Wikinvest Wire

Wow! Haven't seen the $800s for a while

Friday, November 21, 2008

To be exact, it's been 36 days since the gold price last started with the number 8 and it may not stop there given recent developments and what fireworks might be in store next Friday.
IMAGEInterestingly, the gold price began the year around $830 an ounce, so it doesn't have all that far to go to keep its streak of winning years alive. For those who were not aware of this, gold is about the only asset that has posted gains in each and every year of the new decade.


Anonymous said...

What fireworks may be in store next Friday night?

Tim said...

A lot of people think there will be an unusually large number of futures contacts holders asking for delivery in December. The initial word of exactly how many will be announced next Friday.

Anonymous said...

i've heard a lot about this but i can't believe that the exchange isn't already prepared for it since they have had plenty of warning........

Anonymous said...

I'm curious about the mechanics of standing for delivery on a futures contract: I get it that any holder of an expiring long position can demand delivery (assuming the contract so permits; certain contracts are cash-settlement only).

And I think it's the case that any holder of an expiring short position (must? can?) settle by delivering the physical to the exchange. (Even if such a short has the ability to elect to cash settle, it's presumably at an amount of cash determined with reference to the then-current spot price so that in theory the exchange could immediately turn the cash into physical by buying at spot, right?)

And it seems necessarily the case that the number of long contracts equals the number of short contracts at expiry.

So what exactly is the crisis that is to be precipitated? Longs give notice next Friday that they'll be demanding delivery. Whether there's enough gold sitting in the basement vault at COMEX at that Friday or not is sort of irrelevant, because there's settlement is a multi-day affair and in the meantime the exchange is demanding gold from the holders of expired long positions, right?

And I understand, maybe some of the shorts are large financial institutions who are functionally insolvent even if shareholders still pretend to trade their shares in, for example, the sub-$5-a-share range, and they have been trading on margin and so perhaps even though they've somehow been limping along managing their day-to-day cash needs, they will suddenly choose next Friday to declare bankruptcy and breach their legal obligation to deliver per the terms of their short position.

But, I'm still having trouble getting it, because Citi (or whomever) has presumably been meeting its daily margin calls and posting variation margin as the price of gold has gone up and down, so as long as the difference between the spot rate for gold and the futures price on the expiring contract as of the close of business on the previous day is less than 10%, the insolvency or bankruptcy of Citi is completely irrelevant because the exchange already has everything it needs to liquidate Citi's position and purchase physical to satisfy their delivery obligation to the long.

(And I understand that some goldbugs assert there's a huge disconnect between the spot price and the COMEX futures prices, although I haven't seen evidence for that other than people pointing out that if you want to buy 5 1-oz. Krugerrands or Kangeroos or whatever, either on kitco or on ebay, you'll end up paying a premium over the London Gold Fixing price -- which hardly seems like evidence of some kind of massive conspiracy to manipulate the price of gold...)

Sorry to be skeptical (and it's not that I think COMEX traders are a bunch of angels, it's just that it seems like the way the rules work is pretty straightforward, and that they are in fact designed precisely to guard against the sort of "meltdown" people are suggesting is imminent) -- but what am I missing??

Anonymous said...

-- but what am I missing??


This is what you are missing:

The Commercials have naked shorted PM into the Ground. SWFs (i.e. Russia and China) may demand physical delivery in such large amounts that could force a DELIVERY DEFAULT. [Note: your argument that the exchange can turn cash into phycial at any time at the spot price ASSUMES that phycial is always available in any quantity at the spot price. THIS IS NOT ALLWAYS THE CASE --- SHORTAGES DO HAPPEN!!!]

A long contract is basicly a PAPER CLAIM against a phycical material. Such a contract would have very questionable value should the exchange DEFAULT on DELIVERY.

After such a default where would the price discovery for the item in question come from?

Anonymous said...

There's also the possibility that an unusually number of contracts are settled in cash when the holder of the futures contracts wants metal. I think the exchange can do this at their discretion. This would be a big red flag that something is not right.

Anonymous said...

Can someone comment on how this may impact etf holding (IAU or GLD)?

Tim said...

Unless something really crazy happens, the only things that would be affected are the futures prices and, as a result, the ETF prices.

Anonymous said...

Tim...thx for the response!!
My fear is that something really crazy is possible. I did quite of bit of homework and decided Perth Mint was the place to purchase gold. Unfortunately, I get to the office to have a relaxing Sunday only to find that isn't going to happen at least for now. I know you stated you were long GLD. I'm looking to diversify client holdings and I feel gold is a must, however I am afraid of the potential "really crazy."

Tim said...

Goldmoney and the central fund of Canada are two other options - in both cases, I think you can be assured that the gold is there and they won't just cash you out some day.

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