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Comex Stocks: Claims On Bullion Well Below Historical Highs At 5:1

TREASURY VIEW

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 “Comex 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 “registered” 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 “in 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 “the 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 “standing for delivery rate” of between 1%-2%, than we can consider Comex might be under stress and at risk of cash settlement.

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