Is the end of the COMEX nigh?

By Andy Hoffman

The war over gold and silver rages on, with its center stage as always at the NY COMEX futures exchange, often referred to affectionately as the “CRIMEX”. Myself and other metal market observers, most notably Jim Sinclair, Marc Faber, Eric Sprott, and Bill Murphy, have painstakingly watched this horror show play out over the past decade, under the guise of the U.S. “Strong Dollar Policy”, the ultimate oxymoron and falsehood.

We and others have discussed at length the incredibly positive fundamentals for both gold and silver, and by now it should be clear to all that supply for both are PLUMMETING while demand is EXPLODING. And there’s a reason why I’ve capped these words, as I cannot underestimate how powerful these forces have become, and how much strength they gain each day. Aside from the sharp increase in demand, depicted in last week’s World Gold Council quarterly report and by the fact that the Perth Mint, one of the world’s largest, is not accepting any more orders, supply is completely collapsing in nearly all markets.

But, once again, the key to this story is NOT the dollar, NOT other commodities, NOT the credit crisis, and NOT even gold’s supply/demand balance. It is one thing, and one thing alone; the ability of the gold/silver Cartel to surreptitiously (and in many cases illegally) sate the soaring physical demand. Clearly, they are losing the battle of the physical markets, given global shortages, record demand, and record premiums being paid over spot prices. Not to mention that gold is hitting new record highs in nearly all global currencies outside the yen and the dollar, the two currencies that have benefitted the most from the deleveraging (NOT safe haven buying) going on over the past two months.

But the WAR is fought in the NY COMEX market from 8:20 am to 1:30 pm EST each day, as that is where essentially ALL of gold and silver’s losses occur. Amazingly, throughout this nearly nine-year bull market, gold has declined far more than it has risen in New York, and last I read it had fallen in something like 93% of this year’s trading sessions despite being down just 2% this year. And, by the way, that 2% decline has outperformed essentially every asset on earth, not just this year but for seven straight years, soon to be eight!

Anyone wonder why in today’s massive “reflation” trade, in which copper, oil, and stocks all rose sharply, somehow the ONLY asset to decline was gold, which by definition is the asset class of choice if one is betting on “reflation” (read: inflation)? I think you know the answer, an answer which once again was given between 8:20 am and 1:30 pm EST in the NY COMEX futures market.

But the COMEX’s days of setting global gold and silver prices appears to be nearing its end (in itself a ridiculous concept, given that such a tiny percentage of futures traders have anything to do with the business of gold and silver production). As I have been noting for some time now, COMEX open interest, or the number of outstanding contracts, has been plummeting for both metals all year. Consequently, open interest for both gold and silver are currently at multi-year lows amidst the greatest financial crisis in a century.

The gold open interest has plummeted from an all-time high of 593,000 in January to an astounding 276,000 today, a level not seen in three and a half years, at a time when the gold price was just $430/oz versus $817/oz. today. In silver, open interest has fallen from a record 189,000 in February to a scanty 86,000 today, a level not seen since 2004 when the price of silver was about $6.80/oz versus $10.35/oz today.

But the crazy part of this year’s plunge in COMEX gold open interest is that during this period, the price of gold only declined by 10%, from $910/oz at the peak to about $815/oz. today. In silver, the price decline was more significant, but as you know the CFTC is currently investigating this price drop due to the fact that one or two banks (evidence suggests it was just one) shorted 25% of global silver production this summer, taking up something like 90% of the entire short position on the COMEX. Silver is a much smaller market than gold, which is why it tends to be more volatile (read: more manipulated), but either way the record physical demand shows that this drop in the futures price had little semblance to reality.

The other crazy thing about gold and silver futures are that they are the ONLY commodities to have lopsided short positions, not just now but ALWAYS. Gold and silver have been in bull markets for nearly a decade, with nearly all mining companies DE-HEDGING over the past five years. However, somehow the “Commercials” always seem to have a vastly lopsided short position. Remember when oil and copper blew their tops this year to the upside, or corn, soybeans or you name it? Well guess what, none of them EVER had a short position materially larger than their long position, OR vice-versa. In fact, silver has had an acknowledged supply/demand DEFICIT (by CPM and the Silver Institute) for 15 years in a row, but is the ONLY commodity to have had a non-stop commercial short position over the past decade! In fact, as gold and silver continued to rise from 2000 to 2008, each year the “Commercials” short position got LARGER.

But let’s see WHY the open interest has dropped to multi-year lows at the same time that global demand for physical gold and silver has reached ALL-TIME records. Looking at the two above charts, one can see that the “Commercials”, which for the most part are really banks such as JP Morgan and Goldman Sachs, have been massively covering their shorts this summer, to the point that net positive positions are starting to look like a near-term possibility.

The net Commercial short position in gold has not been this low since mid-2005, when gold was about $420/oz, and in silver since EARLY 2003, when silver was just $3.80/oz.. And this trend is not just seen in the U.S., but in Japan as well where the “Commercial” shorts have now gone essentially neutral (including Goldman Sachs) after having MASSIVE short positions 12-18 months ago. In Japan, individual firms such as Goldman Sachs must disclose their long/short position, but in the U.S. the NYMEX allows them anonymity by simply publishing the collective position of the “four or fewer” and “two or fewer” largest positions.

Of course, given that JP Morgan holds the most derivative contracts on the planet, including the most gold derivatives (in amounts FAR EXCEEDING the actual amount of gold in existence), it is reasonable to deduce that they are the largest and most powerful player on the COMEX. And slightly off topic, does anyone find it weird that JP Morgan, the company with BY FAR the most derivatives outstanding, has been not only spared an equivalent level of financial carnage as the other money-center commercial and investment banks , but has additionally been used essentially as a “government garbage can” for smaller, insolvent firms like WaMu and Bear Stearns? Just as Fannie Mae and Freddie Mac were ambiguously called “quasi-government entities” before being fully taken over by the government this summer, I believe JP Morgan has become a de facto “quasi-government entity”.

On the other side of the coin (no pun intended), let’s take a look at the “Large Speculators” positions, in other words the positions of honest to goodness traders simply looking to profit on gold and silver price trends:

Except for a few minor blips, these positions have also fallen to levels last seen three to four years ago. This will happen in a market that falls 93% of the time despite being in a bull market for nearly a decade. Aside from the obviously massive financial losses that gold and silver futures traders have amassed on the COMEX, it is becoming crystal clear that they are fighting the house in a rigged casino.

This likely explains not only the colossal decline in gold and silver open interest during an historic “safe haven period”, but also the massive increases seen in the physical holdings of physical ETFs (such as GLD and SLV), as well as the enormous growth in physical closed-end funds such as CEF.

Yep, it is quite amazing that despite 30% and 60% declines this summer in the prices of gold and silver, respectively, both GLD and SLV are now holding all-time record holdings of actual physical metal.

Not only are such losses enormously apparent in the COMEX futures market, but in the real world where essentially ALL gold and silver miners are operating at losses, with several of the larger players moving toward bankruptcy as we speak. And don’t forget about South Africa, once the largest gold miner in the world by far, where its entire gold industry is now underwater and on the brink of economic catastrophe due to the artificially low price. Unless gold trades well above $1,000/oz for an extended period of time, not only will much of the gold industry shut down, but the risk of civil unrest will increase exponentially.

Anyhow, what makes me think the end of the COMEX is nigh, at least in its role as a price-setting mechanism for global gold and silver prices? Well, nothing is guaranteed, but the December futures contract is the largest of the year, and is set to expire shortly. Physical gold and silver have already started to slowly leave the COMEX warehouses (particularly in silver), and the amount of outstanding contracts this late in the contract yields the potential for significant demands for physical delivery.

Several well-known Precious Metals experts (such as Jim Sinclair and Eric Sprott) have been actively bringing this point into the public light, doing their best to organize physical offtake of the 100 oz. gold and 5,000 oz. silver contracts. At current prices, one such gold contract would cost about $80,000, and one such silver contract about $50,000, hardly large amounts in today’s world of multi-trillion bailouts and “liquidity injections”.

All of the COMEX inventories (currently 8.5 million ounces of gold and 129 million ounces of silver) do not need to be delivered, but any kind of material change has the potential to spook the market into fearing a run on the metals. If this occurs, the COMEX market rigging scheme will be finished, with the obvious results being that 1) gold and silver prices would immediately rise to significantly higher levels, and 2) the non-stop attacks on COMEX gold and silver would either halt or lose their ability to impact the REAL global gold and silver prices. Would such action also have a spillover impact on industrial metals such as copper? It is hard to tell, but clearly the inflationary signal given by rising gold and silver could only help the base metals, particularly at a time where global inventory levels are historically low.

I am not naïve enough to believe the Cartel is not aware of this potential “situation” on the COMEX, and will likely do everything in their power to prevent it from happening. But the December contract will likely see them face some stiff competition, perhaps the most they have experienced yet. And even if it doesn’t happen now, the odds of it occurring in the near-future are rising exponentially, especially given the escalating nature of the financial crisis and its accompanying bailouts.