The Comex gold contract is coming into focus at the moment as the gold price starts to rise, but there are some questions being raised as the usual players in the Comex gold contract try to cover their shorts. Bullion banks in particular are known to wait for the market to become overly bullish about the gold price in order to cover their short positions.
Historically, as prices have risen – e.g. July 2016 – bullion banks have moved to cover their short positions and drive the price down. It is a trend that has evolved out of the use of the Comex futures markets to offset long bullion positions at the LBMA. Very few longs stand for delivery on Comex gold so many contracts need to be rolled, a process which generated a discount on the Comx gold contract for June 2020.
“Over time, bullion bank traders increased their trading position limits, as opposed to their pure hedging activity, making easy money jobbing the other side of the managed money trades,” explains Alasdair Macleod, Head of Research at GoldMoney.
Macleod has highlighted the fact that swaps in Comex gold are more short than they were in July 2016 although open interest is lower. The mark to market is a record new short at just over $36 billion. He says producers and merchants in the gold market have cut their positions, having potentially decided that hedging mine output is less important in the current inflationary environment.
Meanwhile, according to GoldMoney and Comex data, hedge funds are only 25,000 contracts longer than average (June 2016 data). Unlike hedge funds, new players on the long side of the market – e.g. family offices and those buyers who actually want to take delivery of physical bullion – are going to stick around.
This has raised an interesting conundrum for bullion banks. Macleod says the banks are trying to “put a lid on the price”, but this means they are facing rising open interest and rising mark to market positions. The key is the August active contract – bullion banks may be forced into taking large delivery volumes. Comex premiums to the London spot price are also likely to go unchallenged.
“It is increasingly possible the gold contract is evolving into deep crisis, and that force majeure might have to be declared if, as seems increasingly inevitable, a wider banking crisis ensues,” says Macleod.
There seems to be a lack of risk appetite among the banks that are normally active in arbitraging the market against the OTC gold price. The EFP (exchange of futures for physical) blow out in March seems to have affected gold market liquidity.
“Gold remains a large, liquid market, but…it’s not functioning as well as it used to do,” commented John Reade, Chief Market Strategist at the World Gold Council. “This appears to be a particular problem for futures market speculators and investors and may partly explain heavy US-listed ETF buying over the past three months.”
Gold prices have remained north of $1800/oz on Monday, as the US dollar weakened and concerns over the further spread of COVID-19 intensified. “The COVID-19 narrative is not going away and we don’t think the US Federal Reserve is going to change course on the rates anytime soon,” said Stephen Innes, Chief Market Strategist at AxiCorp.
