A respectable amount of Americans hold investments in gold and silver in one form and other. Some hold physical bullion, while some opt for indirect ownership via ETFs or other instruments. A very small minority speculate through futures markets. But we frequently report on the futures markets – why exactly is?
Because that's where prices are set. The mint certificates, the ETFs, as well as the coins within an investor's safe – every one of them – are valued, a minimum of in large part, based on the most recent trade inside the nearest delivery month on a futures exchange including the COMEX. These “spot” prices are the ones scrolling throughout the bottom of your CNBC screen.
That helps to make the futures markets a tiny tail wagging a lot larger dog.
Too bad. A more corruptible and lopsided mechanism for price discovery never been devised. The price reported on TV has less related to physical supply and demand fundamentals and more about lining the pockets of the bullion banks, including JPMorgan Chase.
Craig Hemke of TFMetalsReport.com explained in the recent post how the bullion banks fleece futures traders. He contrasted purchasing a futures contract with something more investors is often more familiar with – purchasing a stock. The variety of shares is bound. When a trader buys shares in Coca-Cola company, they should be paired with another investor who owns actual shares and really wants to sell with the prevailing price. That's straight forward price discovery.
Not so inside a futures market including the COMEX. If an investor buys contracts for gold, they won't be associated with anyone delivering the specific gold. They are followed by someone who wants to sell contracts, whether or not he has any physical gold. These paper contracts are tethered to physical gold in the bullion bank's vault with the thinnest of threads. Recently the coverage ratio – the number of ounces represented in writing contracts relative to your stock of registered gold bars – rose above 500 to a single.
The party selling that paper could possibly be another trader by having an existing contract. Or, as has been happening really late, it might be the bullion bank itself. They might just print up a brand new contract for you. Yes, they could actually do that! And as many while they like. All without placing a single additional ounce of actual metal aside to supply.
Gold and silver are thought precious metals since they're scarce and exquisite. But those features are barely a factor in setting the COMEX “spot” price. In that market, along with other futures exchanges, derivatives are traded instead. They neither glisten nor shine in addition to their supply is virtually unlimited. Quite simply, what a problem.
But it gets worse. As said above, if you bet on the price of gold by either selling a futures contract, the bookie might just be a bullion banker. He's now betting against you by having an institutional advantage; he completely controls the supply of the contract.
It's remarkable a lot of traders remain willing to more info gamble despite all with the recent evidence how the fix is in. Open interest in silver futures just hit a new all-time record, and gold is just not far behind. This despite a barrage of news about bankers rigging markets and cheating clients.
Someday we'll have more honest price discovery in metals. It will happen when folks figure out the action and either abandon the rigged casino altogether or require limited and reasonable coverage ratios. The new Shanghai Gold Exchange which deals inside the physical metal itself can be a step in that direction. In the meantime, stick with physical bullion and understand “spot” prices for the purpose they are.