Charlatan Exposed: COMEX Cash Settlement
NOTE: Originally published at Metal Augmentor on December 4, 2009 at 5:23AM EST.
In our next installment of the Charlatan Exposed series, we look at Gold, the COMEX and Exchange for Physicals as found on Jesse’s Cafe Americain (as an aside, can anybody explain to us the connection between France, coffee and gold bugs?). Jesse tells us that:
Comex is putting forward the offer of paper in the form of money or ETF positions aggressively, and it is the much easier alternative. Delivery of physical gold from the Comex is no longer as straightforward or even as semi-convenient as it had been in the past. In fact, it is difficult, and one must be persistent and wait long periods of time. At least, this is what we hear.
This of course is total nonsense. COMEX is not advocating ETF positions, which are only permitted as the physical leg of an exchange for physicals (EFP) transaction, and only because market participants requested that the COMEX relax EFP rules to be more in line with the types of transactions being done outside the exchange. I went into excruciating detail a few months ago to explain how EFPs work, so I’m not going to rehash the topic. Suffice it to say that allowing ETF shares to be used as the physical leg of EFP transactions has nothing to do with contract settlement during the spot month and it is actually against the best interest of the exchanges to allow them.
As for the idea that delivery of “physical gold from the COMEX is no long as straightforward or even as semi-convenient as it had been in the past”, this is a totally unsubstantiated and dubious claim. In fact, the COMEX-approved warehouses currently have substantial levels of both eligible and registered metal while delivery notices in December are running below normal. Delivery notices in September, October and November were elevated above historic levels but this activity in retrospect appears to have been related to the brouhaha surrounding the IMF gold sales and Barrick’s dehedging. In effect what this means is that the huge COMEX non-commercial long position is almost entirely speculative. So much for the commercial signal failure in gold!
We would like to know if there has been a recent independent audit of the Comex stores, with a clean sheet of bar numbers and the status of same. From what we hear it is a mess, as bad or worse as the recent scandal in Canada and the ‘missing bullion.’
Give me a break, the COMEX warehouses are run by independent and accredited bullion storage operations, each of which are audited under SAS 70. This is essentially the same for products like GoldMoney and BullionVault. Methinks Jesse might be hearing things about a mess at COMEX warehouses, but I’m completely open to being proven wrong. Meanwhile, I’m not holding my breath.
“Some months ago a chap described changes in the comex rules for futures contract deliveries. Therein it was described that the EFP, exchange for physical, rules were amended to allow for delivery of GLD shares in lieu of bullion.
Well take a look at something new, at least for me, in Monday’s comex preliminary volume and open interest report. On page 3 of the attachment, notice that in addition to futures contracts listed under the EFP category, a new category is listed: “Delivery Cash Settled” = 2866 december gold contracts. Just so happens 2866 was exactly the number of delivery notices issued on FND as reported in the Nov 27 vol and op int report.
Conclusion: guess you can no longer get bullion via using comex contracts. This apparently is the next step in the evolution of gold trading.”
Nope, the rules were not amended to allow for delivery of GLD shares in lieu of bullion, the rules were amended to allow the use of GLD shares in order to initiate an off-exchange (ex-pit) transaction in a COMEX futures contract (that’s what an EFP is). EFPs are used to initiate or liquidate futures contracts but they are not used to settle them in the delivery month. That is why you don’t see “EFP Daily Totals” for December contracts in the month of December. It’s simple really: physical futures are settled ex-pit by EFP (or a few other “exotic” means) prior to delivery month and settled by delivery ex-pit during the delivery month.
Here is where it starts to get a bit tricky. Some futures contracts, such as the S&P 500 Index and Treasury Bonds, do not involve delivery at all since they are “cash settled” at contract expiration. But just to confuse the hell out of everybody, “cash settled” contracts are still associated with a “delivery month” in which they expire (typically on the third Friday of the month prior to the contract month). In any case, a particular contract type, such as COMEX gold, cannot have both “cash settled delivery” and “physically settled delivery”. The only sense in which COMEX gold contracts are settled for cash is that the issuer of the delivery notice must pay cash to the stopper equal to the futures price before taking possession of the underlying bullion.
What the &%*@#, you protest! The CME Daily Bulletin clearly says “cash settled” in the delivery month for COMEX gold, no? So it’s true that COMEX futures are not being settled for physical metal?
Of course it’s not true. As noted above, a futures contract that by regulation requires settlement by physical delivery cannot at the same time also be “cash settled”. This is a market myth unsupported by any evidence. Let’s look at an example of physical delivery in action. On December 3, COMEX silver open interest for the December 2009 futures dropped by 493 contracts and that means 254 contracts were offset in the pit (paired long-short trades are netted and therefore reduce open interest) and 238 contracts were settled ex-pit (reducing open interest through delivery). This isn’t completely accurate because not all delivery notices result in consummated transactions, some go back to the pit for trading and eventual offset.
Once again and for a final time, “physically settled” delivery is fundamentally different from the “cash settled” contract. Such “cash settled” contract, however, is essentially ex-pit (settled off exchange) just as physical delivery is ex-pit. Moreover, futures market nomenclature confusingly refers to “cash settlement” as a form of delivery. That is why the “Delivery — Cash Settled” label appears on the CME Daily Bulletin. When the new report template was created, the labels were apparently not customized for different contract types. It should be noted that the CME has made a slight improvement to the label in the past couple of days, now calling it “Delivery — Cash or Phy Settled”. To avoid any remaining confusion, the label should probably read “Cash Settled or Physical Delivery” or even better the label should be customized for each contract type (”Cash Settled” or “Physical Delivery”).
The conclusion we reach for now is that if one is counting on the ability to receive delivery of physical gold from the Comex for whatever purposes, then don’t. You will wait and fight and stand in queue to obtain the goods from the Enron nation.
But one principle we have learned over the years is never to attribute to bad intents what can be attributed to human error and mismanagement.
I would encourage Jesse and others in the gold and silver camp to actually understand how the metal exchanges work instead of “attributing” anything to anybody. From that understanding perhaps some intelligent conversation and debate might emerge.
UPDATE: Based on several comments by observers, I now realize that my attempted play on the semantics of “settled for cash” may have caused more confusion than entertainment. As such, I have edited the wording to be more clear about the difference between delivery and cash settlement. I have made the edits in the text above. The original material is as follows:
Nope, the rules were not amended to allow for delivery of GLD shares in lieu of bullion, the rules were amended to allow the use of GLD shares in order to initiate an off-exchange (ex-pit) transaction in a COMEX futures contract (that’s what an EFP is). EFPs are used to initiate or liquidate futures contracts but they are not used to settle them in the delivery month. That is why you don’t see “EFP Daily Totals” for December contracts in the month of December. It’s simple really: futures are “settled” by EFP (or a few other “exotic” means) prior to delivery month and by cash in the delivery month.
What the &%*@#, you protest! Cash settlement in the delivery month? So it’s true that COMEX futures are not being settled for physical metal?
Of course it’s not true. “Cash settlement” in the context of delivery only means “not EFP”. A futures contract in delivery month is always settled for cash. Either it’s net cash (pit) or it’s gross cash (ex-pit). Net cash is simply netting the short and long contract and happens in the normal course of delivery month trading (in pit). For example, on December 3, COMEX silver open interest dropped by 493 contracts and that means 254 contracts were settled for cash in pit (and 238 contracts were settled for cash ex-pit). [This isn't completely accurate because not all delivery notices result in consummated transactions, some go back to the pit for settlement.] Gross cash involves issuing a delivery notice that is then stopped by a party holding registered metal in the COMEX warehouse. It is “gross cash” because the issuer of the delivery notice must pay cash to the stopper equal to the futures price in order to take delivery of the bullion. It is “ex-pit” because a delivery notice settles the futures contract outside, or ex, the pit.
It is unfortunate that Jesse does not seems to allow comments so you can post a link to this article and get him to debate it.
You may find this interesting http://truthingold.blogspot.com/2009/12/adam-hamiltons-sloppy-inept-commentary.html at least he is civil in debating the issue, but “agree to disagree” is just giving up. Am I wrong in reading the GLD audit as an actual physical count?
I’ve read Hamilton’s analysis with great interest as it improves substantially on my own published efforts to set the record straight in the past about the gold and silver ETFs. I haven’t fully checked all of his facts, especially the independent vault count by Inspectorate, but being a former auditor myself I am intimately familiar with his line of reasoning and find it generally to be without fault. I’m actually planning to write a commentary that leverages Hamilton’s work and includes source links that will allow the facts to be verified by those interested in the truth.
“What the &%*@#, you protest! Cash settlement in the delivery month? So it’s true that COMEX futures are not being settled for physical metal?
Of course it’s not true. “Cash settlement” in the context of delivery only means “not EFP”. A futures contract in delivery month is always settled for cash.”
So is it true or not true? If true, then futures contracts are just promises to pay dollars?
I was being sarcastic with the semantics although perhaps I should have said “is always settled using cash” instead of “is always settled for cash”. In any case, the words “cash” and “physical” are superfluous when it comes to COMEX gold, what matters is whether the futures transaction takes place on the exchange (in which case the futures position is always netted) or ex-pit (in which case the futures position is always settled by delivery when in the delivery month and EFP when not in the delivery month). My problem is that the charlatans picked up on “cash” instead of “delivery”. Strictly speaking, a “cash-settled futures contract” does not involve delivery at all so the proper label for the CME Ex-Pit Breakdown in their daily bulletins should be “Cash Settled or Delivery-Physical”. I notice they instead changed the label from “Delivery - Cash Settled” to “Delivery - Cash or Phys Settled”. In any case, I don’t care if they call it “binga-binga-bang”, an ex-pit transaction in the delivery month cannot by definition be settled by netting. I’ll probably edit the post a bit to make this more clear.
So you’re saying, on the COMEX futures contracts can only be settled in cash. If you want to take delivery you must settle off the exchange with a party holding registered metal, OR, you can settle off exchange with a EFP outside of the delivery month?
If so, that sounds entirely reasonable.
Yes, that is correct. There is no such thing as “cash settled” delivery of COMEX gold. Moreover, technically a contract is not “settled” on the exchange, it is offset or netted. See my revised language above based on some additional comments I received by e-mail. I appreciate your observation and from the others who have helped improve my point (it’s still not perfect but better than any other specific explanation I can find on the Internet).
So here is a piece that tries to unmantle Hamilton´s take on the ETF´s as naive and mistaken. Would be interesting to see Tom take this one into account for further writing on the subject:
http://tinyurl.com/ye378zv
Thanks, This guy makes some really bad arguments especially the idea that the bullion banks don’t make a lot of money off the ETFs, or that there are storage alternatives when it comes to hundreds of tons of metal. If I get a chance I will try to write a reply.
Look at it from the suppliers point of view, if you have a refinery what is the incentive to get COMEX approved? When companies do things, generally it is for money to save or make.
In the COMEX rules you need 25m liquid working capital, and need to produce 5m+ oz a yr for the last 3 yrs. Other than prestige, which isn’t really a selling point for private refiners, what is the benefit to sell your metals here?
SO from that, we would assume that there would be a high premium for this silver or gold. But no, look at kitco prices for comex or LBMA bars, no premium over anything else price wise. Think also that unless you have the refinery somewhere near NYC its not really going to be cost effective to ship your metal there as they have no warehouses in the midwest or west.
Maybe I am missing something. If you traded your metals and speculated on them do you pay a smaller (haircut) fee by going direct or thru a broker with your unapproved comex metal. If it is about receivables with a broker, I know you get settled at day end.
If so what is the difference when you factor in shipping, insurance, and warehousing on the COMEX side or the broker side if he is local?
Math;
5m oz = 312500 lbs
1 semi load avg= 34,000 lbs
9 loads a yr.
“2008 Average operating costs According to (ATRI) American Transportation Research Institute the average cost per mile was 41.73 per mile and $83.68 per hour”
Anyone?
You are ignoring fabrication cost and the need to move inventory immediately (to free up capital for purchasing more unrefined metal). For a 1000 oz good delivery bar the fab cost is on the order of $10 per bar whereas fabricating retail bullion is on the order of 20 cents per ounce ($200 for 1000 oz). Then there is packaging cost. The shipping cost is the same either way. As for sales, you can sell as many 1000 oz bars on a given day as you want but not so for retail bullion. So the answer is that there is a HUGE incentive for a refinery to get COMEX (and LBMA) approved, so much so that if you aren’t an approved refinery then you are at a very serious competitive disadvantage.
Horst Uray, I suggest having a look at my discussion with Jeff Nielson on his claim that the silver ETF fee is unrealistic and therefore indicates that there is no silver - http://seekingalpha.com/article/161973-want-to-own-silver-forget-about-slv
In the end Jeff just ignores my last comment and stops discussing - it was an uninformed statement and he is not man enough to admit he was wrong on this claim.