The Inherent Unfairness of The Comex
By Turd Ferguson
Once again, paper metal prices on the Comex are being set up for a smash. The Cartel Banks, acting as de facto "market makers" are issuing huge amounts of new paper contracts in order to sop up speculator demand and squash momentum.
Please take a moment to understand how a "normal" market works. Let's take an individual equity as an example.
Company XYZ has a outstanding float of shares that totals 1,000,000. On any given day, news flows and other events motivate the holders of XYZ to either buy, hold or sell their shares. In this example, let's say that something fundamentally positive occurs for XYZ. As investor scramble to buy XYZ shares, price rises. Why? Because there is a set amount of 1,000,000 shares on the market, price must rise to a point where existing shareholders are willing to sell, at which point a new price equilibrium is reached. The same is true when price falls. There are more sellers than buyers and price must fall to the point where buyers emerge and a new price equilibrium is found. The key in both situations is the finite amount of shares available. Yes, a company can do secondary offering and issue more shares but these things take weeks to organize with legal and underwriting concerns. Therefore, on any given day, the float and available "stock" to buy or sell static and finite.
OK. Sounds good. Are you with me so far?
However, sometimes things can get disorderly. Back in the old days, the NYSE has people called "Specialists". At their own risk (and profit), these folks were responsible for maintaining their own large block of an equity for the purpose of "making a market" should there ever be a complete absence of buyers or sellers. These Specialists were charged with being the buyers or sellers of last resort and thus "making a market" and keeping things orderly. The key though was that these specialists were only dealing with existing shares that they already owned. They did not and could not simply issue new shares in response to investor/speculator demand. As noted above, the float was finite on any given day and the "market" simply had to respond by moving price up or down in response to demand.
Now, compare and contrast this with how the CME Group allows the Bullion Banks to manage the Comex metals "markets". Many system apologists claim that The Banks, in managing the Comex paper derivative markets, are only acting in this same, benevolent "market maker" role. These folks claim that these altruistic Banks simply seek to provide an orderly and fair market filling the same role as the NYSE Specialists of days gone by. But here's the critical difference:
Instead of dealing with a finite supply of paper metal contracts, the Cartel Banks are able to simply issue brand new paper contracts whenever they'd like. If demand for Comex paper surges due to fundamental or technical reasons, price does NOT have to rise to a new equilibrium where existing holders are willing to sell. Instead, The Banks simply create new contacts...increase the float...in order to meet the demand. Price rises are muted and momentum is contained. Price never breaks out and rises significantly in a single day like an equity might. An individual stock might rise 10% or 20% in single day due to news and information. But when was the last time you ever saw gold or silver do that? And why is this? Because of The Banks' ability to meet demand through the issuance of brand new paper contracts anytime they wish.
Now some folks will say that this is all perfectly fair and that The Banks are only hedging or selling what they currently have. If that's the case, then how do you explain the action of just Wednesday and Thursday or last week?
Up until Wednesday, gold had struggled to move through its 200-day moving average, which is a key technical indicator for speculators large and small. Early on Wednesday, price finally surged through the 200-day and this set off a surge of demand for paper gold contracts as technical trading and hedge funds looked to capitalize on this positive momentum. However, unlike the "fair" markets described above where prices rise to the point where sellers of existing shares (contracts) emerge, this speculator demand was met with a rush of freshly printed new contracts from The Banks. How many? On Wednesday, the total open interest for Comex gold rose by 15,774 contracts. This means that in order to meet demand, the "market making" Banks stepped in and simply created new supply. Ask yourself this...How much farther would prices have risen on Wednesday if The Banks hadn't added this fresh supply of 15,774 contracts? Another $10? Maybe another $20? Unfortunately we'll never know.
On Thursday, with price still comfortably above the 200-day, speculator demand for paper gold continued unabated. As price churned another $8 higher, The Banks added another 6,698 contracts of open interest. Again, how much higher would price have risen if it were forced to simply find an equilibrium where buyers finally found willing sellers of existing contracts? Another $10? Maybe another $20? Unfortunately, we'll never know.
And here's where it gets completely unfair and traders everywhere should question the legality of the process. By adding 22,472 new paper gold contracts over just two days, The Banks created brand new paper obligations for 2,247,200 ounces of gold as each contract represents an obligation to deliver 100 troy ounces. However, no gold was added to the Comex vaulting system over these two days. All The Banks did was create new paper obligations on fully 1/3 of ALL THE GOLD in the Comex vaults. As of Tuesday October 13, the entire Comex vault system held just 6,704,069 ounces. On Thursday October 15, though the total Comex gold open interest had risen by 22,274 contracts, the vaults still held just 6,704,069 ounces.
So, again, in order to meet demand, squash momentum and contain price, The Banks on the Comex were allowed to create new paper obligation representing more than 1/3 of all the gold held on deposit in the Comex vaulting system. Again, how is this fair? How is this even legal?
And lest you think this is the first time this has ever happened, I urge you to click the link below:
That post was written on January 27 of this year after a similar travesty. As price broke the gate and rallied nearly 10% in January, The Banks responded by issuing a whopping 82,910 new contracts between January 2 and January 26, almost all of them soaked up by eager speculators looking to buy paper derivative exposure to gold. This essentially meant that The Banks sold over 8,000,000 ounces of paper gold to meet speculator demand and contain the new year price breakout to just a little over $100. IF the supply of contracts had been held constant and IF price had been forced to find an equilibrium between buyers and sellers of existing contracts, how much higher would have gold surged? To $1400? To $1500? Maybe even farther? And how might this have changed the narrative for 2015? Instead, price was contained and momentum was slowed. Once price was finally maneuvered back lower and below the 200-day moving average following the January employment report of February 6, the bottom dropped out. All of the speculators which bought in January were quick to sell in February. The Banks bought back nearly all of the paper contracts they had issued in January and total open interest was back to early January levels by February 13. Price, which began the year at $1184 and then rose to high of $1308 on January 22, fell back as well. By February 13, it was back to $1226 on its way to a March 17 low of $1148.
What's the takeaway of all of this? Well, besides the fact that The Comex is inherently and structurally unfair, you must be aware that price is going to be smashed again soon, just as it was in January. The Banks do not have the ability to deliver on their obligations so they'll need to cover them all back up just as they did last February. They'll want to do so at a profit so you must expect to see paper price rigged lower again, down and through the same 200-day moving average. Once this happens, the brainless and computer-controlled speculators will rush to the exits and sell back to The Banks the very same contracts the Banks sold to them last week. Price will fall sharply and all of these recent price gains will have been for naught.
Of course, there's always the possibility that something dramatic will happen and that prices will rise, instead. However, far more likely is the possibility that The Banks will soon raid price in order to drive it back under the 200-day moving average. Therefore, be on the lookout for lower prices ahead. Traders should use this foreknowledge to position themselves for the move and stackers should be on the lookout for the next "sale".
Remain optimistic but realistic and prepare accordingly.
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