Why COMEX Won’t Default.
Four Reasons COMEX Won’t Default or Collapse.
Despite the predictions of many smart analysts of an imminent collapse or default of Comex, it hasn’t happened yet and probably won’t. Comex analysts have noted the seeming unsustainble gold and silver trading on Comex and have long predicted “imminent” collapses or defaults of that exchange.
“The COMEX will default in the next week or several weeks and people will be “settled” with Dollars, no more metal will be delivered! So, knowing that “game over” has arrived– Famed precious metals analyst Bill Holter in Silver Doctors, April 2013“* (the story never dies- again in April 2016 COMEX DEFAULT COMING SOON! and again in April 2018 )
Currently, Comex analysts cite blatant anomalies like:
The mere 160,000 ounces of registered gold in the Comex vaults available to deliver and the 260 claims that long contracts have on each ounce of gold should they choose to settle those contracts by taking physical delivery.
The amount of registered gold available to settle contracts requesting delivery is at all time lows.
The rapidly declining registered silver in the Comex vaults:
Registered Comex silver has fallen precipitously since the summer of 2015.
The amounts of registered gold in the Comex vaults are less than Russia might acquire in a few days of buying for its foreign reserves and there is less registered silver in the Comex vaults than India imports in a month.
None of those “stunning” facts seem to matter as the registered Comex inventories of gold and silver continue to be depleted and trading of gold and silver in huge volumes carries on.
There has been no Comex collapse or default.
It hasn’t happened and probably won’t.
The Emperor’s New Clothes
In a story written by Hans Christian Andersen in the early 19th century, the “Emperor’s New Clothes”, a pair of fraudsters trick the King into buying a non-existent but expensive new suit of clothes on the pretense that it is so fine only the incompetent and those severely deficient in mental capacity can’t see it. Everyone in the town, including the King, keep up the pretense that the “clothes’ he has purchased and wears with pride are real and the finest ever designed. It takes a small child at a parade where the King is appearing to state the obvious and break the fraudulent spell when he blurts out – “the King isn’t wearing anything at all!”
The analysts calling for a Comex collapse and default are like the child in the Emperor’s New Clothes. They are pointing out a seemingly obvious fraud that merely needs to be pointed out to put an end to it. The idea is that once the absurdity of trading contracts representing massive amounts of gold and silver well beyond what is available for physical delivery is duly noted, it will expose the Comex exchange and all confidence in it will be lost and the farce of trading non existent gold and silver will come to an end and true price discovery based on physical supply and demand principles will come into play.
Or a perspicacious trader, group of traders or hostile foreign entity will notice the anomaly of the small amount of gold or silver available for delivery in the Comex vaults and “stand for delivery” on their long contracts. At that point, with not enough gold or silver to settle the contracts, it would be “game over” for Comex.
But that hasn’t happened and probably won’t.
The Emperor’s New Clothes 2.0
The modern story of the Emperor’s New Clothes (Comex version) is different. In the 2.0 version, the story has a different twist. The Comex analysts note that the gold and silver that are supposedly being traded on Comex are not there. Rather than being recognized for their common sense in exposing the fraud, the Comex analysts are ridiculed, ignored or drowned out. It is the equivalent of the child in the original story being silenced and put on meds while allowing the King’s naked parade to continue. While the Comex analysts alert everyone to the Comex farce they are greeted with claims of “‘what farce’? these are efficient markets and there is plenty of gold in the Comex vaults”.
The total amount of gold in the Comex vaults (registered and eligible) are at historically normal levels.
Here are four reasons Comex won’t default or collapse (in increasing importance):
1. Comex is not a place to buy gold or silver – it is a paper market
Comex is a place where traders trade gold and silver they don’t have to other traders who don’t want it. They are looking for price exposure to gold and silver not physical bullion. Many of these traders are the bullion banks themselves.
In addition, gold and silver bullion dealers often sell their newly purchased inventory short on COMEX to hedge their purchases. The greater the volume of silver and gold that bullion dealers sell, the greater number of short contracts they have to sell on Comex to hedge their inventory.
Most long and short gold and silver contacts are rolled over or expire by their own terms. Relatively little gold and silver is actually delivered pursuant to Comex contracts. The chart below illustrates the paper nature of Comex vs. a physical gold exchange, like the Shanghai Gold Exchange:
During a two week period ended September 25, 2015 the Shanghai Gold Exchange delivered more gold than Comex delivered during the entire calendar year of 2014.
Comex gold contracts are denominated in 100 troy ounce increments. For gold to be Comex eligible to be traded and registered for delivery it must be of at least .995 fineness and be in the form of either 100 troy ounce bars or one kilo bars.
Comex silver contracts are available in 5000 ounce and ‘miny’ 1000 ounce form. The 5000 once silver contract may be settled by delivery but the 1000 oz does not allow for delivery unless aggregated with four other miny silver contracts
Buy a Comex Approved Silver Bar (1,000 Oz)
Any one serious about acquiring physical metals doesn’t trade Comex contracts with an expectation of taking delivery. People looking to acquire physical metals have countless options, including buying and arranging storage from many of the bullion dealers featured on this web site.
Since the bulk of traders on Comex are using the exchange to hedge their bullion positions or to speculate on price, and are not generally not interested in taking physical possesion, it doesn’t matter if there are only 160,000 ounces of gold registered for delivery. Once the traders accept that there is not a one to one correspondence of metals underlying their contracts it doesn’t matter if there are 2, 20, 200 or 2,000 claims per ounce.
2. Today Traders and Society Accept Fractional Reserve Everything
“You are thinking of this place all wrong – as if I had the money back in the safe. The money is not here.”
Watch as “good” bankster George Bailey in 1946’s “It’s a Wonderful Life” convinces his depositors to have “faith” in fractional reserve banking. The depositors’ money NOT being in the bank isn’t viewed as crimminal, but rather how banking works.
This episode indicates how many people can suspend belief and accept that their money IS in the bank when it clearly isn’t. It shows how one dollar can serve as $10. By analogy, one ounce of gold on Comex can serve as 10 ounces, 100 ounces or even 1000 ounces of gold if the traders believe it.
This suspension of reality doesn’t seem to disturb the vast majority of 20th and 21st century people other than a select few like Tom in “It’s a Wonderful Life” and Kyle Bass, who as a fiduciary famously took delivery of his client’s gold from Comex.
There is a Dollar Shortage and it Doesn’t Matter
Currently, there is a dollar shortage – at least in the quantity of Federal Reserve Notes. For the week ended September 25, 2015 there were an estimated $1.384 trillion in Federal Reserve Notes in circulation. The Federal Reserves estimates that 2/3 of U.S. currency is held overseas.
While there is about $1.4 trillion in U.S. currency in physical form, (of which less than $500 billion is estimated to be in circulation in the United States – most of which is not at banks waiting for depositors to withdraw it), there are about $10 trillion in U.S. bank deposits and $20 trillion held in U.S. stock accounts.
This highlights that there doesn’t exist in physical form nearly enough unbacked paper dollars to cover the amount held in bank deposits. If just a small percentage of U.S. citizens wanted to convert their bank account deposits or dollar denominated assets into physical dollars there wouldn’t be nearly enough.
During the current and ongoing physical dollar shortage there has been no run on the banks.
As long as people have faith in a fractional reserve system, a shortage in the underlying commodity or asset can be ignored as long as the value of that commodity or asset can be recognized by alternative means.
A physical shortage only matters if the underlying asset is required to satisfy an immediate need or use. In such a case, the price of the underlying asset will certainly rise in price relative to its everyday fractional reserve price. For example, if the electronic banking system were to fail, demand for physical cash and its value would skyrocket.
Or if there was a physical shortage of silver required for an electronics manufacturer to complete a large batch of iphones, the price of physical silver would immediately increase over the Comex trading price (and the Comex price would eventally adjust to the higher physical price) as the electronics manufacturer would pay a market price based on the actual amount of physical silver required to complete the order.
People can suspend belief and convince themselves it doesn’t matter that there is not a one to one correspondence in the physical amounts of gold and silver underlying their Comex contracts, until it does. Changes in the silver supply demand dynamic of the shortage nature described above would occur OUTSIDE of Comex and would have the effect of wresting the pricing mechanism from Comex trading temporaily.
3. You Don’t Beat the Casino at the Casino
Commodities exchanges, like casinos have rules in place to ensure the profitable and continued existences of their respective businesses.
What if faith is lost?
Higher Prices Solve Lower Registered Inventory Issues
If indeed traders on Comex became nervous about the very low levels of gold and silver registered and available for delivery, most likely the prices of gold and silver Comex contracts would rise and more of the eligible gold and silver would be registered for sale at the higher price. The higher prices would satisfy the traders and traders wishing to take delivery would be accomodated by willing sellers moving their eligible gold and silver into the registered category.
If prices don’t rise high enough to convince holders of eligible silver and gold to move their inventory to the registered category, Comex has rules on position limits that would serve to prevent the system from being overwhelmed.
In a fast moving market, however, position limits may not work. Traders sensing an untenable circumstance and an actual physical shortage of silver or gold may wish to take delivery in order to possess the physical commodity that will certainly rise in value as confidence in the fractional reserve system is lost.
Given that currently it seems that the Comex registered gold vaults are nearly empty, why hasn’t a trader or group traders “stood for delivery”? Analyst David Kranzler of Investment Research Dynamics took a crack at it – the simple reason: “the Government would step in and prevent the trade from occurring to completion.”
Any such trader would certainly be shut down. The lesson of the Hunt Brothers is instructive. Once it appeared that the Hunt Brothers were becoming successful in gobbling up much of the world’s available silver in early 1980 (some of it by taking delivery on Comex), Comex limited trading in silver to liquidation orders only! With only liquidations (sell) orders going, through the price of silver dropped and and with it the value of the Hunt Brothers margin collateral, eventually resulting in a margin call the Hunt Brothers couldn’t meet resulting in their bankruptcy.
Lesson: You don’t beat the casino at the casino.
At gambling casinos, counting cards in the game of “Blackjack” or “21” is not allowed, meaning if you have found a way to beat the casinos, they won’t let you do it. Indeed, this scene from Martin Scorcese’s movie “Casino” illustrates what happens to people when they try to beat the casino at the casino.
CME Rule 413
Comex is prepared for traders who may wish to “beat the casino” with either malicious or profitable intent.
The CME Group which owns and operates Comex has instituted Rule 413 that provides in relevant part:
The Chief Regulatory Officer or his delegate, upon a good faith determination that there are substantial reasons to believe that such immediate action is necessary to protect the best interests of the Exchange, may order that: 1) any party be denied access to any or all CME Group markets; 2) any party be denied access to the Globex platform; 3) any party be denied access to any other electronic trading or clearing platform owned or controlled by CME Group; or (4) any Member be immediately removed from any trading floor owned or controlled by CME Group.
Comex is prepared to shut down any trader or group of traders, irrespective of the traders’ motive, if such trader(s) engage in a trade or series of trades that might not be in the best interest of Comex. So if a trader(s) “standing for delivery” might indeed cause a default of Comex, that trader(s) can be tossed from the system. A trader so exiled from the Comex trading platform can appeal his ejected within ten days.
Under Rule 413.D. a trader’s access to the Comex system can be denied no more than 60 days “unless the Chief Regulatory Officer or his delegate, upon further consideration of the circumstances that resulted in a prior access denial action, provides written Notice to the party that his access will be denied for an additional period of time not to exceed 60 days.”
Thus, CME Rule 413 D gives Comex the ability to remove traders that may wish to institute trades that are not in the best interest of Comex.
4. Comex is a U.S. Government Protected Exchange
Assume a trader or group of traders “stand for delivery” that can’t be met and they are not satisfied by a higher cash payment and Comex fails to invoke Rule 413 in order to eject such traders to prevent the best interests of Comex from being harmed, certainly wouldn’t it be “game over” for Comex?
Probably not. Enter the plunge protection team.
The President’s Working Group on Financial Markets
The Plunge Protection Team
After the stock market crash of 1987, President Reagan signed an executive order establishing the President’s Working Group on Financial Markets. The task of this group, also known as the Plunge Protection Team (PPT) is to enhance “the integrity, efficiency, orderliness, and competitiveness of our Nation’s financial markets and maintain investor confidence.”
The “Working Group” of the PPT is comprised of Secretary of the Treasury,the Chairman of the Board of Governors of the Federal Reserve System, the Chairman of the Securities and Exchange Commission and the Chairman of the Commodity Futures Trading Commission. The Working Group has broad discretion to intervene in markets and “shall consult, as appropriate, with representatives of the various exchanges, clearinghouses, self-regulatory bodies, and with major market participants to determine private sector solutions wherever possible.”
The United States government is the most powerful government on earth and the members of the President’s Working Group on Financial Markets are comprised of the heads of the most powerful departments in it. When it comes to protecting the U.S. financial markets and the dollar, messing with the U.S. government is no laughing matter.
It appears that the PPT is reluctant to allow the U.S. stock market to fall even a few percentage points with out intervention.
Do you think the PPT is going to allow an important commodity exchange like Comex to default because a trader stood for delivery?
One could imagine that any trader(s) attempting to execute a trade that might cause harm to Comex would be dealt with harshly by the PPT in any number of ways. The trader’s account could be suspended, his trades cancelled, his personal and business accounts audited by the IRS and he would probably be fined, arrested and charged personally as a terrorist.
Do I Feel Lucky?
To the intrepid trader who wants to “stand for delivery” of the last 160,000 ounces of registered gold in the Comex vaults and in the process take on the most powerful government in the world as well:
You have to ask yourself a question: Do I feel lucky?
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*COMEX default is coming soon – Bill Holter April 2016
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