With mines, mints, and refineries closed around the world due to coronavirus, the demand for physical gold has blown through the roof. This has led to some drastic measures by the CME Group, which in turn may have unwittingly sealed the fate of the COMEX and the entire fractional reserve and digital derivative pricing scheme.
This latest crisis began last Tuesday, when the spot market
for gold appeared to seize up as the futures price roared ahead following the
announcement of formalized QE∞ by the U.S. Federal Reserve. The event has been
chronicled by many analysts and experts, with even Reuters and Bloomberg
joining in the reporting.
• https://www.reuters.com/article/us-gold-trading-cm...
As the Reuters article notes, a clear shortage of the COMEX
standard 100-ounce bars had developed. To counter this—
and in a desperate
attempt to maintain the integrity of their trading system
—the CME Group
immediately responded by amending the delivery procedures of their standard
COMEX contract. Instead of the required 100-ounce bars, the COMEX would now be
able to deliver fractions of 400-ounce London Good Delivery bars as well.
• https://www.cmegroup.com/trading/metals/precious/faq-gold-enhanced-delivery-futures.html
First of all, this exposes the charade of what has always
passed for the bi-monthly physical settlement process on COMEX. Oh sure, the
COMEX vaults may have always shown 8,000,000 ounces of gold, but quite
obviously, none of that was actually available for physical delivery. Instead,
each delivery month consisted of simple journal-entry transfers of nothing but
warrants and warehouse receipts. To maintain the charade, one bank would issue
some "gold" and another would take delivery. We've written about this
scheme on countless occasions, most recently here:
• https://www.sprottmoney.com/Blog/the-continuing-comex-fraud-craig-hemke-05-112019.html
But, whatever. Let's get back to the crux of the matter.
Obviously, the CME Group knew that they had a problem on
their hands last week, which is why the sudden rush to amend the COMEX delivery
rules to allow for London bar usage. The current front and delivery month is
the Apr20, and that contract was due to go "off the board" and into
delivery yesterday, Monday, March 30. Due to the virus-related shortages, The
CME clearly anticipated a sudden surge of demand for actual physical delivery
in April.
And did they ever get it! As of the COMEX close on Monday,
the total amount of Apr20 contracts still open and "standing for
delivery" was 25,595! A usual/normal delivery month on COMEX usually sees
8,000-10,000 "deliveries" for up to 1,000,000 ounces of warrants,
etc. For Apr20, however, there is a request for 2,559,500 ounces, and because
of the current shortages, most of these contract holders actually want real,
physical metal.
Apr20 delivery notices began to be posted on Monday
evening...and look at the volume! Be sure to note that the House Account of
JPMorgan had to make a delivery of 7,000 contracts for 700,000 ounces. Not only
is this close to 22 metric tonnes of gold, it's also more than 2X the stated
position limit of 3,000 contracts.
Note, too, that ScotiaBank was also forced to make delivery from their House Account of 235,100 ounces or about 8 metric tonnes. And note that, so far, HSBC has not posted a single delivery. But they're next. How do we know this? Check this massive, unprecedented re-allocation of gold from eligible to registered that took place late last week. JPM took the steps necessary to deliver 7,923 Apr20 contracts, while HSBC looks to have prepared for 3,129.
OK, so now let's look ahead and consider the title of this
post.
It's clear that the virus-related shutdown of mines,
refiners, and mints is having a dramatic impact on the supply of immediately-deliverable
gold. And this comes at a time when physical gold demand is surging. This
places wholesalers and dealers in a very tough position. They need physical
gold NOW but have very few options for acquiring it.
And so they're turning to the COMEX. And why not? The CME Group has maintained for years that
their pricing scheme is fair, sacrosanct, and backed by physical delivery. They
post vault stock reports every day of the week that purport to show a physical
vault inventory of over 8,000,000 ounces. So if you're a dealer and you need
immediate metal, why not just pony up to the bar at COMEX and stand for
delivery? After all, the CME itself claims that the gold is all there and just
waiting for someone to ask for it.
This "delivery" illusion worked out just fine...until
last week. And now the CME Group, in their rush to maintain "the integrity
of their exchange", may have just sealed the exchange's fate.
Why? Because they've opened Pandora's Box. By stop-gapping
COMEX delivery with London bars—
and by forcing The Bullion Banks that
operate on COMEX to actually deliver physical metal versus their paper short
positions
—the exchange itself may now be put in an untenable position.
Watch closely what happens next. After Monday's initial
deliveries, there will still be about 8,000 Apr20 contracts standing and open.
Most of these will likely be demanded for true physical settlement, too. Well,
now that COMEX is open for business as a physical distribution vehicle, what's
to stop funds, wholesalers, and dealers from paying full margin and buying even
more Apr20s as the month progresses? Nothing! So watch to see if that Apr20
open interest number continues to climb through the month.
Next, watch to see what happens in May. Though the May20 is
not a front/delivery month on the COMEX calendar, there’s nothing to stop an
entity from buying a contract and demanding immediate delivery in May. As of
Monday, total open interest for this contract was at 2,338. In the days ahead,
watch very closely to see if that total begins to grow.
And finally, even though the CME/LBMA/COMEX may survive
April, who's to say they'll survive the next major delivery month of June? Now
that the proverbial cat is out of the bag and the entire world knows that COMEX
will deliver actual physical metal if pushed—and with no other
readily-available stores of metal around due to the virus—what if 50,000
contracts stand in June? What if 100,000 stand?? Do you see where this might be
headed???
In the end, the CME may have unwittingly sealed the fate of their pricing scheme last week by rushing to make COMEX a physical delivery facility. While the exchange is likely to survive April, the months of May and June will likely pose a significant challenge. Only a quick containment of the coronavirus may assuage their crisis. If the mines, mints, and refineries can re-open in the next 45-60 days, perhaps the fractional reserve bullion banking system will be salvaged. If not? Well, let's just say that gold investors and stackers are in for a VERY interesting summer.
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