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Why is Gold Draining out of COMEX Warehouses?

Monetary Metals's picture




 

Gold conspiracy theorists have a new bogeyman. Inventories of gold bars held in the COMEX warehouses are falling. This fact is offered to support the stale allegations of “fractional gold” and “manipulation”. They have been predicting a “signal failure” that is coming any day now, like the Great Pumpkin in the Charlie Brown Halloween special. If not that, then surely at least the price of gold is going “to da moon”. Any day now, we have been repeatedly told, every day and every dollar down from the peak around $1900.

The price will rise again, as the centrally planned paper currencies continue their inexorable slide towards the oblivion of bankruptcy. The dollar, like all irredeemable paper currencies before it, will become worthless one day. That does not mean that there cannot be significant volatility in the meantime.

As I discuss in this article, the COMEX inventories are not the best place to look for changes in the scarcity of gold. One should look at the gold basis.

As this chart shows (all graphs are courtesy of Sharelynx), the eligible inventory of gold bars in COMEX-approved warehouses has been falling this year, and is now at a four-year low. An eligible bar is a bar that was manufactured by an approved refiner, has a documented chain of custody, and is in a COMEX licensed depository.

eligible gold

 

Eligible inventory has been in decline since 2011, and has dropped sharply this year. This is bad enough, but what has really got some tinfoil knickers in a twist is the drawdown of registered inventory. A registered bar is an eligible bar for which a registration has been made. Registered inventory is down to a 2-year low, though if it falls much farther, then it will be at a 10-year low.

registered gold

 

Some contend that registered gold means the metal is owned by a dealer, and eligible means a client. I don’t find that explanation satisfactory, any more than to call the bid “wholesale” and the offer “retail”. At best it is oversimplifying, and usually misleading too.

The distinction is not based on who owns a bar of gold, but whether a warehouse receipt number has been assigned. Eligible gold can be owned by anyone, but it cannot be delivered against a futures contract. Once it has been registered, then it can.

The difference between eligible and registered is the filing of paperwork. This may reflect the possible intent of the owner to deliver the gold against a future he has shorted. But that is a tenuous and ambiguous distinction, and I do not consider it to be meaningful in analyzing the gold price.

Before we go on and look at what really drives COMEX inventories, here is a graph of both registered and eligible stocks in silver. If the falling gold inventory is a bullish signal to some analysts, then by the same logic they should write that the rising silver inventory is bearish.

total silver

 

This is a false logic. Since January, I have been calling for silver to underperform gold, and likely fall against the dollar as well. It has indeed fallen from 52oz of silver per ounce of gold to 63.9oz (on Friday, June 7), and from around $32 to $21.66 per oz of silver. My call has not been based on COMEX inventories in either metal.

In What is the Meaning of GLD Outflows?, I explained the falling inventory levels at the Exchange Traded Fund through the theory of arbitrage. In short, gold (and every good) flows to where the price is highest. If it is possible to buy something at a lower price in one place, and sell it at a higher price elsewhere, then someone will do it. The same applies to the gold in GLD. It was possible to buy and redeem shares of the ETF at a lower price per ounce than the metal was worth in the market, so someone did it. In GLD, only Authorized Participants can perform this arbitrage. COMEX is open to anyone (though the practical consideration of transaction costs will preclude retail traders).

What arbitrage could be occurring in COMEX? As with my analysis of GLD, I make no claims to special knowledge. I do not know who is doing what. I have heard no whispers from big traders in London, and have no inside information from the regulators or banks. I don’t talk to large aquatic mammals. I am only doing some basic detective work.

Before we proceed, I want to underscore an important point. I think one has to be extremely careful trying to predict the next price move by looking at gold moving from one corner of the market to another. Such analysis is usually based on a presumption of which money is “smart” and which is “dumb”. Central banks are buying gold? The Indians are buying and Chinese are buying. This must be the smart money, and the anonymous sellers are dumb. Perhaps.

Total stocks of gold (and silver) are extraordinarily high compared to annual mine production. Gold (and silver) are hoarded worldwide, and have been for thousands of years. This monetary reservation demand is what sets the floor under the price, while speculators come and go, temporarily driving prices up and down.

Below, is a six-month chart of the COMEX stocks (registered + eligible) and overlaid with a trace of the (December 2013) gold basis. I have skewed the basis by about two weeks to the right. This is because the basis leads the changes in inventory. The reason is that it takes time to ship bars of gold.

We see there is a reasonable correlation through mid-May, especially if we filter out the one-day spike low (on April 15). Why should COMEX stocks have any correlation to the gold basis? What arbitrage could occur based on the gold basis?

total gold and basis

 

Recall that the basis is the price of gold in the futures market minus the price in the spot market. The basis is the profit one can make by carrying gold, which is buying gold and simultaneously selling a future. One is long a gold bar and short a gold future which neatly offsets it. This trade should require very little margin, and hence allow a lot of leverage. And it would need a lot of leverage, as the basis began this period around 0.6% annualized and is currently below 0.2%. This return does include the bid-ask spread, but does not include exchange fees, storage and insurance, commissions, etc.

Two things are certain. First, the gold carry trade is much less attractive at 0.2% than it was at 0.6% (given the costs, it may not be profitable at all). Second, as the basis falls, fewer and fewer traders will put on a carry position and, below their marginal rate of profit, none will put on a new carry. They may even take their carry position off, if the market offers a profit to do so (called backwardation). The December 2013 contract is not yet backwardated, but February and April went into backwardation before they expired. June and August are currently backwardated.

What happens when someone carries gold? A synonym for carrying is warehousing. In many cases, the metal will remain in the COMEX warehouse especially for short duration carries (probably in the registered category).

What happens when the gold is decarried? Decarrying is when the trader simultaneously sells the metal and buys back the future. The cobasis is the price of gold in the spot market minus the price in the futures market. This is the profit that one could make by decarrying the metal. A decarry trade will close a prior carry trade, or it can be used to make a small spread by anyone who owns gold outright. When you decarry, your buyer can move it out or do anything else with it. The one thing we can be sure of is that he won’t carry it himself. If decarrying is a good opportunity, then carrying is not.

As a segue to discussion of one final point, let’s look at a graph of the (December 2013) cobasis overlaid on the gold lease rate.

gold lease rate and cobasis

 

I did not skew the cobasis to the right because unlike with shipping of metal bars, there is little lag to trade a spread. From the start of the graph through around February, there does not appear to be much correlation. During this time, the cobasis was not moving much (and it was quite negative). As it rises, it drives the decarry trade, which becomes more and more attractive. This is especially true for the April, June, and then August futures (the graph shows December). Nearer months generally have a higher cobasis than farther, and one by one the cobasis of each contract rises above zero as the contract nears expiry.

In the right part of the graph, the correlation is astonishing. What would cause the cobasis to correlate with the lease rate? Or, to put it another way, why would a rising cobasis cause a rising lease rate?

The answer is that one need not own the gold in order to profit from decarrying it. One could lease the metal. Consider this trade (all steps are simultaneous):

  1. Lease gold
  2. Sell gold in the spot market
  3. Buy a future
  4. Park the cash in a bond to earn a yield in the meantime

Since one sells gold metal and buys a gold future, one has no exposure to the gold price. This is purely a way to profit from the spread. This trade tends to become attractive when cobasis > gold lease rate + costs.

To lease gold, one needs cash as collateral. Some of this must be set aside, as margin to cover volatility in the spread (this trade has no price exposure). The rest can be deployed in this trade.

And what will the buyer of the gold do? He may very well take it out of the COMEX warehouse. As the first graph at the top of this article shows, many of these buyers did in fact take it out. By way of clarification, the buyer and his metal are not important. The important party here is the one who sold you the future. So long as he is due to receive gold on or before he must deliver gold to you, the system functions.

There will come a day when he can’t deliver. But the fact of falling COMEX stocks is not an indicator and today is not that day. Watch the gold cobasis (published weekly by Monetary Metals). Look for permanent
gold backwardation
as the harbinger.

 

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Fri, 06/14/2013 - 12:39 | 3658462 stopthenewworldorder
stopthenewworldorder's picture

this guy is a well known tosspot who thinks he knows what he is talking about but actually is a paraiah among the new austrian school.  Ignore him, he is truly ignorant as well as being a twat, even claiming that silver conspiracy theorists think that the methodology of JPM is 'naked shorting' - clearly knows absolutely nothing about it.  Seems like he spends most of the time in the mirror which if you've seen the state of him is a scary thought - look up sandeep jaitly if you want real insight on the basis/co-basis not this douchus....it is a subject of great merit but get your knowledge from the right source, not a tainted one.

Fri, 06/14/2013 - 11:36 | 3658176 Jesse
Jesse's picture

 

I liked the way MM set up lots of basic errors that most informed commentators are not making, and then corrected them.

Listen to me!  Only I know the truth!

Snotty disdain is generally more effective when you actually have something new and useful to offer.  And I saw nothing new in this piece, except for some speculation that is no better than any other.

 

Fri, 06/14/2013 - 11:48 | 3658212 Thisson
Thisson's picture

I thought it was indeed helpful because it explains the concept of the basis and cobasis.  It also implicitly refutes the continual refrain that "gold has no yield" as now we can see that in addition to generating lease income, gold can provide an income stream through the carry/decarry trades.

Fri, 06/14/2013 - 11:28 | 3658158 Raymont
Raymont's picture

I hate to break it to you, but just like everything else, the 'official' COMEX numbers are cooked.

Fri, 06/14/2013 - 11:06 | 3658086 Confundido
Confundido's picture

Sorry, but you still did not explain why the gold is coming out of the COMEX...or did I miss it???

Fri, 06/14/2013 - 11:47 | 3658211 Thisson
Thisson's picture

He explained it at the end: gold is leaving comex because the counterparty to the decarrying arbitrageur is withdrawing it from the warehouse.  This makes sense: as metal prices fall, sales volume increases (of bars, jewelry, and even industrial demand), so warehouse withdrawals occur to satisfy that demand in the short term. 

Fri, 06/14/2013 - 11:03 | 3658078 WTFUD
WTFUD's picture

Dare uze be gold in dem dare hills until dem pesky pan 'andlers gonan dug itup

Fri, 06/14/2013 - 10:59 | 3658066 apberusdisvet
apberusdisvet's picture

The gold pipeline will be mighty empty over the next decade as many miners will cease operations.  Just the decline in ore grades mined and the dramatic increase in mining costs point to that.  Meanwhile do you think the Asians will have less demand?  Unlikely.

Yes, JPM et al can paint the tape any which way, but the rock will meet hard place within a few years.  Patience, patience, patience.

Fri, 06/14/2013 - 10:58 | 3658061 MrBoompi
MrBoompi's picture

I suppose you can look at the basis, or the future price minus the spot price. But since both prices are manipulated, how can draw any firm conclusions without having insider knowledge? People involved in setting the prices in these markets must make outsiders look like tinfoil hat wearers.

Fri, 06/14/2013 - 11:51 | 3658225 Thisson
Thisson's picture

You are making the assumptions that: 1) it is manipulated; 2) it is only manipulated in one direction (now why the hell would they not manipulate it in both directions, so they can make twice the profits, as they have done in LIBOR, FX, etc.???).

I worked on COMEX.  I do not think the warehoues numbers are manipulated.  You have to keep in mind that a large number of the clerks don't even have high school degrees (Hi, Snowden!) so a lot of discrepancies do occur as a result of human error.  This is one of the reasons why the exchange went from open outcry to electronic trading (elimination of human error, in addition to all the other efficiencies).

Fri, 06/14/2013 - 10:52 | 3658045 Long-John-Silver
Long-John-Silver's picture

When do we get charts on the amount of Gold and Silver lost in Boating Accidents?

Fri, 06/14/2013 - 10:51 | 3658039 imaginalis
imaginalis's picture

Another pile

Fri, 06/14/2013 - 10:18 | 3657960 No Euros please...
No Euros please we're British's picture

To predict prices, maybe you should be looking at inventory at Bowaters?

Fri, 06/14/2013 - 10:27 | 3657956 russwinter
russwinter's picture

The gold is going to Shanghai. $32 premium there. 

http://seekingalpha.com/article/1499412-who-will-ultimately-be-the-real-driver-of-gold

Manipulators of Gold May Not Be Who You Think

http://winteractionables.com/?p=3308

Fri, 06/14/2013 - 11:35 | 3658174 rlouis
rlouis's picture

Interesting -(link 2)

"That leaves speculation that this is the handiwork of some large hyper-leveraged rogue hedge fund, a whale. There’s precedent for this. Hedge funds could be used as foils or set-ups for squeezes by big bullion banksters"

The only rogue whale connecected enough to put balls on the block that comes to mind is G. Soros. But, I'm sure there are others working for the Rothcillers.

Fri, 06/14/2013 - 10:29 | 3657986 fourchan
fourchan's picture

...and my stack.

Fri, 06/14/2013 - 10:14 | 3657947 RaceToTheBottom
RaceToTheBottom's picture

After reading this, I need coffee

Fri, 06/14/2013 - 09:59 | 3657910 bardot63
bardot63's picture

Allow me to boil this article down and connect the only two dots that matter.  When JPM sells 500 tonnes of paper gold in one nanosecond, succeeding in driving gold dollar prices over the cliff, this cobasis infomercial posing as analysis is Horsefuck. 

Copies to NSA, TSA, CIA, FBI, NASA, CSI, CSI Miami, MGM, M&M, S&P, A&P, TG&Y.

 

Fri, 06/14/2013 - 11:17 | 3658128 knotjammin2
knotjammin2's picture

The best part about the above article is your comment!!!  Made it worth the read!! 

Fri, 06/14/2013 - 09:54 | 3657889 putaipan
putaipan's picture

any word of the peruvian ball bearing magnets' attempt to take delivery? inquring minds want to know.

Fri, 06/14/2013 - 09:17 | 3657779 Fuh Querada
Fuh Querada's picture

It is apparently being assumed that all the data in these beautiful charts are reliable. Just like the COT which is of course a model of integrity.

"Gold cobasis" and "permanent gold backwardation" are jargon terms  flawed for the same reason and have never been validated as predictors of anything.

The price of physical gold in any significant amount for immediate delivery ( and I don't mean a handful of Eagles from your local coin dealer)  is never published because it of its dependence on the amount purchased and the location of the transaction.

In addition to the aforementioned FOFOA I recommend Jim Willie's articles (both public and in  the Hat trick letter subscription) because he has contacts in the real market and does not produce academic  babble like the above.

Fri, 06/14/2013 - 11:54 | 3658238 Thisson
Thisson's picture

That's nonsense.  If you want more than 100 ounces of gold or 5000 of silver you can take physical delivery off of COMEX.  Until and unless a default in delivery happens, statements to the contrary are WISHES not facts.

Fri, 06/14/2013 - 09:58 | 3657896 Non Passaran
Non Passaran's picture

Oh come on gimme a break I like Willie but isn't his making a comparison of physical likeness between Bernanke and the creator of Matrix silly?

I like this article and its should be noted that this "academic babble" follows Fekete's observations.

P.S. I agree that "the info with a disclaimer" may not be reliable, but as to the approach it doesn't seem any less valid than other readings of similar material (CoT, etc).

Fri, 06/14/2013 - 08:15 | 3657611 diogeneslaertius
diogeneslaertius's picture

inb4 $ABX

Fri, 06/14/2013 - 08:14 | 3657609 diogeneslaertius
diogeneslaertius's picture

algobot hologram

Fri, 06/14/2013 - 08:09 | 3657600 eddiebe
eddiebe's picture

With all the manipulation going on, all 'facts' and charts are suspect. The fundamentals of owning the precious metals by people wanting to retain value with liquidity along with a hedge against shenanigans of all types by all types remain the same. Period.

Fri, 06/14/2013 - 08:16 | 3657615 diogeneslaertius
diogeneslaertius's picture

Whoa there shitizen!

looks like youve had a bit too much to THINK!

im afraid im going to need to see some identification, even though we already have all of your data, im going to need to push you around and dog train you so the other slaves dont get any funny ideas about outdated concepts like freedom and liberty.

Fri, 06/14/2013 - 07:38 | 3657559 edwardo1
edwardo1's picture

Hello Monetary Metals,

1.) Your arbitrage explanation regarding the removal of physical from GLD is wanting. That is plain if one does even a cursory analysis of the flow of physical in and out of the fund on a day to day, week to week, or even a month to month basis. I refer you to FOFOA's blog where a far more compelling explanation awaits on the meaning of the steady drain of physical from GLD.

2.) As for the basis, given what we know about the manipulation of Libor and now the shenanigans in the FOREX market, there is precious little justification for placing any creedence in metrics of the sort that inform your gold basis analysis.

Fri, 06/14/2013 - 08:17 | 3657619 diogeneslaertius
diogeneslaertius's picture

:3

Fri, 06/14/2013 - 10:24 | 3657972 gmrpeabody
gmrpeabody's picture

All of that...,

was just a sales pitch?

Fri, 06/14/2013 - 11:09 | 3658091 Pinto Currency
Pinto Currency's picture

 

When a market participant sells physical gold and buys a future position to cover, the exposure is to a failure to secure physical gold in the future to close out the position.

Rising lease rates and rising cobasis speaks of gold shortage - which is difficult to explain in a world with 5 billion oz. above ground. 

It appears that increasingly, the market is less interested in paper profits and more interested in securing physical gold.

Fri, 06/14/2013 - 11:57 | 3658248 Thisson
Thisson's picture

Well, I agree with you mainly, but it is not difficult to explain.  When prices decline, demand spikes, so we would expect near-term shortages, increasing lease-rates and a rising cobasis until stocks can be replenished.  That's the inducement for long term holders to temporarily decarry, filling the gap.  Presumably, prices will rise again, quenching demand and contango will be re-established.

Fri, 06/14/2013 - 12:12 | 3658326 Pinto Currency
Pinto Currency's picture

 

The movement now is to physical possession of metal.

Cyprus accelerated an already heated trend and the revelation of metal delivery default by banks holding gold for clients (think ABN Amro) has rippled through the market raising the urgency of delivery for metal owners.

In addition, the Chinese and Indians are buying hand over fist:

http://www.goldminerpulse.com/v/shanghaiGoldExchangePhysicalDelivery.php

Fri, 06/14/2013 - 12:28 | 3658401 OutLookingIn
OutLookingIn's picture

registered, non-regestered, eligible, non-eligible, cobasis, ratio, futures, ETF share, certificate, etc. etc. etc.

Why make it so complicated to own gold and silver?

Because the banking crooks want that. Easier for them to steal when the issue is fogged in and confusing.

Just buy the stuff outright. Exchange your fiat for the real thing and take immediate delivery.

There now. Done deal. Take it and put it some where safe. No muss. No fuss. No third party risk. Simple.

Do NOT follow this link or you will be banned from the site!