ByPatrick A. Heller
Commentary on Precious Metals Prepared for CoinWeek.com....
New York’s COMEX commodity gold market has been one of the two most important venues referenced for determining the price of gold for all other trading purposes. Yet this market, which largely reflects the trading of paper contracts rather than physical metal, is quickly heading toward the point where it may no longer be used in setting the price of gold in the physical cash markets. There are two significant developments which could make the COMEX gold market obsolete within the next 90 days.
The COMEX gold market exists as an easy way for investors to take a position in the price of gold without the necessity of having to bother with possession of the physical metal. The contracts traded on this exchange are for 100 ounce gold bars that are deliverable almost exclusively in some future month. Most traders, since they are only investing in the price, pursue one of two options as a contract nears maturity. They might purchase an offsetting contract to close out their position entirely or, if they wish to continue to invest in gold, they might close the contract by trading it for one with a maturity further into the future. Historically, only a tiny percentage of COMEX gold contracts are held to maturity to take delivery of the physical metal.
The COMEX bonded warehouses store gold for two different purposes. Gold bars can be “registered” on the COMEX, which means that the gold is specifically being held for physical delivery to a customer holding a maturing contract. Sometimes investors will use the convenience of COMEX storage but not commit their holdings for delivery against COMEX contracts. Such inventories are classified as “eligible,” which means they could be used to deliver on a maturing COMEX contract, but only if the owner decides to make it available for that purpose. While total COMEX inventories are important, the key figure is only the registered quantities, because only they can be called upon to fulfill maturing contracts.
Total COMEX gold inventories have declined by more than one-third since the beginning of 2013. Registered inventories are now below one million ounces and declining quickly. Many analysts, including me, believe that the significant decline in exchange traded fund gold holdings this year was caused by major gold dealers cashing in shares. The probable reason they have done this is to obtain physical gold to deliver to maturing COMEX contract holders who wanted to take physical possession.
If the COMEX inventories get too low, especially when you consider that there are open COMEX contracts representing a liability of well over 40 million ounces of physical gold, the COMEX allows contracts to be settled by cash payment instead of physical metal. At the rate the registered warehouse inventories are being depleted, there is the very real possibility that all gold contracts may have to be settled for cash before the end of 2013.
At the same time that the influence of the COMEX on the price of physical metals is on the brink of disappearing, activity on the Shanghai Gold Exchange is soaring. The Shanghai Gold Exchange does not deal in paper contracts. Instead, every contract is to be fulfilled by delivering physical gold. For the first six months of 2013, a total of 35 million ounces of physical gold was delivered on this exchange, which is close to 100% of worldwide newly mined gold over that time.
The Shanghai Gold Exchange, by far, delivers the largest amount of physical gold of any market in the world. The London and the New York COMEX markets may trade much larger amounts, but they are almost exclusively dealing in paper contracts.
It probably would not surprise you to know that the gold price on the Shanghai exchange trades at a premium to prices in the London and New York markets. If the Shanghai market was actively traded during the same hours as London and New York, I think it would be supplanting those markets as the reference point used for trading all physical gold. As the COMEX turns largely into a paper and cash market in the coming months, I would not be at all surprised to see the Shanghai Gold Exchange becoming THE market used for pricing physical gold around the world.
Patrick A. Heller was honored with the American Numismatic Association 2012 Harry J. Forman Numismatic Dealer of the Year Award. He owns Liberty Coin Service in Lansing, Michigan and writes Liberty’s Outlook, a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Other commentaries are available at Numismaster ( under “News & Articles) and at CoinInfo. His award-winning radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com. He is also the financier and executive producer of the forthcoming movie “Alongside Night” (trailer posted at http://www.youtube.com/watch?v=sTZ8vn45Cds).