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Dave Kranzler
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I spent many years working in various analytic jobs and trading on Wall Street. For nine of those years, I traded junk bonds for a large bank. I have an MBA from the University of Chicago, with a concentration in accounting and finance. Currently I co-manage a precious metals and mining stock... More
My company:
Golden Returns Capital
My blog:
Investment Research Dynamics
  • The Comex and The Fractional Bullion System 1 comment
    Apr 16, 2010 9:53 AM | about stocks: GLD, SLV, IAU, PHYS, CEF, GTU

    Everyone knows the concept behind a "fractional" banking system, right? You have $1 in deposits and you lend out $10. The Romans invented the concept and it is widely understood to have been one of the ingredients that led to Rome's demise.

    As per the electrifying CFTC hearings on March 26, and a fact that GATA has long understood, the Big Banks which deal in gold and silver, also known as "Bullion Banks," apply and utilize the fractional banking system to bullion dealings.

    In 2007 Morgan Stanley settled a class-action lawsuit in which Morgan Stanley was selling silver to customers and charging them for storage. It turned out that Morgan Stanley was selling and storing silver that didn't exist.  One of MS's defense arguments was that it was common industry practice to sell and store metal that didn't exist. And as long as the customer buys and sells thru MS without asking for the metal to be delivered, MS can get away with it because the round-trip transaction is cash in/cash out. The scheme crumbled when some investors asked for serial numbers and weights. Details are here, if you are interested: LINK

    Let's apply this to the Comex. As of the most recent COT report, which shows open interest, long and short positions for speculators and commercials (primarily bullion banks), the total net short position for the bullion banks in gold was 244,900 contracts and in silver 51,700 contracts. This translates into 24.9 million ounces of gold and 258.5 million ounces of silver. Here's the problem, as of today, April 15, the total amount of gold reported by the Comex that is available to be delivered, the "registered" inventory, was 2.4 million ounces. In other words, the total paper short position of the bullion banks in gold was more than 10 times the amount of gold available to be delivered. Similarly in silver, the amount of registered silver was 48.9 million ounces. The bullion banks are short 5.3 times the amount of silver available. No other futures-traded commodity, in the history of the earth, has ever had this kind of imbalance between the paper-traded open interest and the amount of the underlying amount of the physical commodity that could be delivered.

    The key to this scheme is that for each delivery month, a small percentage of the long position, relative to open interest and relative to the short positions, actually stands for delivery. That being the case, the CFTC and the powers that be at the Comex look the other way with regard to the absurd amount of paper gold and silver sold short in relation to the amount of underlying physical gold and silver that can be delivered. It's a complete "fractional" bullion banking system. But what will happen if some large investors - or sovereign funds or foreign Central Banks - decide to take long positions in gold in silver with the intent to take delivery? I expect that eventually this will happen and we'll see the Comex-equivalent of a catastrophic bank run.

    Another interesting event has been occuring with SLV. Since February 26 thru today, 16.7 million ounces of silver has been removed from the SLV trust. At first glance, this might not seem unusual. However, a quick perusal of the data over the last two years (data history is available on the SLV website), reveals that this is an unusually large amount of silver to be withdrawn over a 6 week period.  What makes it even more unusual is that since Feb 26, the price of silver has risen from $16.46 to $18.41 - nearly 12%.  Typically, drops in the gold and silver held in GLD and SLV correlate with price declines and market sell-offs.

    We can only speculate about what is going on.  However, I would like to point out that JP Morgan is by far the predominant holder of the massive silver short position on the Comex. They are also the custodian (i.e. the keeper of the silver) for SLV. And to add one more layer of intrigue, over the past couple weeks, there has been an unusually large amount of silver which has moved in and out of the Comex warehouses. That data can be tracked here: LINK. You'll note that today ScotiaMocatta experienced a very large withdrawal from its "eligible" category. This category is the silver that Scotia safekeeps for investors and which is not available for futures delivery. Scotia's reliability as a bullion depository has recently come under intense scrutiny.

    Coincidence?  Only time will tell. But it is now becoming much more widely recognized by big bullion investors that it is crucial to make sure that the bullion you are invested in is being held on an "on demand" verifiable basis and that it has not been misplaced by the fractional system that is an accepted industry practice among the bullion banks.

    I know exactly where my gold and silver is and I know exactly where the gold and silver (and the weights and serial numbers of the bars) owned by the fund I manage is. Do you? Are you sure you really own gold and silver, or is it a worthless paper certificate with little or no metal backing the claim?



    Disclosure: none
    Stocks: GLD, SLV, IAU, PHYS, CEF, GTU
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  • kohalakid
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    The author is comparing apples to oranges.


    He begins by bringing up Morgan Stanley's case where they settled a case where they were alleged to not have segregated, allocated silver in customer storage accounts.


    He then proceeds to apply that same standard to COMEX, which is clearly NOT a spot metal exchange. It's a futures exchange, dummy! There is no obligation for a trader to have physical metal when he sells a futures contract! He's making a promise to deliver and the buyer is making a promise to take delivery and pay for the metal. The fact that 99% of all futures transactions DO NOT result in delivery means that the vast majority of buyers and sellers are coming together and entering a contractual obligation that suits their needs.
    For those who want physical metal, such as jewelers and other fabricators, there are certainly cheaper ways of obtaining it than taking delivery of a COMEX futures contract.


    So the author compares a Ferrari to a Lear jet and complains that one can't go as fast as the other.


    The author also understates the amount of gold stored at COMEX warehouses that is available to deliver against contracts. There is currently over 10 million ounces total of registered plus eligible gold at COMEX, the largest figure I've ever seen.
    16 Apr 2010, 01:30 PM Reply Like
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