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Gold Movements Suspect
By Patrick A. Heller
August 03, 2010

A rough rule of thumb I follow is that once is a coincidence and twice is a pattern. There has been a run on COMEX silver inventories since June 16. Now there are strange developments with COMEX gold inventories.

There were unusual movements of COMEX gold inventories on July 28 and July 30 that 1) coincidentally roughly equaled what was needed for the sellers of contracts to meet delivery requirements, and 2) may indicate that unusually large quantities of COMEX gold will be withdrawn by the end of August.

The COMEX reports two forms of gold (and silver) inventories. All are stored in bonded warehouses. The first category is registered inventory, which are committed to delivering against open contracts. It is useful to think of this as dealer inventories as they really represent trading positions rather than investment holdings. The second category is eligible inventory.

Because they are in bonded warehouses, they are eligible to be delivered against COMEX contracts if the owner of the metal so chooses. However, the owner may also chose not to make this metal available to deliver against a COMEX contract and just use the bonded warehouse for only storage purposes. The advantage to an investor is that it gives him or her the flexibility to go in either direction. The eligible inventories are often referred to as customer inventories.

On July 28, there was a sizable withdrawal of 96,592 ounces from dealer inventories. This is relatively close to the 89,400 ounces of gold standing for delivery of maturing July contracts, which is not particularly remarkable by itself. However, on that day, there were still 112, 977 open August contracts, representing 11.3 million ounces of gold. This liability exceeds the entire COMEX registered and eligible gold inventories. What is unusual this time around is that normally contracts maturing within a month have long since been closed out or rolled over into future months. Though only a small percentage of these maturing August contracts are likely to be delivered, there is a strong likelihood that deliveries in the next month will be much higher than usual. If this is developing, the move on this day to deliver so much gold against maturing July contracts may have been a ploy to create the image that available physical gold is plentiful.

Owners of August long contracts would need to state by July 30 whether they were going to close out (by selling their contract), roll over, or stand for delivery of their contracts. If the delivery option is selected, the contract must be fully paid by that day.

On July 30, a massive 367,716 ounces of gold (3.2 percent of all COMEX registered and eligible inventories) were reclassified from customer inventory to dealer inventories. The same day, JPMorgan Chase issued delivery notices of 368,500 ounces, virtually identical to the amount that was reclassified.

Gold and silver COMEX contract prices went into backwardation on July 23. In normal commodity markets, the prices of future month contracts are higher than the current or “spot” month, typically by the amount of the interest rate and transaction costs. The standard condition is called contango. When the spot month price is higher than one or more future months, the market is said to be in backwardation. If spot month prices remain higher than the near future months for more than two or three days, that is a sign of a physical supply squeeze, which often foretells a near term rise in the price.

At the close on July 29, the COMEX July, August and September gold contracts settled at the exact same price. While not technically in backwardation, it is also not a normal contango market. The moves of COMEX gold inventories on July 28 and July 30 could be indicators of one or more of the following conditions:

• There is a supply squeeze where there just isn’t enough gold to meet delivery requirements; or,
• One or more dealers such as JPMorgan Chase may literally have no metal immediately available to meet delivery requirements; or,
• Much larger than normal amounts of gold will be withdrawn from COMEX warehouses in the next month.

These moves of COMEX gold inventories are the akin to the run on COMEX silver inventories since June 16. If both are happening at the same time, as I suspect, they will almost certainly result in much higher precious metals prices by September. Roughly two months ago, I thought there was a high probability for much higher gold and silver prices by the end of July. That did not happen. I think my conclusion as to the direction of the market is still valid, but the timing will take one to two months longer than I originally thought.

Another significant news development not covered by the mainstream American media:

On July 29, London’s Financial Times ran a story explaining what their researchers think was behind the huge gold swaps handled by the Bank for International Settlements this year.

The Financial Times reported that more than 10 banks based in Europe swapped gold to the BIS in order to obtain U.S. dollars. Among the participating banks named in the article are HSBC, Societe Generale, and BNP Paribas. Two central bank officials told the paper that the commercial banks needed the U.S. dollars to meet demands from depositors to withdraw funds from the dollar accounts. The article does not speculate why investors may want to liquidate their holdings of U.S. dollars, but I think the main reason is a concern about the future decline in the value of the dollar.

The article goes on to say that much of the gold used as collateral in the swap came from the unallocated accounts of private investors. Although these investors, in theory, own the gold in unallocated accounts, this gold is now subject to a prior claim by the BIS should the owners want to remove or sell their position. This very possibility is one of the reasons I have urged readers to close out their unallocated gold storage accounts and turn them into physical gold under their direct control. Other gold for the BIS swaps was leased from central banks in emerging nations.

These swaps emphasize what I have regularly stated – gold is a safe financial asset that is more desirable for collateral than any of the world’s currencies. The central banks may talk about this not being true, but their actions belie their words.

Here’s one story that did get mainstream media coverage:

The Houston Chronicle carried a recent story disclosing that the University of Texas Investment Management Co. had allocated $500 million to purchasing gold, nearly 3 percent of the university’s total investment fund of $22.3 billion. On Aug. 1, the Chronicle carried a story discussing the reasoning behind this change in investment direction. The first reason discussed was the growing U.S. debt crisis. UTIMCO’s CEO, Bruce Zimmerman, also mentioned fiscal and monetary stimulus programs as being a potential source of inflation, where gold would typically outperform other asset classes. About the growing federal budget deficit, the article even quoted former Federal Reserve Chair Alan Greenspan as saying, “Unless we start to come to grips with the long-term outlook, we are going to have major problems. I think we misunderstand the momentum of this deficit going forward.”