Monday, February 21, 2011

Silver, the Opportunity of the Decade - Part 2: The Comex, what is it?

Last December, when President Obama announced a tentative deal with Congressional Republicans to extend the Bush-era tax cuts at all income levels for two years, you could clearly see the writing on the wall.

Extending those tax cuts will cost $900 Billion - equal to QE2. In essence we had QE3.

And as the political realities of the mounting debt issues of the US Federal Goverment met head on with the burgeoning debts of the individual US States and cities, there is no practical way out of the debt problem – none.

QE4, 5 and 6 are all but assured.

And it's not just America.

China has been printing money too...

The UK has been printing money...

Japan has been printing money...

India has been printing money...

And so has the EU...

As I wrote last May, the story of the coming decade is one of soverign debt and how nation's respond to it.

I wrote then that this is already creating a mini-panic and rush on precious metals, a trend which will only intensify. Almost a year later, that demand has most definately intensified.

For large scale buyers of precious metals, the primary source to acquire Silver is via the COMEX.

So before talking about what is happening in Silver, we must first understand the COMEX and how it works.

What is the Comex?

There used to be two exchanges in New York. The New York Mercantile Exchange and the Commodity Exchange, Inc (COMEX). In 2006 these two exchanged merged and became one. It is now the New York Mercantile Exchange (NYMEX) but is divided into two parts, the NYMEX Division upon which is traded such commodities as oil, gas, palladium and platinum and so forth, and the COMEX Division on which gold, silver copper and aluminum is traded. On this exchange are traded 'Future Contracts' of gold and silver.

Futures Trading

Futures trading is the basic action of entering into a legal contractual agreement with another (known or usually not known) individual to exchange money or assets of some value at some time in the future and with the pre-determined price (called a futures price) based on the underlying asset. Such an asset could be stock, an interest rate even or, in this case gold or silver.

So traders agree to exchange gold/silver (or equivalent cash flows) at a future date.

When you enter into these contracts you are betting that the value or price of that asset or stock or gold is going to be at a certain value at a predetermined time in the future. At that time, when the contact is completed and 'settlement date' arrives, you or the other party cough up with the difference between what was originally paid and what the settlement price is.

One of the perceived advantages of futures trading is that you do not have to put up all the money needed for the contract but usually only a percentage. Usually around 10%. This means that people can trade with a smaller amount. It is rather like going to the races and placing a bet for 1000 dollars but only putting 100 dollars down. If you lose you have to come up with the 1000 dollars of course but if you win you have only needed 100 dollars to play the game. There are some other factors, of course, but that's the primary gist.

Both parties of a futures contract must fulfill the contract on the settlement date. The seller then delivers the commodity to the buyer, or, more often than not, it is a cash-settled future, and cash is transferred from the futures trader who sustained a loss to the one who made a profit.

Incidentally, you can bet both ways of course, that the price will go up or down.

To take actual phyical delivery of the silver in a contract, you will need to wait until the term of the contract expires and you can take delivery. This is called taking a long term. Various entities, such as banks for example, take a short term. They have no intention of taking delivery and so, with the ten percent leverage mentioned earlier, they can take enormous amounts of contracts and sell them short, keeping the price down and, in effect, manipulating the gold and silver price.

But if you intend to take possession you will have to ante up the whole amount required to complete that contract and you would have to wait until the contract expires before you can organise and take delivery.

For example, if a contract was bought today, and the price on the gold contract was between $695 - $735 per ounce, the full value of the contract you bought would be $69,500 - $73,500 per 100-troy ounce. Likewise if the price on the silver contract was between $9.74 - $9.16 per ounce, then it would be $48,700 - $45,800 per 5,000 troy-ounce contract.

These figures would not include any commission charges incurred going through a broker of course and are just an example to illustrate how it works.

Of course, if you did not want to take possession of the metal you could simply enter a position without posting the full contract value, but instead post around 10 percent (The actual percentage may vary depending on your broker and other factors). This is the "margin" which is posted "in good faith". Price can go through some dramatic changes in the any futures market and if the price of gold drops significantly you might be called upon to add funds to your account to maintain your position. (called a maintenance margin) or you might find your position is liquidated. There is usually a risk maintenance level and if your account falls below that level then you would need to top up your account with the requisite funds.

Now, when the time comes to take delivery you will get a Notice of Delivery and the full amount will be debited from your account. So you would be required to have the full contract value deposited in your account with your broker at the price the contract was originally purchased. There would be a few days of processing at the end of the contract but then you would be able to take possession, usually a couple of weeks later.

You can do this in three ways.

You will receive a receipt, which in effect is like a stock certificate, and you could store that. The gold would be in storage in a vault and you would be up for some storage charges, This premium, compared to the gold price, will be minuscule. The gold is kept in storage for you and you can take physical delivery anytime you want of course. This is the first method.

The second is that you could have the gold bullion shipped to a warehouse. You can be put in touch with the vault that contains your gold (generally in or around New York, US) and have brinks or an Armored car transfer your gold to a warehouse or bank of your choosing. There would be more costs involved with this but, again, the charges would not be very much compared to the value of the gold bullion.

Of course you can avoid doing any of this by simply depositing the full value of the contract when you establish the position. Note, you can decide not to take delivery of course at any time and close out your metals position and take a profit or loss depending on the price movement.

However, IF you want to take it out of the Comex warehouse and have it stored elsewhere then it would be your responsibility to organise this. This would be typically done through a security shipping service and arranged storage at a bank vault.

If your intent is to actually receive the physical metal, it is held in storage at specific "delivery points." It is your responsibility to make the arrangements to do this. There are fees associated with removal from the storage facility. In addition, if the metal is taken out of storage, it cannot be sold for delivery on the exchange without being re-assayed.

Tomorrow we'll talk about the banking cabal manipulation of the Comex, something you will see on a massive scale in overnight trading of silver tonight in a desperate attempt to bring the price of silver down.



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