Nick Laird produces some unique charts at www.sharelynx.com.
His Comex gold stocks cover (or owners per ounce) chart has recently received
coverage, with bloggers focusing on the fact that there is only 1 ounce of
registered gold in the Comex warehouses for every 80 ounces of futures
contracts. I think they are overplaying this metric and feeding the ��€�œComex
to default��€ meme.
Before we get into it, a recap on Comex stocks. The chart below gives a
long term view of the amount of gold in the various Comex warehouses.
Registered means the gold can be delivered against a futures contract,
eligible means the gold meets the Comex delivery standards, but is not ��€�œregistered��€
to be available for delivery.
This chart clearly shows the effect of the bull market, with more gold
being held as bars in the warehouses rather than being converted into
jewellery. However, the stock figure by itself can be misleading when looked
at over decades, as population and economic activity grows over time - there
are more gold speculators and investors now than compared to the last gold
bull market.
The way to compare the stock figures over time is to look at it in
relation to the size of the futures market at that time. This is measured by
looking at Open Interest, which is the number of futures contracts ��€�œin
play��€ or active at any time. If there are more people holding futures
contracts, then we can expect stocks to be higher. Similarly, if stocks
decline but open interest declines as well, then the stock drop is not
unusual.
The charts below show this relationship by dividing Open Interest by Gold
Stocks. You can also invert it, which gives you a percentage cover indicator
of how much of the open interest is backed by gold in the warehouses. The top
chart just looks at registered gold stocks versus open interest, while the
bottom one looks at total gold stocks.
Commentators
have been focusing on the top chart because those short futures can only
deliver from registered stocks. They therefore have observed the recent
reduction in registered stocks relative to open interest as indication of a
potential for default, or a lack of gold. A few comments on this:
1. Note that in 1998 peak of 40:1 (or 2.5% cover) is overstated
because Nick doesn��€�™t have the registered/eligible breakdown.
Nevertheless, the ratio would still have been quite high and there was no
Comex failure at that time.
2.Most holders of futures cash settle and don��€�™t stand
for delivery. In the past five years the percentage of open interest which
stood for delivery averaged between 1%-2%, with a few months of 4% and 5%.
3. Note also that the chance of everyone (or a majority) standing
for delivery is highly unlikely, as most people trade futures on margin and
don't have the cash to pay for their futures in full (that is why futures are
popular, because they allow you to leverage your money to control more ounces
- magnifying your gains, and losses).
Certainly, the current ratio of 80:1 (or 1.25% cover) is very low
historically and below the average historical percentage standing for
delivery. This has led for some to predict that Comex would run out of gold
to settle futures contracts and default (or more accurately, force cash
settlement, which the rules allow them to do).
However, eligible gold can be easily converted into registered gold with
the click of a mouse. Hence I think one has to use the bottom chart, which
compares the total stocks to open interest.
This chart presents a completely different picture, with a ratio of 5:1,
or 20% cover, well below the 1998 ratio of 40:1. Now while eligible gold is
not "registered" for delivery, I think one needs to include it for
the following reasons:
1. the fact that the owners keep it in Comex deliverable form and
in Comex warehouses means they have an intent to sell it back into the
futures market (if they took it off eligible there would be costs to get it
accepted back as eligible) and they will sell it if the price is right;
2. one has to consider the possibility that sellers may try and
"hide" their intention to sell by holding eligible (making it look
like gold is not available for delivery and thus get the price bid up) then
at the last minute instantly change their gold to registered status; and
3. for those of a conspiracy bent, consider this blogger��€�™s
possibility that ��€�œthe owners [or eligible]
would likely be strong-armed or forced into converting their eligible
supplies into registered should things become desperate for the cartel."
As evidence of the above points, consider that during 2013 a total of 2.6
million ounces (80 tonnes) was converted from eligible to registered. There
was also 3.2 million ounces converted from registered to eligible. So I think
those just looking at registered stocks are not presenting the full picture,
giving a misleading or one-sided view of the state of the futures market.
So while registered stocks are at historically low levels relative to open
interest, there appears to be an abundance of total gold stocks covering 20%
of open interest. When that percentage coverage gets a lot closer to the average
��€�œstanding for delivery rate��€ of between 1%-2%, than we
can consider Comex might be under stress and at risk of cash settlement.
