When the Oil Price Went Negative
Many of you remember that strange day in April of 2020 when the oil price went negative. Robert Wenzel, rest in peace, had put together a great breakdown of what was going on behind the scenes. In short, he explained that because of the Covid lockdowns, the demand for oil in the short-term collapsed and oil storage facilities, for the most part, were filled with nowhere to put any excess. It wasn’t that oil producers couldn’t sell oil necessarily. It was that the May futures contract was expiring and speculators were faced with the delivery of oil that they had no capacity to store. Thus they were forced to pay big time to incentivize the seller to keep the oil.
Well, at that time Peter Schiff asked the question, “what if the opposite were to happen in gold and silver?”
In other words, for gold and silver, if the “longs” (the buyers) want delivery, but there is no physical metal to be delivered, then all of a sudden the price would spike as the “shorts” (the sellers) would scramble to acquire physical metal to make good on the delivery.
This would signify a dollar crisis as investors would rush to grab physical gold and silver. So to try and identify the “canary in the coal mine”, Peter Schiff’s group has started to track COMEX delivery data. While there could be multiple reasons for taking delivery of gold and silver, a dollar collapse could ultimately manifest as a run on the metal at the COMEX.
What is the COMEX?
The COMEX is one of four exchanges in the global derivatives marketplace of the CME Group, Inc. It facilitates trading in futures contracts of precious, base, and ferrous metals by two parties while guaranteeing the transaction. It was previously known as the Commodity Exchange prior to merging with the CME Group. The majority of gold and silver is traded in paper form on the COMEX within the futures market rather than in the physical market.
Similar to oil futures, a COMEX futures contract expires every month. Investors can either take physical delivery at contract expiration or they can roll the contract over to the next month with a gain or loss.
The COMEX guarantees the deliveries each month, but the deliveries typically stay within the COMEX system. Sellers must have the metal, such as gold or silver, deposited in a COMEX-approved depository. The physical metal is registered with a warrant number, like a serial number, that is traceable to the depository. When people refer to trading “paper gold” or “paper silver,” they are referring to the trade of these warrants. See an example of a delivery cycle for a gold futures contract in the below diagram.
Delivery Data
The COMEX puts out daily, monthly, and year-to-date delivery data in the form of their “Issues and Stops” reports. The name of the report comes from the process of fulfilling the contract delivery: the short position “issues” a notice to transfer ownership of the paper metal to the long holder (the “stop”). The sum of the “issues” should add up to the sum of the “stops” since they are two sides of the same transaction. An example of a page from a year-to-date report is shown in the snapshot below.
The denotations of “H” and “C” in the report stand for House and Client accounts, respectively, identifying whether the metal transfer is to or from individual investors with the bank house accounts on the other end of the transaction.
In conjunction with the issues and stops data, which shows paper ownership transfers, we must look at the “stock” inventory reports. The stock represents the physical amount of gold or silver within the COMEX system. Metal under warrant is identified as “registered,” while other gold within the COMEX vaults is identified as “eligible” which can be converted to “registered” if needed. Below is a snapshot of a portion of a gold stock report showing the movement of physical gold (either registered or not) in and out of the system.
So what can the delivery data tell us? Deliveries indicate that someone wants to take paper ownership of the physical metal. The stock inventory tells us whether the physical metal is actually present in the vaults. So, if there was a run on the COMEX system, we would see deliveries spike and the stock inventory diminish rapidly. This is, presumably, what Schiff is looking for.
“Metal moving from the House to the Client means investors are taking ownership of physical metal directly from the bank. The metal could stay in the Comex vault, and even under the same custodian, but moving from a house to client account is an entirely different owner. In essence, this could be metal moving from weak hands to strong hands.”
He presents the data showing delivery to and from the house accounts, where negative values represent money leaving the house and positive values show metal coming into the house. From the below two charts, we see the monthly house activity for both gold and silver showing a record sum of deliveries last month and for the year 2021 in total.
The charts show a decade of house accounts stockpiling physical gold and silver up through 2019, with the last two years showing a sudden, sharp increase in metal ownership being transferred to investors.
What is Happening?
Well, Peter Schiff thinks that maybe this is the canary in the coal mine and investors are beginning to see the reality of the dollar’s fragility.
But although the demand for paper ownership is accelerating, will investors call for actual physical delivery out of the COMEX vaults? If so, could the COMEX vaults maintain the stock supply of actual gold and silver to keep up with withdrawal demand? If not, this would be the “run” on the COMEX system and the price of gold and silver would soar.
Looking at the progression of the gold and silver stock inventory in the below two charts, we see a sharp increase in the percentage of registered metal increased dramatically after Covid-mania hit in early 2020.
Interestingly, the percentage of registered silver is much lower relative to that of gold. But both seem to have some cushion of eligible stock available for conversion to registered if needed.
The recent monthly spikes in deliveries cause one to wonder if the pace will slow down, maintain, or accelerate. If it accelerates, will the available stock cushion be enough to keep up with demand to hold physical metal? If the delivery pace accelerates, watch out. As Schiff said, “the longs will try and take delivery, but the shorts won’t have it!”