321gold.com’s Bob Moriarty recently took someone to task for making the wrongheaded
assertion that there was a high risk of the CME (usually still called the
COMEX) defaulting due to the amount of paper claims to gold being orders of
magnitude greater than the amount of physical gold in store. Bob makes the correct
point that a default isn’t possible because the COMEX allows for cash
settlement if necessary. However, the assertions being made by the default
fear-mongers aren’t just wrong due to a failure to take into account the cash
settlement provision; they would be complete nonsense even if there were no
cash settlement provision. I’ve briefly explained why in previous blog posts
(for example, HERE). In this post I’ll supply a little more detail.
I suspect that when it comes to the idea that a COMEX default is looming,
ZeroHedge.com is “fear-monger zero*”. Every now and then ZeroHedge posts a
chart showing the total Open Interest (OI) in COMEX gold futures divided by
the amount of “Registered” gold in COMEX warehouses. An example is the chart
displayed below, which was taken from the article posted HERE. The result of this division is supposedly the
amount of gold that could potentially be demanded for delivery versus the
amount of gold available for delivery, with extremely high numbers for the
ratio supposedly indicating that there is a high risk of a COMEX default due
to insufficient physical gold in storage. I say “supposedly”, because it
actually indicates no such thing. The ratio routinely displayed by ZeroHedge
— and other gold market ‘pundits’ who spout the same baloney — is actually
meaningless.
One reason it is meaningless is that the amount of gold available for
delivery is the amount of “Registered” gold PLUS the amount of “Eligible”
gold, meaning the TOTAL amount of gold at the COMEX. It is true that only
Registered gold can be delivered against a contract, but it is a quick and
simple process to convert between Eligible and Registered. In fact, much of
the gold that ends up getting delivered into contracts comes from the
Eligible stockpile, with the conversion from Eligible to Registered happening
just prior to delivery.
Taking a look at the ratio of COMEX Open Interest to total COMEX gold
inventory via the following chart prepared by Nick Laird (www.sharelynx.com), we
see that it has oscillated within a 3.5-6.5 range over the past 7 years and
that nothing out of the ordinary happened over the past three years.
Another reason that the OI/Registered ratio regularly displayed by
ZeroHedge et al is meaningless is that the total Open Interest in gold
futures is NOT the amount of gold that could potentially be demanded for
delivery. The amount of gold that could potentially be demanded for delivery
is the amount of open interest in the nearest contract. For example, when
ZeroHedge posted its dramatic “Something Snapped At The Comex” article in late-January
to supposedly make the point that there were more than 500 ounces of gold
that could potentially be called for delivery for every available ounce of
physical gold, in reality there were about 15 ounces of physical gold in
COMEX warehouses for every ounce that could actually have been called for
delivery into the expiring (February-2016) contract.
Although it provides no information about the ability of short sellers to
deliver against expiring futures contracts when called to do so, it is
reasonable to ask why the ratio of total OI to Registered gold rose to such a
high level. I can only guess, but I suspect that the following chart (also
from www.sharelynx.com) contains the explanation.
The chart shows the cumulative stopped contract deliveries, or the amount
of gold that was delivered into each expiring contract, in absolute terms and
relative to open interest. Notice the downward trend beginning in late-2011.
Notice also that the amount of gold delivered to futures ‘longs’ over the
past two years is much less in both absolute and relative terms than at any
other time over the past decade.
It is clear that as the gold price fell, the desire of futures traders to
‘stop’ a contract and take delivery of physical gold also fell. In other
words, the unusually-small amount of gold maintained in the Registered
category over the past two years reflects the unusually-low desire on
the part of futures ‘longs’ to take delivery.
It’s a good bet that if a multi-year gold rally began last December (I
think it did) then the desire to take delivery will increase over the next
couple of years, prompting a larger amount of gold to be held in the Registered
category.
In conclusion, the fact is that at no time over the past several years has
there been even a small risk of either a COMEX default or the COMEX falling
back on its cash settlement provision. However, this fact is obviously not as
exciting as the fiction that is regularly published by scare-mongers in their
efforts to attract readers and separate the gullible from their money.
*The equivalent of Patient Zero in an epidemiological investigation.
