COMEX stock drawdown: single most important metric to watch

To understand what is going on with COMEX stocks, don't look at the stock level - it will lead you astray. You need the metric I presented at the Gold Standard Institute's 2009 seminar; one which Professor Fekete thought was the single most important metric to determine stress in the market. The second thing you need to do is put recent market action in historical context.

Firstly, lets review some historical stock levels for gold and silver for some key years - the 1980 peak, the 2001 bottom, 2012 and now. There is only one place I know that has that data going back that far, and it is www.sharelyxn.com. It is a lot easier to follow by looking at the charts of the stock levels, which are available for gold and silver if you have a subscription. If not, then just sign up for a free trial, it will be worth it just to see the charts I'm talking about.

The table below shows the average total (registered + eligible) COMEX stock in millions of ounces for each of those years.

Year	Gold	Silver
1980	3.5	80
2001	1.0	100
2012	11.0	140
Now	8.0	166

First thing to notice is that even after the big gold drop being talked about, the total gold stock is still massively up on the 2001 bottom and the 1980 bull market. Not surprisingly, given the behaviour of SLV's holdings, COMEX silver hasn't dropped.

However, the stock figure by itself doesn't tell us much, as how can we compare the 1980s with today when we have a much larger economy. The important metric is to compare stocks in relation to open interest. If stocks decline but open interest declines as well, then the stock drop is to be expected.

Thankfully Nick at Sharelynx calculates this for us - what he calls Owners per Ounce, or Stocks Cover and you can find the charts here. It is just open interest in ounces divided by stock in ounces. I like to invert it, which gives you a percentage indicating how much of the open interest is backed by stock, a sort of fractional reserves figure. The table below has those approximate figures I've eyeballed from Nick's charts.

Year	Gold	Silver
1980	13%	10%
2001	9%	28%
2012	26%	22%
Now	19%	21%

So even after that COMEX stock drop in gold, we still have a coverage ratio that is way above that which applied in the 1980 bull and which is not down much on 2012. The current coverage of around 20% also needs to be kept in context of the percentage of open interest which stands for delivery, which for gold and silver over the past five years averages between 2% to 4%. So it looks like COMEX has plenty of stock on a historical basis. It is when that percentage coverage gets a lot closer to the average standing for delivery rate that we can consider COMEX under stress and at risk of cash settlement. We aren't close, no matter how the much the pumper sites like to hype the recent stock declines.

And for those who will say what about if everyone stands for delivery, well consider that while most of the shorts don't have the metal, most of the longs don't have the cash. We know this because of all the talk about margin calls causing people to have to sell. Think about that - if they couldn't meet the margin calls, then it means they didn't have the money to stand for delivery.

Chill out dudes

OK, it is all getting a bit silly out there on the gold interwebs, particularly in respect of the supposed physical-paper price disconnect. I have been trying to kill this meme ever since it first appeared in 2008 but it seems the idea of production capacity shortages seems too difficult for many to get.

The "real" price of gold isn't what you pay for a 1oz coin on eBay. As Mish says "Premiums on small denomination coins is not the same a general premium on physical gold itself." But don't take his or my word for it, here's what Jim Sinclair says:

"For many retail investors around the world they are dialed into the paper market in various exchanges. The second market is a small one, but popular among retail investors, and that’s your corner or even major coin dealers. But neither of those are in fact the real gold market, which is the cash market for gold. This is the cash market for 400 ounce deliverable fine gold bars. That represents the true price of the market on any given day. ... for the physical market, not the coin dealers, but the real market, the 400 ounce deliverable market and Asian type settlement ..."

So what is going on in this real market? Well, don't look to Jim Willie who thinks that "those who purchase metals in bulk are having to pay $2000 or more an ounce for gold in the Asian markets". I work for the Perth Mint and we sell tonnes and tonnes of gold kilo bars into Asia every week and we'd be lucky to get a few dollars of premium above the so-called fake paper spot price. That tells me there isn't any stress in the wholesale markets. So COMEX and LBMA aren't going to be failing any time soon.

Then we have the ABN Amro story with John Embry claiming that "the Dutch Bank ABN AMRO came out and literally said that if you have allocated gold with us, you can’t have it. That, to me, is a default". Sorry, not true, thanks to About.Ag who found this link to the English translation of the conditions of those accounts and on page 6, section 4.3, it says:

"1. You have no right to the physical precious metals which you invest. However, under certain conditions, you can physically obtain the precious metals. ... 3. You cannot always physically receive the precious metal. ... In that case, you therefore have no rights or receivables vis -à-vis DBN or the bank."

Sounds like a classic bank unallocated account, which unlike the Perth Mint's, is not necessarily backed by physical. So it is not a case of default.

Final example is Bill Downey's claim that "the London physical platform that buys and sells physical gold gets locked up. The system freezes". When I told Dan at The Fundamental View that there was no "the" London platform, he followed it up and discovered that:

"The screen shot in the article is not of a "physical" market but just a trading platform from a bank (one of many, each BB has their own platforms) for trading spot unallocated XAU/USD FX pair. The post made it seem (to the unaware) that this was "the" London platform. – Mr. Downey acknowledged this error in his email to me. ... His articles made it seem as though the system “shut down and locked people out from placing orders”. To his credit, Mr. Downey admitted to me that this could not be proven and that this was simply speculation on his part. He did admit that orders could still be phoned in."

Simply speculation on his part. This price drop seems to have resulted in a lot of that. Look, it is great news that retail investors have gotten a bit smarter and are buying on price drops rather than chasing the price up like they have in the past, but it does not portend the end of the (paper gold) world, yet.

If you want to be a little smarter, consider what I said to Ed Steer today, "buyers really need to go for the cheapest physical they can and be a bit more flexible on who makes it...or go from coins to bars. Paying high premiums just because you want a certain brand or bar size, just means your money buys less ounces, which takes less ounces off the market."

I note that Sprott's gold trust is trading pretty much at spot. So if you are a suspicious goldbug, which is why you want physical, then doesn't it make a lot more sense to buy the trustworthy PHYS at spot and then when this rush dies down, to sell your PHYS and buy physical coins/bars at more reasonable premiums? Funny how none of the physical pumpers mention this. That's because they can't make money off exorbitant fabrication premiums if you buy PHYS rather than their coins.

Like the post title says, Chill Out, and think a bit deeper about the memes being pushed on you. To help with that, suggest reading this speculation that Andrew Maguire is a US Federal Reserve double agent. That site is a joke by the way, for those without a sense of humour, although the question of why Andrew hasn't produced a CV to stick in Jeff Christian's face is valid and something that puzzles me and some on this Kitco forum thread.

Bringing forward demand

The most interesting thing about this price drop is the reaction of retail clients, who have gone crazy like its 2008. The Perth Mint's bullion website has been having traffic problems and we've had lines at our Perth retail outlet. Depository buying is relatively more subdued, but still the volumes are up.

It is an encouraging sign as usually retail business is only strong when there is a clear upward trend in the gold price. Maybe they have learnt something fom our Asian and Indian friends, who are much more canny buyers.

I was talking to one of our coin dealers a few days ago and he said about a 3rd of business was newbies. At this time my question is whether the price drop has just brought forward

1. New investors who were thinking about buying
2. Existing holders who were looking to top up

But both had not previously acted as the price was going sideways. If we are just sucking demand from the future then this demand will fade. I think this is probable as there has been no change in the underlying fundamentals, no event that would freak people out to buy gold suddenly (Crypus and Boston I don't think would have that effect).

We will need to keep an eye on retail demand to see if it continues. If it does then we should get a repeat of 2008 when coin distributors started to look further afield to overseas mints for coins. Given the Perth Mint's distance and higher quality/higher fabrication price, we should be the last to start to run out of production capacity. If we report these sort of problems then you know the retail demand is serious.

If they didn't warn, then don't listen

So every gold commentator has an opinion on gold's drop. My question is if they didn't warn you beforehand about the risk of a big drop, why pay attention to what they have to say about it after the fact? That is my response to Gordon's comment.

I find it particularly amusing that those who purport to have inside information on the physical market or contact with deeply embedded kingpins did not warn their readers that the market setup was weak, that central banks would not be buying aggressively on the dips and in increasing size at $x price. Yet their followers still think they are gurus.

I could say that they either knew and traded against you, or that their contacts are no good, or that their contacts knew but fed them wrong information (ie they are being played) because their contact knows they have a wide audience and wanted to trade against the guru's followers, or that they are just frauds and don't have any contacts and just make up those stories as it sounds a lot sexier than just saying "my opinion is". I think the most likely answer is just that the gold market is an opaque over-the-counter market where participants only have a view of (their) part of the market.

From my part of the market weeks before the crash the Perth Mint was getting a strong bid from bullion banks for our refining output as kilo bars into Asia. I only really watch those premiums as they are for tonnes at a time and we are about 10% of new mine production. So if you asked me I would have said the physical market was looking good.

So the drop was leveraged paper longs head-to-head against paper shorts. Yes the shorts don't have the gold, but obviously the longs don't have the cash either, otherwise they wouldn't have had any problem meeting margin calls and being ready to stand for delivery.

This is a case of the tide receding and finding out who is swimming naked. That is, we now know that when gold was $1900 it was composed of $1300 of strong hands and $600 of speculative weak money. That is the lesson to remember for next time gold has a run - ask yourself how much of the price is strong and how much speculative.

But why listen to me? I didn't warn you beforehand.