A respectable amount of Americans hold investments in gold and silver in one form and other. Some hold physical bullion, although 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 which is where prices are set. The mint certificates, the ETFs, as well as the coins in an investor's safe – every one of them – are valued, no less than in large part, depending on the most recent trade within the nearest delivery month with a futures exchange like the COMEX. These “spot” prices are the ones scrolling throughout the bottom of your CNBC screen.
That makes the futures markets a little tail wagging an extremely larger dog.
Too bad. A more corruptible and lopsided mechanism for price discovery hasn't been devised. The price reported on TV has less about physical supply and demand fundamentals and more related to lining the pockets in the bullion banks, including JPMorgan Chase.
Craig Hemke of TFMetalsReport.com explained in a recent post how a bullion banks fleece futures traders. He contrasted buying a futures contract with something more investors may well be more familiar with – getting a stock. The quantity of shares is fixed. When an investor buys shares in Coca-Cola company, they should be paired with another investor online resources actual shares and wants to sell on the prevailing price. That's simple price discovery.
Not so in a futures market including the COMEX. If a trader buys contracts for gold, they will not be paired with anyone delivering the particular gold. They are associated with someone who would like 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 policy ratio – the variety of ounces represented in some recoverable format contracts relative to the actual stock of registered gold bars – rose above 500 to at least one.
The party selling that paper may be another trader having an existing contract. Or, as has been happening a greater portion of late, it could possibly be the bullion bank itself. They might just print up a brand new contract for you. Yes, they are able to actually do that! And as many because they like. All without placing single additional ounce of actual metal aside to supply.
Gold and silver are viewed precious metals as they are scarce and exquisite. But those features are barely a factor in setting the COMEX “spot” price. In that market, and other futures exchanges, derivatives are traded instead. They neither glisten nor shine as well as their supply is virtually unlimited. Quite simply, this is a problem.
But it gets worse. As said above, should you bet about the price of gold by either selling or buying a futures contract, the bookie could be a bullion banker. He's now betting against you with the institutional advantage; he completely controls the supply of your contract.
It's remarkable a lot of traders continue to be willing to gamble despite here all from the recent evidence that the fix is in. Open interest in silver futures just hit a new all-time record, and gold just isn't far behind. This despite a barrage of news about bankers rigging markets and cheating clients.
Someday we'll convey more honest price discovery in metals. It will happen when we figure out the sport and either abandon the rigged casino altogether or insist upon limited and reasonable coverage ratios. The new Shanghai Gold Exchange which deals in the physical metal itself may be a step in that direction. In the meantime, keep with physical bullion and understand “spot” prices for the purpose they are.