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In previous articles we have covered both the gold and silver COMEX inventories, with a particular focus on the massive decline in gold inventories. In this article we will cover the COMEX gold cover ratios, which is possibly the most important COMEX indicator because it tells an investor how many ounces of gold are stored at the COMEX for every outstanding gold contract.
This ratio is only regularly observed by some of the most sophisticated gold market participants. But recently, just as we have seen unprecedented drops in COMEX inventories, we are now seeing this ratio reach levels that have not been seen before in recent COMEX history and we believe gold investors should give it some attention.
It is something that is very relevant to investors who own physical gold and the gold ETFs (GLD, PHYS, and CEF) because this ratio relates to the physical supply present at one of the two largest gold trading markets, the COMEX. Abnormal activity in the COMEX may signify extraordinary events behind the scenes that would ultimately affect the gold price and would interest any investor in the precious metals.
Before we get into the gold cover ratios, lets quickly cover some basic concepts related to COMEX warehousing.
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on behalf of banks and their clients and can be used to settle futures contracts, transferred between clients, or withdrawn from the warehouse.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.
What are Gold Cover Ratios?
The COMEX gold cover ratio is simply the number of COMEX contract ounces of gold (you can find COMEX contract open interest here) divided by the number of physical ounces present in COMEX warehouses. It essentially gives investors and idea of how many ounces of gold are stored at COMEX for each outsanding claim. A high ratio signifies many claims for every ounce of gold, while a low ratio means that there are only a few claims per ounce of gold.
For example, if there are 300,000 open COMEX contracts this would signify COMEX open interest of 30,000,000 ounces of gold (each contract represents 100 ounces of gold). If there are 10,000,000 ounces of eligible gold in the COMEX warehouses, then the ratio would be 3.0 - meaning there are three owners for every existing ounce of eligible gold present at COMEX warehouses.
This will give investors an idea of how many outstanding ounces are traded versus how many are present in the warehouses, or put in another way, how much physical gold backs the current traded volume of gold. There will almost always be more open interest outstanding contract gold then gold at COMEX warehouses simply because the vast majority of COMEX participants do not ask for delivery of gold and usually settle in cash or roll forward their contracts.
But if this ratio gets too high it signifies that there is very little gold backing outstanding contracts. This is one of our favorite ratios to look at to signify possible tightness in the gold market. So now let us take a look at the gold cover ratio for both registered and eligible gold contracts.
Eligible Gold Cover Ratio
In the chart above, investors can see that the cover ratio for COMEX eligible gold stocks is around 5.62 (last mini-chart), or there are 5.62 owners per every ounce of eligible gold stored at the COMEX. While it has been increasing and is relatively high for the last five years, the ratio still isn't at its peak levels from 2003 and 2004 where there were more than 10 owners per ounce of gold. Based on this chart, it is interesting that it has been rising, but the eligible gold cover ratio is really not alarming for gold investors.
But what is very interesting has been what has been going on with the registered gold cover ratio.
Registered Gold Cover Ratio
In the chart above, investors can see that the cover ratio for COMEX registered gold stocks is around 50.62 (last mini-chart), or there are 50.62 owners per every ounce of registered gold stored at the COMEX. While the eligible gold cover ratio was not particularly interesting - the increase in the number of owners per registered ounce has been stunning!
Additionally, we believe that this ratio is much more important than the eligible gold cover ratio because it signifies how much deliverable gold backs outstanding contract. Investors should remember that eligible gold (the previously discussed ratio) is gold stored at the COMEX but NOT available for delivery - so it cannot be used to physically settle an outstanding contract's demand for delivery. Registered gold (the type we are now discussing) can be used to settle delivery, and thus it is much more relevant when discussing cover ratios because it actually can be used to "cover" a contract.
The increase we are seeing in registered cover ratios is unprecedented and is 25% higher than the previous high that was seen in the middle of 2011 when gold hit its all-time high over $1900 per ounce. It seems there is something strange going on in the gold market.
What does this Mean for Gold Investors
This is another one of those bullish signs that we see in the gold market, and in our opinion, this is even more bullish than the rapidly declining COMEX inventories (though they are obviously related to each other). That is because the registered gold cover ratio takes into account both the interest in gold and the actual existing physical inventories to cover that interest - so high numbers signify large interest in relatively small stocks of gold.
So why is this ratio increasing? Unfortunately, we cannot tell you and nobody really knows. But what it does signal is that entities that are keeping their gold in COMEX warehouses are becoming less interested in using that gold to meet delivery demands for outstanding contracts. This is exactly what one looks for when trying to gauge the tightness in the gold market.
Additionally, these levels are now hitting unprecedented levels of owners per registered gold ounce - we just have never seen this before in the history of the data we have from the COMEX. As with any other ratio that ventures into uncharted waters, we really do not have any historical precedent for this so it is tough to predict what happens from here. But we think that in this case common-sense dictates that investors would want to have a significant gold position and should consider investing in the gold ETF's (GLD, CEF, and PHYS) and absolutely should own some physical gold.
Investors wanting to take on a little more risk (and possible reward) may want to consider investing in mid-tier and large gold miners such as Randgold (NASDAQ:GOLD), Goldcorp (NYSE:GG), and Alamos Gold (NYSE:AGI), though they should remember there is a lot of non-gold risk company-risk when you buy a miner. These miners have also run up recently, so they may have outrun the increase in the gold price and may be a bit overvalued.
Finally, investors interested in really leveraging the gold price and taking on a lot of risk (and possible reward) may want to consider investing in some of the well-financed exploration companies with large possible gold resources such as Pretium Resources (NYSE:PVG), Chesapeake Gold (OTCQX:CHPGF), and Western Copper and Gold (NYSEMKT:WRN) - though we stress that these companies are very speculative and should be researched thoroughly. But many of the smaller ones (such as WRN) have not seen the price increases that the larger miner stocks have had, so they may still offer good value at current gold prices.
Regardless of the method investors choose for gold exposure, the sky-high registered gold stock ratios signify that something is afoot in the gold market - after all we have never seen this before in the current gold market run. So investors should ask themselves the following question: do you want to be long or short gold as more people lay claim to less ounces? We think the answer is obvious.
Disclosure: I am long SGOL, SIVR, GG, GOLD, AGI, OTCQX:CHPGF, WRN, PVG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.