its highs? This type of gold stock decline has not been witnessed in prior periods with similar price drops, so it doesn't seem to have much weight behind it.
The second problem with this argument is that we are just not seeing the same decline in COMEX silver. We know that investors that buy physical gold and store it at the COMEX are the same investors that buy physical silver and store it at the COMEX - so why not see the same declines in COMEX silver especially since it is more costly to store silver than gold? If the above argument were correct, we would expect investors to be removing their COMEX silver too, which is not what we are seeing.
This suggests that there is something specific regarding gold that is causing such large inventory declines. Our belief is that the reason for this large decline in gold stocks is because it is being used to satisfy gold demand outside the United States. Foreigners demand both gold and silver, but their gold demand is much greater than their silver demand and thus we see the significant decline in gold stocks that is not matched by a similar decline in silver stocks.
What does this Mean for Gold Investors
This is extremely bullish for investors in physical gold and the gold ETFs (GLD, CEF, and PHYS). As COMEX gold stocks drop, there is less gold to satisfy outstanding contracts which may cause a major problem in the future if these stocks are not replenished or the number of outstanding contracts does not decline. While we don't expect a COMEX default (though we cannot rule it out), we do expect the price to rise significantly if stocks continue to decline - rather than a default we see a large price rise to replenish COMEX inventories.
Additionally, we know that demand for physical gold across the world has been very strong - if this gold is being used to meet demand outside the United States then we may not have much longer before COMEX gold cannot be used to fulfill this demand. This is very bullish because if whoever is using COMEX gold to meet their physical demand no longer has it as an option, demand will have to come from elsewhere - which will push up the price.
Finally, we know that many hedge funds and retail investors have heavily shorted gold, anticipating prices below $1000. Unfortunately for them, we believe that the physical market is very tight and this physical market stress is about to push the paper price of gold much higher and cause many of these shorts to scramble and cover. The physical market may be much slower to affect price with the large volumes of paper gold being traded, but when it does catch up to the price the result is often violent moves.
As a gold investor, it is difficult to think of a better situation to own physical gold than when gold inventories are dropping to unprecedented levels and large short positions exist amongst investors who really have little knowledge of the gold market. For those investors seeking much higher returns, we suggest considering gold miners such as Randgold (GOLD), Goldcorp (GG), and Alamos Gold (AGI), though for the more conservative investors gold seems like a very good value at these prices.