What Do Declining COMEX Inventories Signify?
Warehouse Stocks of Gold and Deliveries
We have come across many articles recently (here is an example) discussing the decline in COMEX inventories and/or the decline in inventories held by physical gold ETFs like GLD. Invariably the writers conclude that these inventory declines must be a bullish sign. We don't believe this conclusion to be correct.
We want to get one item immediately out of the way, because there seems to be a lot of misunderstanding on this particular issue. Many observers argue that if the so-called 'registered' inventory (metal designated and available for deliveries) were to decline below a certain level, then there could be a 'delivery default'. This is highly unlikely. First of all, historically only between 1.5% to 3% of open COMEX gold contracts ever get to the delivery stage. Secondly, 'eligible gold' can move into the 'registered' category and vice versa. Thirdly gold that is to be delivered may be stored at any warehouse licensed by the exchange and it is up to the seller which one he wants to use. Fourthly, movements from one vault to another are actually entirely independent of deliveries, which consist simply of paperwork – proof that the seller has paid storage up to delivery day, and issuance of a receipt (called a 'warrant') that confers ownership. Other than that, the exchange specifies that deliverable gold must be of a minimum fineness of 0.995. The rules can be viewed in detail here (pdf).
The new owner of the warrant can then decide whether to move the gold out of the vault, leave it in the 'registered' category, or move it into the 'eligible' category ('eligible' gold is gold fit for delivery, and as noted above may at any time be moved into the registered category for delivery purposes). Note that the categories 'house' and 'customer' accounts which are identified on COMEX delivery reports are not congruent with 'eligible' and 'registered'. Both categories of traders may hold receipts for either types of gold.
So if you take delivery, there isn't going to be a DHL truck showing up one day to dump the gold on your front lawn. Moreover, it is irrelevant (gasp!) if JP Morgan has 'enough' gold in its own licensed warehouse to deliver into the contracts it has left open past notice day, since it can deliver gold held at another licensed warehouse. Finally, should a member ever default on a delivery, there are specific rules dealing with such situations. There may be a 'force majeure' situation for instance. In case of a genuine default, the clearing house will refund the cash value of the underlying commodity to the buyer, but it has no obligation to actually deliver the underlying commodity. The specific rules concerning these cases can be viewed here (pdf).
So much for the technicalities. Below is a chart of COMEX warehouse stocks over the past decade. Examine it closely – it does actually have some informative value as we will explain.
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