Did an Arbitrage Opportunity Expose the Weakness in the London Gold Market?
The CME Comex is the Exchange where futures are traded for gold, silver, and other commodities. The CME also allows futures buyers to turn their contracts into physical metal through delivery. You can find more detail on the CME here (e.g., vault types, major/minor months, delivery explanation, historical data, etc.).
The data below looks at contract delivery where the ownership of physical metal changes hands within CME vaults. It also shows data that details the movement of metal in and out of CME vaults. It is very possible that if there is a run on the dollar, and a flight into gold, this is the data that will show early warning signs.
Gold
The data coming from the Comex continues to show unprecedented delivery volume. The analysis last month called out the massive divergence along with the post in December. This activity has now started to get the attention of the mainstream media:
- Mining.com attributes the activity to the fear of tariffs
- Reuters explains how the premium in gold prices on the Comex is creating an easy win arbitrage opportunity
- Kitco also highlights tariffs but explains the chaos this is causing
The possibility of tariffs created a gold premium in US markets. Despite billions of dollars of gold flowing from London to New York, the premium has still not closed. This continues to be a major story.
Wait times for deliveries are growing. If the physical gold markets remains under pressure like this, it’s only a matter of time before something breaks (if it has not already). The Kitco article above highlighted how major players are doing whatever they can to restore confidence to the system and get things to calm down. If they are unable to calm the market in the coming weeks and months, it could throw the entire London gold market into dissaray.
Expect the powers at be to do whatever possible to stop this from happening. The importance of the gold market can not be overstated. It could be argued that the confidence in the global financial system hangs in the balance!
Paper gold investors around the world might be waking up to the fact that, “if you don’t hold it, you don’t own it”!
The Premium
First, let’s take a look at the us premium that has created this chaos. The chart below shows that premium of the futures contract on the Comex over spot.
Figure: 1 Spot vs Futures
As shown above, prior to Covid, it was a bit chaotic. During early Covid the Comex came under pressure, similar to how it is today… just on a smaller scale (more on this below). Once the market stabilized, the futures/spot spread came under tight control. This can be seen above in the very consistent zig-zags over the last few years. Then after the US election, the market went back into turmoil… prompting the strain in the physical market.
So how much strain? The chart below shows delivery volume going back 5 years. It’s clear to see just how different things are today.
Figure: 2 Recent like-month delivery volume
So, what drove this massive delivery volume of 74,518 contracts or $22.3B? The February contract was already coming in hot, but then there has been a massive surge in net new contracts coming in throughout the month (just like last month). These are contracts that open and settle immediately with delivery. The chart below shows how much this deviates from past months.
Figure: 3 Cumulative Net New Contracts
So, how has the Comex respond to this? It has seen a massive increase of gold flowing into its vaults. As shown below, this is looking similar to the response during early Covid. The market came under strain and the Comex moved quickly to restore confidence.
To restore confidence, the Comex changed their delivery requirements allowing London 400oz gold bars to be deliverable. This is what brought on so much inventory in early 2020. It wasn’t new metal getting brought in, it was existing metal that was recategorized as being delivery eligible. Unfortunately, that card has already been played so there is no easy fix this time around. The metal flowing in is not just from an administrative change like in 2020 but actual physical metal flowing into vaults.
Figure: 4 Inventory Data
So is this trend getting close to exhaustion? The data does not indicate as much. The chart below shows the open interest going into the March contract. It should be noted that March is a minor month and not a major month. We will not see 70k+ delivered like in February, but we could still see massive delivery volume for a minor month.
Figure: 5 Open Interest Countdown
Even with the massive surge in inventory the open interest relative to physical stocks is still at very elevated levels.
Figure: 6 Open Interest Countdown Percent
Silver
Silver is a minor month in February but that didn’t stop it from also seeing elevated demand. The silver market is not coming under as much pressure as gold (yet?), but it is still seeing large delivery volumes.
Figure: 7 Recent like-month delivery volume
Net new contracts in silver were much more in line with history as well.
Figure: 8 Cumulative Net New Contracts
That said, the Comex has taken action to restock inventory levels (plotted separately). As the plot below shows, Eligible has seen a massive surge higher.
Figure: 9 Inventory Data
Registered silver is also seeing increases.
Figure: 10 Inventory Data
March is a major delivery month in silver. The contract currently sits above trend which should indicate another big delivery month coming up.
Figure: 11 Open Interest Countdown
On a relative basis, open interest is actually quite low because of how much the Comex has restocked silver inventories.
Figure: 12 Open Interest Countdown Percent
Conclusion
What if what started as an arbitrage opportunity all of a sudden exposed the weakness in the London gold market? Maybe something like this:
- The possibility of tariffs created a gold premium in US markets over spot
- Traders capitalized on this arbitrage opportunity by taking physical delivery
- Metal started moving from London to New York
- Wait times quickly grew which rattled confidence in the London gold market
- The premiums remained elevated because of growing concern in London
- The arbitrage opportunity remained
- Deliveries continue putting more strain on the market
- The cycle repeats
If things keep up as they have been, this is no longer something that will take months to play out, not years.
It is very possible that someone steps in and does something. It might be a change in rules or some other action to calm markets. If they succeed then the markets should quiet down. However, if they don’t things could get very ugly, very quickly.
As noted above, the global financial system hangs in the balance. Someone is going to do something, will it be enough?
