Comex Default, GOFO & SIFO

There have been quite some rumors circulating amongst gold bugs that we might see a default of Comex. The argument is that several big shots might be demanding delivery of their December contracts in gold and silver, forcing the exchange to deliver physical metal it doesn’t have. Is it likely that we’ll see such a default in December or in future? Further, what are GOFO & SIFO telling us?

December Gold & Silver

Starting off with the December gold contract, as per today the open interest is roughly 34,000 contracts. If every long holder demands delivery on Thursday (the first notice day) then Comex would need to deliver about 3.4 million ounces of gold. Their warehouse shows a total eligible stock of 5.7 million ounces. So no potential delivery problem there.

December silver is worse. Eligible warehouse stocks at Comex are about 48 million troy ounces, while open interest in December is about 11,000 contracts. So at 5000 ounces per contract that means a potential delivery request of 55 million troy ounces, which is more than is currently available for delivery from the Comex warehouse.

Total Open Interest

As of today, total open interest in Comex gold futures is about 276k contracts (up to June 2013). Silver futures open interest amounts to 87k contracts. It’s clear that there’s not enough metal in Comex’ vaults to honor delivery requests from all these holders. Lucky for Comex, investors seldom take delivery of metal. So that allows them to in essence run a 5:1 leverage in gold (for every 5 ounces of promises to gold, there’s 1 ounce of physical metal in the warehouse) and a 9:1 leverage in silver. These statistics certainly don’t rule out that we’re going to see a run on the vaults of Comex some day. Once it does though, it’s more likely to occur in silver than in gold. Especially considering the fact that possible Comex delivery problems can more easily balanced by central bank sales of gold than by sales of silver (central banks hardly have any of the latter).

GOFO & SIFO

The 3 month GOld Forward Offered rate (Gold Lease Rate -/- Libor) is currently -7 basis points. The SIlver Forward Offered rate is around 22 bp. As can be seen in the charts below these are very low levels by historical standards.

GOFO & SIFO have dropped in my view because there’s simply no interest to borrow gold and silver (for shorting purposes) and therefore bullion banks have to offer an incentive by means of low lease rates in order to lend their bullion. Current GOFO is quoting below the level seen in 1999, just before the Washington Agreement on Gold. Following that agreement on the 26th of September, where central banks said they would limit gold sales and the metal would continue to play an important monetary role, gold rallied 40% in a matter of weeks.

Conclusion

There’s definitely something ‘brewing’ in the gold and silver markets, now that forward offered rates are near historic lows. It shows that informed players are very reluctant to short the metals right now and therefore a significant move higher might be in the cards. It doesn’t seem likely though that such a move will be triggered by a Comex default on delivery for gold and silver contracts this week. Nevertheless the gold bugs do have a point when arguing that Comex is leveraged and therefore vulnerable for a run on their vaults somewhere down the line. Time will tell, as always, but these two facts are good enough reasons to add to the other dozen out there suggesting to be long precious metals in the current circumstances.

Related:

• http://goldnews.bullionvault.com/gold_forward_rates_backwardation_112620083


• http://news.moneycentral.msn.com/provider/providerarticle.aspx?feed=MY&date=20081105&id=9353188

Data:

• http://www.nymex.com/gol_fut_cso.aspx

—— This is an opinion on the state of financial markets and the opportunities it provides by quirijns.com. It is not investment advice and not a substitute for your own judgment. When taking on any investment, make sure to have a first aid kit at your disposal that is jammed with tranquilizers and sleeping pills, as you’ll need it. It also comes in handy for other possible disappointments in life. History is not a guide to the future, nor is anything else. Any sane person knows that there’s no sure thing except death and taxes. Fortunes are made and lost each day in this arena. If you can’t stand that heat, please stay out of the kitchen.