The latest statistics on the COMEX gold stocks show that the amount of gold in the “Registered” category is at a record low level. Gold has been draining away at an astonishing speed in 2013 and the trend seems to continue in 2014. In particular, the gold stock in the “Registered” category went from 2.6 million ounces to 0.42 million a year ago, which is a sharp fall of 85%. Chart courtesy: Goldchartsrus.
From an historical perspective, the “Registered” gold stock is at levels not seen since 2002, the period of time when the current bull market started.
A lot has been written, especially in the blogosphere, about this trend, and there has been a lot of speculation about the outcome. Some are of the opinion that the COMEX is about to default.
What most tend to forget, however, is to look at the total picture. First, the “Registered” category is just one of the two categories at COMEX, the other one being the “Eligible” category. The “Eligible” gold stock level shows a totally different picture, which is visible on the following chart (chart courtesy: Goldchartsrus).
Before continuing, let’s have a look at the difference between the two COMEX categories. BullionVault has provided a useful definition:
When acceptable bars are brought into an exchange-approved warehouse they become “eligible” for settlement of gold futures contracts traded on the exchange. So at this point, the owner of the bars may deliver them onto the exchange, and warehouse receipts are created. That is when the gold bars become “registered” stocks.
Eligible gold stocks may or may not ever become registered stocks. Why? Because the warehouse is still a warehouse and the owner may simply want to vault their metal securely, before using it to meet demand elsewhere – for manufacturing, or from investors in another marketplace, such as Asia. This eligible gold may belong to an investor, a refiner, a hedge fund, a bank or producer. Many times these people are holding the metal for their end customers. And it may move at any time, and is much more flexible than the warehouse receipts that are registered stocks.
We reached out to one of the veterans in precious metals markets and investing, David Morgan, founder of what we consider the most qualitative precious metals investment newsletter “The Morgan Report”, to get his view on the above trends.
First, what does it mean when “Registered” stocks continue their downtrend and end up near zero while there is plenty available in the “Eligible” category? It suggests the dealers are running out of inventory and so far whomever “owns” the gold in the eligible category is not (at this point) willing to place it into the registered category. Further thinking implies that the strong hands hold the eligible and the dealers are becoming venerable to a squeeze.
Second, what does this trend mean in the context of the COMEX futures market which already reached extremes lately, i.e. commercials net long currently vs speculators lowest net long position ever? Based on historic data, David Morgan believes it usually means the commercials win and the speculators in the “specs” category (i.e. trading funds) lose. This has been proven again and again, it is a function of when contracts are closed or “settled”. The Futures market is a zero sum game, someone wins someone loses, it is that simple. The trading funds on a net basis – lose! Therefore, the current “set-up” implies that gold will go higher and even if some of the eligible gold is held by the commercials it most likely would not come into the market until higher prices are obtained.
Third, how could it affect the bifurcation we already see today in the gold market, in particular the fundamentally different dynamics in the “paper market” vs “physical market”? Here it gets interesting as it touches the key premise (read: speculation) whether this trend could spell a default of the COMEX exchange and, hence, the whole fractional gold system.
David Morgan thinks it is very unlikely that the COMEX (run by the CME) will run out of physical metal to deliver. But in the hypothetical case that it would happen, we could see a couple of scenarios:
One could see backwardation — the spot month would be priced higher than future months. Perhaps a two tiered price structure – a paper price and a different price for real metal. There are many other possibilities including a shutdown of the exchange or moving it to a cash only market.
Most likely in my view is cash settlement will be forced and this could be the tipping point precious metals investors have been waiting for because it proves the paper settlement “price” does NOT set an accurate price for physical metal.
The latter statement brings up the question what to look for as the end of the paper market setting the price for the physical market? There are too many variables to know exactly where to focus as far as the physical market showing stress:
- German gold is not being delivered
- Dutch banks are forcing cash settlement for physical buyers
- As outlined above, there are low dealer inventories at the CME.
We know physical reality trumps the paper paradigm — what we don’t know it exactly how and when it will occur, but we certainly are closer than ever before!
This article was created with the support of David Morgan, founder of the precious metals investment newsletter “The Morgan Report” (click for a 30 day free trial and receive 16 specialized precious metals reports for free).