Gold Customer or Gold Dealer; Woocoodanode?
In our previous post we told of events at the COMEX and today we will discover a bit more about the COMEX. By the end of this series you will have a bit more knoweldge, find the gold market a little less confusing, and realize just how little I know, about gold or anything else.
The COMEX is a commodity exchange, one of five that comprise the CME, (Chicago Mercantile Exchange). Forget the technical definitions of a commodity exchange. They are confusing. I like to think of the Comex as a market, (think outdoor open air where folks are yelling and haggling), where sellers and buyers meet to ‘exchange’ precious metals for federal reserve notes. Rarely do they ever exchange the actual metal. Mostly they exchange a promise to deliver metal in the future.
(DISCLAIMER: I am not a trader, or expert, or anything else that may claim to know what it is talking about. I am just rambling on because it helps to clear the cobwebs in my brain. If you find some mistakes in my observations of the COMEX workings, let me know. What is fascinating is that one finds out what one does not know when one writes about what one thinks one knows. You can quote me on that last statement. What is also fascininating is how little one finds out one knows when one starts writing about what one knows, or really doesn’t know. This is great. I could go on like this for awhile. But, you, our dear readers, assuming that readers is plural or that there are any readers at all, are probably getting miffed with our egocentric musings.)
Hence the term ‘futures market’. In a regular market, farmer Josephine, (political correctness), brings her rutabagas to the market and sells them to the grocer who is the son of Albert, ( Get it? Huh? Get it?). They negotiate a price depending on their haggling skills and the current supply and demand for rutabagas, but the market for rutabags is so much simpler than the market for gold. The seller of gold at the COMEX may bring his gold to the market and he may not. He may just bring a promise of future delivery of gold, especially if he is a gold farmer. No, that’s not right. See, you caught me already. How about especially if he is a gold miner? Yeah, that’s better.
Gold mining is a business and businesses are fraught with risk if the price of their product is subject to price volatility. Potential owners, stock buyers or sellers, are more likely to value shares of a company if the revenues are consistent and can be measured or calculated reasonably. So, a gold mining company may sell it’s future production at the COMEX. Why would a buyer want to buy future production rather than a present day bar or ounce or whatever of gold? Because said buyer thinks that between the time she buys and the time she sells, the price of gold, (pog), will increase. (All prices for the purposes of this rambling will be in terms of Federal Reserve Notes, or what most of us think of as dollars.) So she buys a future ounce of gold for say, $1000.00 in the hopes that by the time she takes sells, the price will be $1100.00, and she can turn right around and sell that future ounce for a $100.00 profit. In this example, the mining company sold it’s future ounce for $1000.00 which is $50 more than it’s production cost per ounce, $950, thereby instilling confidence in it’s stock. Wow! Everybody is making money and everybody is happy! Right?
Hold on there Babalouie! What if the pog decreased during the time between the sale and delivery? Then the buyer may lose money, depending upon the amount the pog decreased. In this case, the seller has “hedged” their position with limited upside potential while passing off downside risk. And the buyer has eaten muck. Well, that is what makes a market. End of story.
No, dear reader, you are not getting off that easy. There is so much more to the story.
For some reason, a reason I have yet to ascertain, the COMEX requires that some of the actual physical stuff be stored at a COMEX approved facility. And that the actual physical stuff meets COMEX approved standards. But, the COMEX does not require that all trades require that 100% of the stuff being traded is at the COMEX approved facility and meets COMEX approved standards. Remember I said that RARELY does the buyer take actual physical delivery? You don’t? You don’t remember? Geez, you’re memory is as bad as mine. Maybe worse. ( I don’t think Sister Mary Margaret would have approved of me using, “Maybe worse.”, as a complete sentence, but soon I am going to stop caring what Sister Mary Margaret thinks, or thought. Heck she may not even be alive. I think she was about 110 when I was in 6th grade.) Anywhooz, (That’s a word ya know. Don’t believe me? Look it up. Ooo-o-o-o-o, called my bluff this time did you? Ok, it’s not a word, but I am gonna use it anywhooz. HA!!!! You and Sister Mary Margaret should go have coffee or lunch or something. You could both complain about the dumbing down of America or what is wrong with our public school system, or private school system, or whatever.) Anywhooz, the buyer, rather than taking physical delivery, usually sells the future back or rolls it over to the next front month or another delivery date.
BUT, sometimes the buyer does take delivery, and that is why there has to be some physical stuff at the market rather than just promises. See, writing helps my memory. I told you I didn’t know the reason, and I didn’t at the time I wrote that, but now I remember. Sometimes the buyer DOES take delivery, and that is the premise for the rest of this sorry excuse for a post. Notice how IR only publishes these scrawls on weekends, (readership is smaller and less descriminating on weekends.)
When the buyer wants to take delivery, either the physical stuff or just paper ownership of the physical stuff, there has to be some physical stuff to take delivery of or else the COMEX will look rather foolish, or that is the general perception. I don’t see why the COMEX would look foolish because when traders sign up for a COMEX trading account, the COMEX does not promise delivery of the physical stuff. The COMEX says that the traders will be made whole, but there is no promise that the buyer of the future will get the actual physical stuff. Ha! I’ll bet you didn’t know that! The COMEX promises the buyer either the physical stuff or shares of GLD in the case of gold futures, or a check for Federal Reserve Notes, (hereafter referenced as FRNs). Interestingly, it seems more buyers are taking delivery than is usual, and the inventory of gold ounces available for delivery has declined.
Before we get to that chart, we need s’more backround info. So, let’s start with another chart.
The above chart shows the amount of physical gold ounces held at the COMEX storage facilities at various times, and it shows the pog at those times. I find it fascinating that the total number of ounces has historically increased as the price goes up and decreased as the price goes down, or am I getting the chicken before the egg, or the egg before the chicken? Either way there is a STRONG correlation between the price and the total number of ounces held in the COMEX facilities. Which reminds me of something you, our dear readers should know. The COMEX storage facilities are also known as bullion banks and recently, a few months or so ago, the COMEX added a disclaimer to it’s daily report of COMEX gold inventory. (It is not really the COMEX’s inventory. It is really owned by whomever owns it, but we refer to it as COMEX inventory for reasons which may become clearer. If the reasons do not become clearer, then I am not doing my job. And Irvine Renter may not pay me. So pretend that you understand, even if you don’t. Or I may not write. Hmm-m-m-m, not much of a threat, eh?) The disclaimer said that the COMEX is not responsible for the accuracy of the daily inventory report, and said the report was for informational purposes only. Sounds like another good reason for a conspiracy theory to me. I love conspiracy theories because it is almost impossible to disprove conjecture and so they thrive, at least in my brain. You may be wondering, can’t the COMEX count it’s own inventory? It could, but it relies on the bullion banks that are storing the gold to tell the COMEX how many actual physical ounces they have in their vaults. No kidding! And one of the bullion banks is JP Morgan, that venerable bastillion of integrity and goodwill. Others are HBSC, Barclays, and Deutsche Bank; all paragons of EQUAL virtue, (if you haven’t figured it out, equal to each other, as in all equal pits of scum.)
Again looking at the same chart, (you may have to scroll up a bit to see it again), you can see that there are two types of COMEX gold inventory; eligible and registered. The names eligible and registered are quite confusing until you have been reading about this stuff for some time and then they kinda make sense; not good sense, but sense, if that makes any sense. And you want to know the difference between eligible and registered inventory, but we are going to change the terms for awhile so that this whole mess seems like less of a mess and more of a guess, (not really, but it rhymed). We will call the elegible category, ‘customer’ inventory and the registered category, ‘dealer’ inventory. The dealer may or may not own some of the dealer category, but don’t concentrate on that minutiae. It isn’t to be confusing. Others use the terms customer and dealer inventories when referencing COMEX gold inventories so just trust me, ok? The customer inventory is that portion of the physical gold ounces that is in the form of gold bars approved by the COMEX, held at a COMEX approved bullion bank, has not left a COMEX approved facility or transporter, and is NOT available for sale on the COMEX futures market. The dealer inventory is the same as the customer inventory, EXCEPT it IS available for sale on the COMEX futures market. We all good so far? Ok, for you smart-alecs, forget about all good and just think about whether or not we understand. Good, you understand. I can see you nodding your head. Next is a chart of Comex dealer inventory, as of January 08, 2014:
Sorry I could not find a chart without the commentary. This chart shows that there are 416,563 ounces of gold in the dealer inventory of the COMEX on Jan. 08, 2014 as reported by the bullion banks. Ahh-h-h-h, you say; a trend. Yes, the COMEX is being drained of deliverable gold ounces. There is still a bunch of non-deliverable/customer ounces, but the deliverable/dealer ounces are just about cleaned out. “What is the point?”, you ask. The point is, it really does not make any difference if there are a lot less dealer ounces, … until it does.
Open interest is the number of futures contracts that are still open at the end of the trading day. Each futures contract represents 100 ounces of gold to be delivered in the future, so open interest ounces would be the number of gold ounces that are represented by the number of futures contracts that are open at the end of the day. Historically, the ratio of the open interest ounces to the actual deliverable/dealer ounces averaged around 12:1 until April of 2013. If you look two charts up you can see that April, 2013 is when the dealer ounces at the COMEX started falling, … rapidly. April, 2103 also happens to be when the Fed told Germany to go pound sand after Germany asked for it’s gold back in January. Are the two connected? I dunno. Before July, 2013 the ratio of open interest to real ounces had never gone above 40. On Jan. 8, 2014, there were 383,021 gold futures contracts open and there were 416,563 dealer / deliverable ounces making the owners per deliverable ounce ratio 92:1, or in COMEX cover ratio, 1%.
You may read that the lack of deliverable ounces will lead to a default, or using the cool term that makes the writer sound like they know what they are talking about, “force majure”, by the COMEX. It ain’t true. Remember, the COMEX has not promised physical delivery, and the COMEX holds enough of the traders cash account to make the buyers whole. “Yes,”, you say, “but won’t the inability of the COMEX to deliver physical gold cause the market for gold to go nuts? Won’t everybody and their grandmother realize that there is no more gold and want to get theirs thereby sending the price skyward?”
You see, all those customer ounces, 7,360,000 ounces, are there for one of two reasons; either because the owner took delivery from a futures contract and has had her ounces moved from the dealer inventory to the customer inventory with the intention of taking actual physical delivery, (called ‘backing up the truck’), or because the owners will eventually put them up for sale/delivery, by moving them to the dealer category, with just a phone call. Most of that over 7 million ounces is not for sale presently because the owners are waiting for a better price. If they were not waiting to sell them, they would not be sitting at the COMEX bullion banks’ vaults for any length of time. Keeping your gold at the bullion banks’ vaults ain’t cheap, and entails a risk that the bullion banks will sell your ounces without your consent, (think about that one for awhile). The total explanation of how and why ounces are moved to and kept by the COMEX is a whole other post, so you will just have to trust me when I say that most, if not all those ounces are sitting in the COMEX customer inventory to be sold, eventually. Well, you don’t have to trust me, but they are there to be sold, eventually.
Eventually in this case means at a higher price. The pog is not going to go nuts when the COMEX runs out of dealer inventory, the pog will just increase. How much? I dunno. Each owner of ounces in the COMEX customer inventory has their own price or prices, and only they know what those prices are.
January 16, 2014 Update: Yesterday, 89,756.629 ounces of gold were withdrawn from the COMEX dealer/registered inventory and 89,756.629 ounces were deposited in the customer/eligible inventory. This type of movement is called a settlement and it is indicative of a futures buyer standing for delivery and subsequently removing his gold from the futures market while leaving it in the Comex storage facility. This movement is also fairly typical of COMEX gold inventory movements since April of 2013. COMEX dealer gold inventory now rests at 370,140 ounces with the open interest increasing to 41,542,600 ounces for a owners to deliverable ounce ratio of 112:1.
By the way; whatever happened with that report from Goldman Sachs that Venezuela was going to lease it’s physical gold to GS? And wasn’t it reported that Cyprus was going to sell it’s gold to pay for the bail-in? Hmmm-m-m-m-m.