OK, this is required reading From Ann Barnhardt. She does an excellent job articulating how the futures market works and how its continued operation is in serious trouble. Understand the problem is simply one of confidence, specifically the lack thereof. Decoupling of the gold futures and the cash market must happen when:
1. When cash sitting with a commodity broker can “disappear” like it did at MF Global.
2. When your positions can be frozen by the exchange, effectively locking you in positions where you cannot close them to protect yourself from fraud like we see at MFG.
3. When it occurs to enough people that there isn’t sufficient supply to provide real delivery on demand, not the delivery of a promise to deliver.
It is only a matter of time before the paper price of gold and the spot cash price diverge. When it does diverge it will be disorderly and sudden. This is because the situation is dynamically unstable. No manner of smoke and mirrors or shoestrings and bubble gum is going to change the fact that we are talking about fraud. The Go to Jail and Do Not Collect $200, Ass in the Slammer and Throw Away the Key kind of fraud.
The thing newbies to this kind of thinking must realize is that the price of gold will not rise to Freegold valuations, it must fall hard first. This is simply because the paper gold (futures) market cannot exist with Freegold. Freegold cannot be “free” until the paper market dies and paper supply collapses with it. This very process frees gold.
Since gold is priced by the futures market, price will fall as the process Ann describes plays out. It will dawn on people at some point that “in your hands physical” is the only safe place to be where your capital has a 100% chance of being retained and not stolen. The smart ones will immediately cash out in dollars and head for somewhere where they can acquire physical. The dumb ones will attempt to take actual delivery, and I mean actual where they hire a Brinks truck to pick the shit up at the vault. Then they will find out that the “delivery” was really and IOU (Certificate) for gold. When they show up at at the vault they will be informed that the gold has already been removed by some guy that an identical Certificate. That’s when the shit hits the fan and real panic sets in.
In short order we are going to see a divergence of the paper price and the spot price. For us small ants it will look like this: we will be licking our chops as price collapses on the Comex and we will call our favorite gold dealer with a purchase order. He is then going to quote us a price that in no way resembles the price on the CNBC ticker. He will politely tell you that the real price is what he is quoting, and that is if you are lucky. This is going to happen so fast he probably will say he’s not a seller at any price, but would be more than happy to buy your gold.
Waiting for the gold price to plunge in order to pick up your physical at a bargain price is a fools errand and will end with you holding a fistful of dying dollars. The flow of gold will disappear and gold will go into hiding. Only a Freegold price will bring it back out into the light of day.
So be happy when the price of gold is rising, it means you can still buy physical gold with your bank credit. Do not be happy because you are richer, it is a pittance compared to real Freegold valuations. Do not be depressed when gold price plunges because you are less rich. Be depressed because you do not have enough physical gold and do not have the capability to purchase more. Be happy when price plunges if you have spare bank credit or have enough physical gold to preserve your wealth at Freegold valuations.
If you’re not happy do something about it! You know what to do, do it!!!!
On Sychophants, Process Servers & Decoupling
1. Corzine and Abelow testified again before the House Financial Services committee, and it was another nausea-inducing spectacle. Today’s questioning was actually WORSE, because Terry Duffy had lobbed the committee a grapefruit on Tuesday regarding Corzine’s knowledge of the customer seg funds being raided and sent off to Europe. (OF COURSE HE KNEW. BACK OFFICE TREASURY DATAPUNCH CLERKS DON’T SEND CUSTOMER SEG FUNDS TO EUROPE OR ANYWHERE ELSE OF THEIR OWN VOLITION.) But, of course, none of the congresscritters were even remotely smart enough to ask about any of that. In fact, one chick congresscritter was fawning over Corzine so hard, I honestly thought that she was going to come down off the dais, crawl in Corzine’s lap, push back his greasy mullet, and start blowing in his ear. Her line of questioning – if you can call it that – was along the lines of, “Mr. Corzine, is it possible that no one within the company notified you of any problems because you are so brilliant and awesome and thus people find you intimidating?”
2. The best part of the whole day was Corzine getting served with a big ol’ lawsuit as he walked out of the hearing room during the break. A commodity trading advisory service who is hung out to dry for into the NINE FIGURES is suing the top 20 or so executives in the company. AWESOME. Here’s the video:
3. Finally, a very simplistic explanation of how the cash commodity markets are soon going to decouple from the futures markets. This is a little complex, but stay with me. I think this is important to understand because none of us who have lived our whole lives in the U.S. have ever seen a market disintegrate.
The threat (or promise) of delivery upon expiration is what keeps the futures markets tethered to the cash markets. Up until now, if an unreasonably wide spread between the futures price and the underlying physical commodity market got too out of whack, a process called “arbitrage” would kick in. Arbitrage is when a party simultaneously buys and sells on two separate but related markets in order to capture an inefficient spread between those two markets.
I’m going to use precious metals as my example commodity because there are alot of metals guys reading this, and because the metals markets will be the big tell in term of when decoupling and thus total futures market disintegration is upon us. But these examples apply to all of the physical commodities.
Let’s say that the physical silver market is trading far lower than the silver futures price. This is what is called a WEAK BASIS. The BASIS is the relationship between the cash market and the futures market and is very simply defined as (CASH minus FUTURES). If cash silver can be bought at $25.00 per ounce and the futures are at $30.00 per ounce, the cash is $5.00 under the futures. When cash is under the futures, this is called a WEAK basis.
Up until now, what would a metals trader do? In very simple terms, he would buy the cash silver at $25.00 per ounce and then simultaneously sell the futures at $30.00. Because he has short-sold the futures, he could hold the contract to expiry and then deliver the $25.00 cash silver he bought to make good on the contract and receive his $30.00 price. So his simple net profit would be $5.00 per ounce. As many traders saw this spread and simultaneously executed this same strategy of buying the cash and selling the futures, what effect would this have? Right. It would cause the cash-futures spread to move back in toward convergence by pushing the futures price down (lots of sellers) and propping the cash market up (lots of buyers).
Now the opposite scenario: a STRONG basis. Let’s say cash silver is trading at $32.00 and the futures are trading at $28.00. A trader might take physical silver that he has in inventory and sell it in the cash market, and then immediately take those proceeds and buy back and equal number of ounces in the futures market and take delivery. Since the same number of ounces in the futures market cost $4.00 per ounce LESS, he would end up with the same number of ounces in his inventory PLUS $4.00 per ounce in CASH in his pocket. If he and many other traders saw this condition and they all sold cash silver and bought the futures, this would, again, converge the spread between the cash market and the futures market.
The lynchpin that is holding this dynamic together and keeping the futures markets tied to the underlying cash market is the fact that the futures contracts are deliverable, and a trader can either deliver or take delivery of actual physical silver via his futures position.
Are we seeing a problem yet? The futures markets have lost their viability and trustworthiness because of the MF collapse and theft. At some point in the not-too-distant future, people everywhere are going to realize that the delivery mechanism is not reliable. Heck, just holding cash and/or positions in a futures account is no longer reliable. The the market itself is not reliable, traders will no longer attempt to arbitrage these basis spreads because the risk to the trader that the rug will be pulled out from underneath them is simply too great.
And in the metals markets, the delivery process itself is . . . um . . . shall we say, easily corrupted? When you “take delivery” of physical metals, it doesn’t get sent to your house. All you get is a certificate saying that X number of ounces are being held in a certified vault somewhere with your name on them. After the MF collapse, that sounds like a joke, right? A CERTIFICATE with my NAME ON IT? Yeah. That really is how it works.
When the arbitrageurs finally lose all confidence in the markets, the cash market will decouple from the futures because no one will be willing to take the risk of having their money, positions and/or physical metals stolen/confiscated. If no arbitrageurs are willing to trade these spreads – no matter how wide they may become – and thus there is no force causing the cash and futures to converge, we will see the basis spreads become extremely wide. As people flee the futures markets, the futures prices will drop, while the cash markets hold steady or even diverge and actually rise as all of the former paper players realize that physicals are the only remaining game to be played.
Watch for this. Watch for the gold and silver futures to sell off as people walk away from paper while the online cash dealers, seeing that market demand for their physical inventory is robust, begin to ignore the futures prices and hold their prices steady or even raise them. When you see this basis decoupling and absence of arbitrage, lo, the end is nigh. A parabolic spike is coming.