Counterparty Risk May Lead to Potential Squeeze in Gold Market

Gold rallied sharply last week and was up nearly 9% despite continuing uncertainty and a very mixed performance in stock markets. The US dollar index fell some 4% on the week and it looks increasingly likely that the dollar may have topped out and may soon resume its bear market. For the year, gold is now up by more than 4% in dollar terms and by much larger amounts in euros (+11.7%) and pounds (+40.4%).

Gold rallied sharply on the open in Asia and has remained elevated as oil is stronger (up some 4%) and the dollar remains weak.

The FT reported late Friday on the potential for squeeze in the gold market by year end which would see prices rise materially.

The FT’s Chris Flood reported that:

Traders have been hearing talk that the gold market could face a potential squeeze at the end of this year if market participants with futures position on New York's Comex exchange decide not to roll over their positions, because of concerns about counterparty risk and opt for physical delivery instead.

But dealers dismissed the threat of a squeeze, pointing out that Comex gold stocks stand at 8.5 million ounces, well above the five-year average of almost 6 million ounces. ..."

The 8.5 million ounce figure cited by the FT is actually the total Comex gold inventory which includes gold that belongs to customers who are storing it on the exchange which is not available for delivery. The amount that is registered to dealers, and therefore available for delivery, is only 2.846 million ounces. The delivery notices that have been issued so far in December total 1.26 million ounces, which is 44 percent of the available deliverable gold. There is also the possibility that some of the gold may be encumbered in lending/swap operations.

According to the Gold Anti-Trust Action committee (GATA), the Comex authorities themselves have been alerting various futures firms about the potential of a squeeze on the December contract . The Comex is allegedly advising the $840 December shorts to exit their remaining open positions. There have been 12,636 notices of delivery. The shorts have until December 31 to make delivery. Normally they deliver early to take in cash and earn the interest.

This represents about 43 percent of the gold available at the Comex. Some speculate that concerned futures players could buy the February gold contract and then spread into December, which would shock the shorts and lead to a massive short squeeze sending prices markedly higher in a short period of time.

Former Federal Reserve Governor Says Fed’s Gold is Important Asset

Another bullish development for the gold market was former Federal Reserve Governor, Lyle Gramley reassuring that the Federal Reserve’s solvency was not at risk (due to its rapidly deteriorating balance sheet). Gramley denied such concerns were valid as he said the Fed has significant assets in the form of undervalued government gold certificates.

Interviewed Monday last week on the "Trading Day" program of the Business News Network in Canada, Gramley hinted that a big upward revaluation of gold may figure heavily in the Fed's attempt to rescue the U.S. economy. Gramley, now senior adviser at Stanford Group in Houston, was asked about the seemingly grotesque expansion of the Fed's balance sheet in recent months by the program's guest host, Niall Ferguson, an author and history professor at Harvard.

Ferguson asked:

I've heard it said that the Fed has turned into a government-owned hedge fund, leveraged at 50 to 1. Do you feel nervous about what this might actually do to the Fed's reputation?

Gramley reponse was:

I think you have to reckon with the fact that one of the Fed's assets is gold certificates, which are priced, as I remember, at $42 an ounce, and if we were to price them at market prices, the Fed's leverage would look a lot less than it is now.

More signs that gold is increasingly being viewed as the potential savior of central banks internationally from the global deflation gripping the world. The Federal Reserve is one of the largest holders of gold in the world with most of its foreign currency reserves in gold. A devaluation of the dollar and revaluation of gold may help the U.S. government and the Federal Reserve to protect their solvency and inflate their way out of a Depression.

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