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NOTE:
Originally published at www.metalaugmentor.com on December 4, 2009 at 5:23AM
EST.
In our
next installment of the Charlatan Exposed series, we look at Gold, the COMEX and
Exchange for Physicals as found on Jesse’s Cafe
Americain (as an aside, can anybody explain to us the connection between
France, coffee and gold bugs?). Jesse tells us that:
Comex
is putting forward the offer of paper in the form of money or ETF positions
aggressively, and it is the much easier alternative. Delivery of physical
gold from the Comex is no longer as straightforward or even as
semi-convenient as it had been in the past. In fact, it is difficult, and one
must be persistent and wait long periods of time. At least, this is what we
hear.
This
of course is total nonsense. COMEX is not advocating ETF positions, which are
only permitted as the physical leg of an exchange for physicals (EFP)
transaction, and only because market participants requested that the COMEX
relax EFP rules to be more in line with the types of transactions being done
outside the exchange. I went into excruciating detail a few months ago to
explain how EFPs work, so
I’m not going to rehash the topic. Suffice it to say that allowing ETF
shares to be used as the physical leg of EFP transactions has nothing to do
with contract settlement during the spot month and it is actually against the
best interest of the exchanges to allow them.
As for
the idea that delivery of “physical gold from the COMEX is no long as
straightforward or even as semi-convenient as it had been in the past”,
this is a totally unsubstantiated and dubious claim. In fact, the
COMEX-approved warehouses currently have substantial levels of both eligible
and registered metal while delivery notices in December are running below
normal. Delivery notices in September, October and November were elevated
above historic levels but this activity in retrospect appears to have been
related to the brouhaha surrounding the IMF gold sales and Barrick’s
dehedging. In effect what this means is that the huge COMEX non-commercial
long position is almost entirely speculative. So much for the commercial signal
failure in gold!
We
would like to know if there has been a recent independent audit of the Comex
stores, with a clean sheet of bar numbers and the status of same. From what
we hear it is a mess, as bad or worse as the recent scandal in Canada and the
‘missing bullion.’
Give
me a break, the COMEX warehouses are run by independent and accredited
bullion storage operations, each of which are audited under SAS 70. This is
essentially the same for products like GoldMoney and BullionVault. Methinks
Jesse might be hearing things about a mess at COMEX warehouses, but I’m
completely open to being proven wrong. Meanwhile, I’m not holding my
breath.
“Some
months ago a chap described changes in the comex rules for futures contract
deliveries. Therein it was described that the EFP, exchange for physical,
rules were amended to allow for delivery of GLD shares in lieu of bullion.
Well
take a look at something new, at least for me, in Monday’s comex
preliminary volume and open interest report. On page 3 of the attachment,
notice that in addition to futures contracts listed under the EFP category, a
new category is listed: “Delivery Cash Settled” = 2866 december
gold contracts. Just so happens 2866 was exactly the number of delivery notices
issued on FND as reported in the Nov 27 vol and op int report.
Conclusion:
guess you can no longer get bullion via using comex contracts. This
apparently is the next step in the evolution of gold trading.”
Nope,
the rules were not amended to allow for delivery of GLD shares in lieu of
bullion, the rules were amended to allow the use of GLD shares in order to
initiate an off-exchange (ex-pit) transaction in a COMEX futures contract
(that’s what an EFP is). EFPs are used to initiate or liquidate futures
contracts but they are not used to settle them in the delivery month. That is
why you don’t see
“EFP Daily Totals” for December contracts in the month of
December. It’s simple really: physical futures are settled ex-pit by
EFP (or a few other “exotic” means) prior to delivery month and
settled by delivery ex-pit during the delivery month.
Here
is where it starts to get a bit tricky. Some futures contracts, such as the
S&P 500 Index and Treasury Bonds, do not involve delivery at all since
they are “cash settled” at contract expiration. But just to
confuse the hell out of everybody, “cash settled” contracts are
still associated with a “delivery month” in which they expire
(typically on the third Friday of the month prior to the contract month). In
any case, a particular contract type, such as COMEX gold, cannot have both
“cash settled delivery” and “physically settled
delivery”. The only sense in which COMEX gold contracts are settled for
cash is that the issuer of the delivery notice must pay cash to the stopper
equal to the futures price before taking possession of the underlying
bullion.
What
the &%*@#, you protest! The CME Daily Bulletin clearly says “cash
settled” in the delivery month for COMEX gold, no? So it’s true
that COMEX futures are not being settled for physical metal?
Of
course it’s not true. As noted above, a futures contract that by regulation
requires settlement by physical delivery cannot at the same time also be
“cash settled”. This is a market myth unsupported by any
evidence. Let’s look at an example of physical delivery in action. On December 3,
COMEX silver open interest for the December 2009 futures dropped by 493
contracts and that means 254 contracts were offset in the pit (paired
long-short trades are netted and therefore reduce open interest) and 238
contracts were settled ex-pit (reducing open interest through delivery). This
isn’t completely accurate because not all delivery notices result in
consummated transactions, some go back to the pit for trading and eventual
offset.
Once
again and for a final time, “physically settled” delivery is
fundamentally different from the “cash settled” contract. Such
“cash settled” contract, however, is essentially ex-pit (settled
off exchange) just as physical delivery is ex-pit. Moreover, futures market
nomenclature confusingly refers to “cash settlement” as a form of
delivery. That is why the “Delivery — Cash Settled” label
appears on the CME Daily Bulletin. When the new report template was created,
the labels were apparently not customized for different contract types. It
should be noted that the CME has made a slight improvement to the label in
the past couple of days, now calling it “Delivery — Cash or Phy
Settled”. To avoid any remaining confusion, the label should probably read
“Cash Settled or Physical Delivery” or even better the label
should be customized for each contract type (”Cash Settled” or
“Physical Delivery”).
The
conclusion we reach for now is that if one is counting on the ability to
receive delivery of physical gold from the Comex for whatever purposes, then
don’t. You will wait and fight and stand in queue to obtain the goods
from the Enron nation.
But
one principle we have learned over the years is never to attribute to bad
intents what can be attributed to human error and mismanagement.
I
would encourage Jesse and others in the gold and silver camp to actually
understand how the metal exchanges work instead of “attributing”
anything to anybody. From that understanding perhaps some intelligent
conversation and debate might emerge.
UPDATE: Based
on several comments by observers, I now realize that my attempted play on the
semantics of “settled for cash” may have caused more confusion
than entertainment. As such, I have edited the wording to be more clear about
the difference between delivery and cash settlement. I have made the edits in
the text above. The original material is as follows:
Nope,
the rules were not amended to allow for delivery of GLD shares in lieu of
bullion, the rules were amended to allow the use of GLD shares in order to
initiate an off-exchange (ex-pit) transaction in a COMEX futures contract
(that’s what an EFP is). EFPs are used to initiate or liquidate futures
contracts but they are not used to settle them in the delivery month. That is
why you don’t see
“EFP Daily Totals” for December contracts in the month of
December. It’s simple really: futures are “settled” by EFP
(or a few other “exotic” means) prior to delivery month and by
cash in the delivery month.
What
the &%*@#, you protest! Cash settlement in the delivery month? So
it’s true that COMEX futures are not being settled for physical metal?
Of
course it’s not true. “Cash settlement” in the context of
delivery only means “not EFP”. A futures contract in delivery
month is always
settled for cash. Either it’s net cash
(pit) or it’s gross cash
(ex-pit). Net cash is simply netting the short and long contract and happens
in the normal course of delivery month trading (in pit). For example, on December 3,
COMEX silver open interest dropped by 493 contracts and that means 254
contracts were settled for cash in pit (and 238 contracts were settled for
cash ex-pit). [This isn't completely accurate because not all delivery
notices result in consummated transactions, some go back to the pit for
settlement.] Gross cash involves issuing a delivery notice that is then
stopped by a party holding registered metal in the COMEX warehouse. It is
“gross cash” because the issuer of the delivery notice must pay
cash to the stopper equal to the futures price in order to take delivery of
the bullion. It is “ex-pit” because a delivery notice settles the
futures contract outside, or ex, the pit.
Tom Szabo
Silveraxis.com
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Szabo
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