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The intention of The
Golden Chalkboard is to feature a focused selection of data
or rare commentary that I think will be useful to enhance your
insights into the gold market and the monetary system.
A few posts in which Aristotle gives a good overview of the (in)significance of COMEX warehouse stocks (depository inventory). He puts perspective on a "down day" for the price of gold and also describes the gold price discovery and trading process based on futures markets, and the subsequent derivation of the spot price of gold.
Aristotle (6/4/02; 19:41:04MT
- usagold.com msg#: 77498)
Sir Cavan Man "COMEX...They
do have a FEW tons to sell."
Contrary to popular perception, COMEX actually doesn't have an
ounce to sell.
And what of all that Registered and Eligible "inventory"
present on the books of the licensed depositories -- Scotia Mocatta,
HSBC, and Brinks? Not an ounce of it belongs to the Exchange.
It is entirely possible at any given time that some of the Eligible
ounces people might see listed at Scotia, Honkers & Shankers
or at Brinks is actually my own property, completely unavailable
to COMEX participants.
How is this possible? If I happen to have kilo bars in temporary
safe storage at those institutions, say, in the process of conversion/exchange
for the extra safety (and a potential premium play) on European
oldies, then they are listed among the "Eligible" inventory
of those institutions. This doesn't signify that the Exchange
owns it, but rather that it meets the specs for delivery in satisfaction
of a standard Contract and is "Eligible" (as opposed
to "Registered") in the sense that I haven't had it
officially parceled and registered into standard delivery "warrants."
When my favorite Gold broker ("Hi, guy!") tells me that
my Swiss Gold francs and German Gold marks have arrived on his
end of the deal, orders are given by each of us for an exchange
of our forms of gold.
Now pay attention here. If his account is with an institution
outside of the COMEX triumvirate, then the level of their Eligible
inventory will fall as Brinks hauls my kilo bars away, replacing
them with a form of Gold that is off the radar screen -- coins
do not match the standard spec for delivery against a contract,
and thus are not listed among Eligible inventory.
Eventually, this Gold coin leaves NY as I bring it closer to home,
but prior to that, and at all points whether in the form of kilo
bars or coins, it remained my property and was never the Exchange's
to sell. The Exchange merely matches (anonymously) a paper long
against a paper short, and should it come down to delivery issues
in those rare cases, all eyes look to the short to deliver the
Gold through a warrant, the exchange of which is done through
the auspices of the Exchange and its licensed "depositories."
(Again, these are depositories of other people's Gold.)
But this rarely happens because true commercial interests don't
move their Gold through the Exchange, showing up merely to hedge
cashflow. And the big speculators? They're in it for cash. And
the little speculators? They exhaust their resources on the margins,
and can't afford to stand for delivery for the full bodied contracts
they theoretically represent. (There's an exception, but that
shall remains the topic of another post.)
So as you can see, in a crisis of confidence in paper and counterparties,
it is more likely to see a SELLOFF of America's form of Gold Benchmark
(that is, the COMEX Gold Contract) rather than a price runup.
Then, out of discredit the market's attention will shift to the
phsical Gold market where the price (premium??) will break free
from the dying paper proxy.
Gold. Get you some. --- Aristotle
Aristotle (06/05/02; 15:37:11MT - usagold.com msg#: 77561)
Leigh and others, try
to keep your perspective
If ten weeks ago, when Gold was trading at $290, I had been able
to state with authority and absolutely that Gold would be trading
above $320 on June 5th, you'd have all likely been thrilled with
that outcome.
Well, here it is. Why are you seemingly stressing out over the
details of its exact journey getting from there to here?
Would you have been happier if it had dropped intermittantly to
$200 first? Or had visited $500 for a day along the way? Or first
one, then the other? Or the other way around?
It's not going to move in a straight line. I hope you all know
that. So get used to it. But move it will. It's in the cards.
Now, if I were to suggest to you that Gold will be much *much*
higher in 2004, that should be universally accepted around here
as a good thing. But I'm willing to bet that a number of people
are playing silly exotic games with it, and will be likely burned
by the path Gold's price will take in the getting to there.
It's the rare bird that manages to exit from leverage at a real
profit, while most others just get themselves cooked.
That's why I hold to my approach. I buy my Golden Property on
nice days like today and then sit back and enjoy the view, taking
pleasure in the fundamentals shaping up like the finest of sunrises.
The day will come when futures will sell off and the coin premiums
won't follow them lower.
Gold. Get you some. --- Aristotle
Aristotle (06/05/02; 17:32:29MT - usagold.com msg#: 77567)
Sir Sierra Madre, let's
talk price discovery American-style, shall we?
The American Benchmark for price discovery for Gold is the COMEX
trade in futures contracts.
As you've pointed out, this opens the door to inadequacies because
the instrument of the Exchange is not representative of an actual
two-way physical market.
First, some background for anyone following along who needs to
be brought up to speed on the mechanics of futures trade.
It's easiest to look at the Contract instrument this way. First
of all, market participants pay an "ante," the margin
put down for each Contract which is a pledge of their commitment
to stand behind their bet -- at least for awhile.
Participants arrive as the exchange, some with perceptions that
the Contract prices will move higher, some with perceptions that
they will move lower.
To pay the margin and enter/open a contract with expectations
that prices will move higher sometime between now and the expiration
date (this attitude is called a "long" position,) this
person is technically agreeing to receive 100 times whatever price
hike may occur between now and when he sells his contract, or
contrariwise, should he be wrong and the price falls instead,
he agrees to pay 100 time whatever that price fall may be at the
time he exits his contract.
Here's the other side of the contract -- the "short"
position. This person pays his margin to enter/open a contract
with expectations of profiting as the price falls sometime between
now and the expiry date. He agrees to accept a long's payment
of 100 times whatever the price fall may be; and contrariwise,
if he has guessed wrong, he agrees to pay 100 times whatever price
rise might materialize at the time he exits his contract prior
to expiration.
The price changes on these futures Contracts as speculators show
up to place their bets and stake their positions through time.
If the longs outnumber and are more aggressive in their bidding
than the shorts, the contract price will rise as it moves across
the spread, ever toward the higher "ask" price of the
nearest short in the queue. If the shorts are more aggressive,
the price will fall as it moves ever toward the lower "bid"
price of the spread being offered by the nearest long in the queue
at the Exchange.
So in simple terms, this is what mechanically drives the COMEX
Contract price. For brevity, I won't trouble anyone here with
what motivates these long and short participants.
Obviously, no Gold need be set aside or taken off the table as
these paper games are played. Longs *feel* like they have Gold,
but truly, the shorts have the upper hand. Also a topic left for
another post. Suffice to say, if faced with the prospect of ponying
up cash to pay for delivery of a full-bodied contract of 100 ounces,
most longs (likely with more than one contract) have wallets that
are too thin. So in the end they, too, become a seller of contracts
as they sell their position for a cash out (win or lose) rather
than apply any physical pressure with a Gold offtake. At that
point it's candy-from-a-baby for shorts to cover their position
by buying offsetting contracts when the puny longs capitulate.
So, with America's Benchmark Gold price "discovered"
through COMEX trading, where does the cash-on-the-barrelhead payment
on the "SPOT" price come from? It is merely conjured
(derived) from the nearest active COMEX contract.
Because the Contract theoretically represents the price at which
market participants will buy and deliver real Gold at a particular
date at the end of a Contract month, the going contract price
represents a forward price and must therefore be mathematically
adjusted or "corrected" for a theoretical "spot"
price at the present time. This is done by adjusting out the time
value of the Gold as well as the time value (interest rate, such
as LIBOR) of the currency being used for payment/pricing.
It's a squirrelly deal, and taken together with yesterday's post
on "COMEX Inventory" it should be easy for even the
most casual observer to recognize how danger signals of an impending
lockup in the physical market will not be forecast through the
America's paper-dominated benchmark of Gold price discovery.
In the physical market, there is more new demand than new supply,
begging the question: Where does the "extra" Gold come
from to satisfy these needs if we don't have a legitimate price
to clear/balance the physical supply and demand?
Anyone intimate with banking knows the answer. The wonders of
expansion of the books through the lending process allows many
"owners" of unallocated accounts to think they have
unique claims for immediate demand on their deposits, when in
fact they do not. It has been lent out to generate a marginal
return at great risk. Along with the futures arena of price discovery,
the unavoidable inflationary illusion of banking (bullion banking
in this case) act together to give this lifetime buying opportunity
to anyone wise enough to take delivery.
The physical element has ALWAYS been the Achilles' heel of banking
-- especially Gold Standard banking -- and modern times are no
different. As we assess the international web of bullion banking
practices today, we are staring over the brink of the mother of
all bank runs.
Obviously, the Central Bankers are aware of the gravity of this
commercial risk, and are impressed with the magnitude of financial
crisis that could be precipitated as a result.
Through this, you can perhaps gain some insight as to why the
ECB/BIS would be keen upon ushering in an era of Free Gold --
one less aspect of systemic risk to worry about. Free Gold would,
in fact, impart a significant stabilizing force to any economy
built upon its foundation... a foundation of real wealth and honest,
incorruptible savings among the populations. People usually riot
when their savings and future security has been wiped out. It
won't happen under Free Gold.
Believe it!
Gold. Get you some. --- Aristotle
Sierra
Madre (06/05/02; 17:48:22MT - usagold.com
msg#: 77568)
Thank you very much,
Sir Aristotle!
Clarity, brevity and truthfulness are the mark of a writer who
knows what he is talking about.
Your piece is a "saver" and I suspect more than one
at this Forum will profit from it.
I don't want to impose upon your generosity with your time and
patience, but "Free Gold" - perhaps discussed here at
length in days gone by - is a concept I am not sure I understand.
I think that a review of the concept at this time might not be
amiss, especially for those who, like myself, have not yet fully
grasped what it means and implies.
Thank you once again, for your explanation of the futures market
and its impact on spot.
Sierra
Aristotle (06/05/02; 18:32:47MT - usagold.com msg#: 77570)
Sir Sierra, "Gold
Advocates" and "Free Gold"
http://www.usagold.com/halldiscussion.html
Way back if February 2000, I tried to break some new ground here
at the forum and shake loose some cobwebs (in my own brain) by
delving into the harsh realities of the Gold Standard to ferret
out why its demise had come about. As I gave thought to the matter,
my investigations revealed that its failure was inevitable if
not also completely natural.
I went on to describe what I foresaw as the natural evolutionary
path for banking and for Gold's new economic role "within"
the next/final phase of the still unfolding modern System. A perfect
fit for use in an imperfect world.
In the process, to avoid the derisionary term of Goldbug in an
already stressful presentation, I introduced the phrase "Gold
Advocate" for my purposes, and have been happy to see it
blossom into wider use.
I believe that it was at this same time, in his first response
to my series of posts, that FOA first introduced his term of "Free
Gold" (and variant "Free Gold Market") to me and
the rest of us here.
These posts touched of a whirlwind of discussions on all sides
of the matter, much of which was kindly captured for posterity
at some pages that have been indexed in the Hall of Fame. (I've
just checked, and yes, it's still there. The link above will take
you directly to the start of it all.) Lots of reading!!! Or scrolling????
Ha ha!! Skip my tireless blather if you will, but be sure to give
attention to FOA's input. Let's see... you'll need to scroll halfway
down the page to find it. Oooops, wait-a-minute, he was posting
at the forum as Trail Guide then. (I forgot that the moniker FOA
became reserved for his Gold Trail posts.)
It's all good. More relevant today than it was then. "Time
proves many things."
Gold. Get you some. --- Aristotle
Aristotle (7/4/02; 00:23:52MT - usagold.com msg#: 79885)
Selling that COMEX stuff
down the river
I was almost *almost* among the brain surgeons and rocket scientists
who "sold" COMEX Gold (contracts) today.
No, I didn't have a long position to liquidate (never have, never
will.)
What I'm talking about is establishing an outright short. Plunking
down my $1,350 margin per each and every contract on what could
easily become a one way ride down to the Intrinsic Value (i.e.,
Zero) of these danged ol paper contract thingies.
I know, I know... one of you good-hearted (yet sweetly naive)
souls will at this point surely chime in, "But Ari... the
COMEX exchange promises -- PROMISES on their own good name --
to ensure against counterparty default! Therefore these contracts
CAN'T be considered intrinsically worthless! Being short on COMEX
Gold can be dangerous!"
To that I'd say the world is filled with danger. Now run along
and play indoors where it's safe, my sweet innocent wearer of
short pants, and leave the grown-ups to look each other eye-to-eye
across the table until the weak side blinks.
I've said this before, as have many others, and I'll say it again
now. It is naive to think that COMEX Gold futures -- merely private
contract instruments overseen by a commercial enterprise (the
Exchange) -- are immune from reaching their intrinsic value of
zero simply because The Exchange stands behind them with their
"full faith and credit."
Sheeeeeeeeeeesh!!! Where have I heard *that* one before?!
Ohhhhhhh YES! NOW I remember! There was once an entity, no less
powerful than the United States Government itself (in fact, it
WAS the Government) throughout the 1960's (and before) tried to
put across the same scam. But even better than mere COMEX guarantees,
these futures contracts were backed by the full faith and credit
of the United States of America.
And you know what, folks?
That's right. They defaulted.
For those not quite up to speed on their history, the parallel
I'm talking about here is the U.S. bond market, and the 1971-73
default on the Bretton Woods "Gold standard."
You see, if you'll allow me a bit of latitude, similar to the
COMEX Gold futures contracts were the monetary bonds issued under
the monetary system of that era. (Bretton Woods is where the post
WWII treaty was held that established the international Gold-exchange
standard in which the U.S. dollar was "guaranteed" to
be exchangeable and as good as Gold at a rate of $35/oz.) As such,
a person could plunk down a little bit of money (similar to a
COMEX margin) to buy a bond -- a contract which promised (under
the full faith and credit of the U.S.of A.) to give them future
control of an even greater quantity of money/Gold. (That quantity
being the principle PLUS interest, paid out in a schedule according
to the terms of the bond contract.)
I submit to you, if the U.S. government can thumb its nose at
contract participants no less prestigious and influential than
its international trading partners (among others,) then it takes
no stretch of the imagination to see COMEX doing the same to you
under very similar circumstances, that being a crisis of confidence
in the deliverable good of all those contract thingies.
And for those obstinate folks who think that a COMEX fallback
plan of "cash settlement" is good enough to make the
Long Gold contract worth their while/risk, listen to me now and
do yourself this favor of FULL consideration. Those market participants
in the wide world (yes, the grown-ups wearing the long pants)
who have no faith in the dollar will short the dollar outright
as a pure currency play. They won't piss away their resources
through this pathetic little Exchange -- expressing their expectation
of dollar demise through plunking down margin money on Long positions
in COMEX Gold futures contracts. They simply don't play that way.
Yes, there are exceptions, but these exceptions don't set the
trend, and the prevailing trend is for Gold paper -- Gold contracts
backed by ANYBODY regardless of size or power -- to default and
to diminish to the intrinsic value of the paper they are written
on.
So why DIDN'T I plunk down my big fat wad of cash on margins for
a bunch of COMEX Shorts?
Because there's a curious feature about your own money -- you
can only spend it once. Given one alternative or the other, I
decided it would be most beneficial to forego each payment of
an initial Short margin for an outright purchase of 4 ounces of
real Gold.
I can't say with any certainty when it will happen, but when the
contract market does go into default, neither the Short side nor
the Long side will benefit from the outcome. The way I figure
it, with my latest tranche of spendable cash, I would be better
off with an additional 40 ounces of Gold in my vault than holding
ten Intrinsically Paper COMEX Gold contracts, be they Short OR
Long!
Protest if you must, Mister Small Pants. The lesson of 1971 is
apparently too big for you to fathom... "A problem for others,"
perhaps you'll say, one that only afflicts sailors who allow themselves
to foolishly drift past the clear warning signs too close to the
edge of the flat earth. You, of course, will surely *know* when
to turn back.
The world is round, my friend... and we've been this way before.
Real Gold. Get you some. --- Aristotle
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