paper or plastic -- the effects of paper trading on hard commodity prices

[grapejelly]

Hedge funds, bank credit and other leveraging mechanisms has been increasingly used to fund trading of commodities.

Many of these commodity markets are very thin. The big pools of credit-financed capital are the 800 pound gorillas in these markets that can obliterate the traditional supply and demand dynamics between producers and consumers in these markets.

I believe that commodities such as gold or silver are primarily traded on the futures market. Very few people take delivery (under 2% I am told). So:

1. large pools of capital paper trade these commodities
2. these large pools have no interest in the commodities other than
speculation
3. most trades do not involve physical delivery, or if they do, it's in the
form of transferring title rather than physically moving goods from
one party to another for purposes of consumption

Normally commodity futures markets are in contango, so the further out delivery is set, the higher to price. This premium pays for carrying costs and risk of loss.

However, normal contango premiums can grow or shrink and even fall below zero.

It is my contention that this happens with paper trading and that this can completely screw up the underlying physical market. So while in theory the gold price may be $650 as set by the futures market, perhaps the physical price of gold is $700. Arbitrage is what keeps these aligned, but what if physical is in such demand that there is inability to deliver?

I'm wondering what your thoughts are on the possibility
of certain commodities (like gold or silver) skyrocketing in price if and when it becomes evident that the paper traded price is insufficient to actually meet real physical demand and if failure to deliver could result in a breakdown in these markets.

[Spartacus]

Re: paper or plastic -- the effects of paper trading on hard commodity prices

I'm a little concerned that the legal framework in the US has evolved to protect the large financial institutions and that legal framework is now tilted against the normal investor in PMs and the industrial user.

Note the new products being traded on NYMEX and COMEX that involve no delivery obligations. How does this possibly make sense for a commodity exchange? Set up a separate company, maybe a subsidiary that trades horse-track tickets called "Silver contracts", but don't rip out an exchange's raison detre ON THE SAME EXCHANGE.

I can't wrap my head around that one at all.

I do foresee the possibility that one will not be able to buy actual, real, physical Gold, Silver and Platinum - no one having these will be willing to sell at prices as are set by the large traders on the futures exchanges - traders who may never, ever have to deliver are setting the delivery price.

Considering the London Zinc exchange just a few months ago defaulted on deliveries and took an enormous hit to its reputation, one would think exchanges would be cleaning up their acts, but I don't see it.

I'm wondering what your thoughts are on the possibility
of certain commodities (like gold or silver) skyrocketing in price if and when it becomes evident that the paper traded price is insufficient to actually meet real physical demand and if failure to deliver could result in a breakdown in these markets.

[jk]

Re: paper or plastic -- the effects of paper trading on hard commodity prices

this situation is reminiscent of credit default swaps which far outsize the bonds on which they are supposedly providing insurance. this has led to problems when the cds's were written to require delivery of the underlying impaired credit. [translation for those who need it: the insurance policies written on, e.g., gm bonds becoming junk, required that the insurance policy holder deliver the now-junk bonds in order to be paid off on his "insurance" bet. {i'm making this example up, though it may in fact be true i'm not sure that this was in fact an instance of the phenomenon i'm describing.} but far more "insurance" was written than there were underlying bonds. so the people who thought they were making "a bet" that gm bonds would go to junk couldn't collect.]


a reverse example occured when pimco, the bond mutual fund giant, demanded delivery on a whole bunch of bond futures contracts after having bought much of the underlying issues, thus squeezing the futures sellers.

these games will be played.

[grapejelly]

Re: paper or plastic -- the effects of paper trading on hard commodity prices

I believe in the bonds cases, one for treasurys and one for GM bonds, the parties agreed to exchange US$ in lieu of delivery.

This and the no-delivery gold futures show the game for what it really is, which is pure gambling speculation. It's a confidence game, that this Monopoly money trading has anything to do with an actual physical commodity.