Posts Tagged ‘Futures’

Something fishy happening in the physical gold and silver market

Thursday, December 9th, 2010

Have you noticed something fishy going on in the silver market? Take a look at this chart:


This chart shows the ratio of gold to silver prices over a period of a year. As you can see from the trend, silver is getting more and more expensive relative to gold since before September. If you extend the period to 36 years, you will see this:


The latest move is pretty major, even when you see it from a time-frame of 36 years.

So, what is the story behind this major move? Remember what we wrote in page 59 of our book, How to buy and invest in physical gold and silver bullion? There, we wrote about the possible fuses that can ignite silver prices. In that section of our book, we mentioned the colossal short silver positions of JP Morgan.

Well, according to J.P. Morgan and the Great Silver Caper,

?A viral campaign (Crash JP Morgue Video [below]) to buy a physical silver and ?crash? the bank is now spreading like wildfire on the Internet,? SFGate reports

Even more fishy is that the futures market for gold and silver are in backwardation (see Investors to Silver: ?Let?s Get Physical?). In case you do not know what "backwardation" means, you may want to take a read at How futures price affect market price. What does this mean?

Well, in theory, backwardation is not supposed to happen. But if it happens in reality (as it is happening right now, which is rare), it is a sign of distrust in the paper gold/silver markets as traders/investors are queuing up to take physical delivery of the precious metals.

Another interesting observation: as you know, we are an affiliate partner of We noticed that all the customers that we referred to them are buying silver. We have yet to see a gold purchase.

Note: This article is not financial advice. Take it as a piece of juicy ‘gossip’ from the financial markets that we are passing to you.

Precious metals shenanigans- ETFs to be delivered for futures

Thursday, August 13th, 2009

One question we often ask ourselves is: how much are the prices for gold and silver manipulated? Remember, back in Possible fuses that can ignite silver prices: price manipulation, we wrote that,

The problem is, the paper silver that is being sold through the futures market is unlikely to exist. Why? Commodities traders on COMEX have made bets in which they promise to deliver more than twice the amount of silver known to exists!

As the prices in the futures market affects the prices in the spot market, any manipulation in the futures market will indirectly manipulate the prices in the spot market.

Also, a lot of ‘gold’ and ‘silver’ are traded in the form of ETFs. At Possible fuses that can ignite silver prices: ETFs, we asked,

A very big question to ask is this: how much of the ETFs are backed by the physical precious metals?

Since ETFs accounts for a significant fraction of demand for precious metals, how much of these demand translate into actual demand for the physical precious metals?

Then, there’s another piece of shenanigan. As this article from the Gold Anti-Trust Action Committee (GATA) alerted us to this document from the US Commodities Futures Trading Commission (CFTC),

The New York Mercantile Exchange, Inc. (“NYMEX” or the “Exchange”) hereby notifies the Commodity Futures Trading Commission (“CFTC”) that, as set forth in the attached rule interpretation, it will accept gold-backed ETF shares as the physical commodity component for EFP transactions involving COMEX gold futures contracts, provided that all elements of a bona fide EFP pursuant to Exchange Rule 104.36 are satisfied.

In other words, gold ETFs can be delivered in lieu of the physical gold commodity as part of the obligations of the futures contract!

Humanity has finally invented alchemy!

Possible fuses that can ignite silver prices: price manipulation

Sunday, June 21st, 2009

We will continue our silver series today from our previous silver article. The full guide in our silver series can be found here. This article will assume that you have already read all the previous articles in our silver series.

As you know by now, we believe that silver prices are severely undervalued.

In fact, it is likely that it is manipulated. It seems that certain entities are using the New York Commodities and Mercantile Exchange (COMEX) to use it to offload a lot of paper silver into the silver market. To do that, it sold a lot of silver futures into the COMEX market (that is, it sold a lot of promises to deliver physical silver in the future). As we explained in How futures price affect market price, the futures price have an effect on the spot prices (market prices). By manipulating the futures prices, the spot prices of silver can be manipulated.

The problem is, the paper silver that is being sold through the futures market is unlikely to exist. Why? Commodities traders on COMEX have made bets in which they promise to deliver more than twice the amount of silver known to exists! If the traders who bought the promises to deliver silver in the future demand the physical silver, the rest of the world have to be starved of silver for more than a year. That means all production of iPhones, Blackberrys, netbooks, notebooks, etc has to be ceased for a year. No other commodity has such a large short position. In contrast, the amount of gold sold through the futures market amounts to only 2.5 percent of known inventory.

Even more suspicious, of all the commodites, silver have the largest proportion of futures contracts held by the smallest number of traders. Only 4 traders hold the vast majority of the silver short (sell) positions, of which just one or two hold more than 50 percent of all of them. This means only couple of entities are controlling the price of silver for the rest of the world. These 4 traders have sold, for future delivery, more than 4 months of worldwide silver production.

The market for paper silver is far larger than the market for physical silver, with the prices of physical silver determined by the prices of paper silver. That means that the prices of physical silver are artificially set far too low. This means that with such artificially low price, the consumption of physical silver is much higher than what it should be had market prices been allowed to find its price level. Couple that with the declining supply and constrained production of silver, it will only be a matter of time before the paper silver market will fail (i.e. all these ‘promises’ to deliver physical silver fails), sending prices of physical market soaring. As this Time magazine article reported (in 2001),

Still, the jump in price spread chaos across the market as Buffett called for delivery of more than 42 million oz. of the silver he had bought–after already having some 87 million oz. in tow. Panicky short sellers, who had borrowed silver and sold it in the expectation that the price would fall, had to swallow huge losses to complete the deals. Major buyers of silver like Eastman Kodak, which processes millions of ounces a year into film, faced big increases in raw-material costs. And everywhere families began eyeing grandma’s precious flatware as a possible source of cash. “We think we may see the spike reach double digits–maybe $10 an ounce–but one doesn’t really know in this rarefied territory,” says Nick Moore, director of Flemings Global Mining Group in London.

In 2001, Warren Buffet reported buying up 129.7 million ounces of silver. His demand for physical delivery caused chaos in the market.

This silver price fuse is a Black Swan event

Pricing of gold forward rate

Wednesday, April 8th, 2009

Back in Pricing of futures, we discussed about the theoretical pricing of futures. But the futures price (or more technically correct, the forward price) of gold is calculated differently. This is because there is a lease rate for gold. As we mentioned before in Get paid to borrow gold and silver?,

But for a certain class of gold owners, they DO earn interests on gold. Right now, instead of receiving interest for lending out gold, they are paying people to borrow gold.

The best way to explain gold forward pricing is to use an example. To understand this, we assume that you have already read and understood Pricing of futures beforehand. Let’s suppose the spot price of gold is $1000 per ounce. The lease rate for 180 days is 2 percent per annum while the carry cost (which includes storage and interests) is 5% per annum.

So, we borrow $1000 for 180 days. At the carry cost of 5%, we have to repay $1000 * (1+.05(180/365)) = $1024.66 in 180 days time. With the borrowed $1000, we buy 1 ounce of gold and lease it out. At the end of the 180 days lease period, we expect to get back 1 * (1+.02(180/365) = 1 (1.01) = 1.01 ounce of gold.

Therefore, 1 ounce of gold has grown to 1.01 ounce in 180 days time at a value of $1024.66. Therefore, the forward price of gold will have to be $1024.66/1.01 = $1014.51. If the 180-day forward price of gold is not at $1014.51, then an arbitrage opportunity exists (see How futures price affect market price for more details).

To sum it all up with an equation, if the spot price is S, the forward price is F(T) for a time-horizon of T days, the carry cost is r, and the gold lease rate is r*, we have:

F(T) = S [1 + r (T/365)] / [1 + r* (T/365)]


How futures price affect market price

Wednesday, May 28th, 2008

In our previous article, Who is to blame for surging food and oil prices?, we mentioned that institutional investors,

… through the futures market, affecting futures price, which in turn affected the spot prices (i.e. the real world market price).

Now that we have explained the basics of futures in Introduction to futures and Pricing of futures, we can now explain how those Index Speculators can affect real world market price through the futures market.

What happens, if the Index Speculators push up the price of a commodity futures above its theoretical price? When that happens, there will be an arbitrage opportunity.

Let’s say the price of a July futures is $110 when its theoretical price is $105 (i.e. spot priceĀ  of $100 + carry cost of $5). In that case, you can sell the overpriced July futures at $110 and buy the underlying at $100. When the futures expires in July, you can then sell the underlying at $110. Your arbitrage profit will be $5 ($110 futures price – $100 spot price – $ carry cost).

What if the futures price is below its theoretical price? Let’s say, the futures price is now $103 instead. You can short sell the underlying at $100, earn the carry cost $5 (e.g. interests) by holding the proceeds of the sale as cash. When the time comes to close out your short position in the underlying, you can buy the underlying at $103 when the futures expires. Your arbitrage profit will be $2 ($100 short sell proceed + $5 carry cost – $103 close out short sell position).

All these are at least true in theory. In reality, for whatever reasons, futures price can veer out of its theoretical price. It can even fall below the spot price! That phenomenon is called “backwardation.”

And one last thing. Critics of Michael Masters’ theory that Index Speculators are behind the price inflation of commodity prices will point to the fact that inventory levels had not risen considerably as a result.

Pricing of futures

Monday, May 26th, 2008

After having introduced futures yesterday in Introduction to futures, we will explain the basics of futures pricing. It must be noted that the pricing of futures is a theoretical concept, which is what the price shoud be. In real life, the actual price could deviate from its theoretical prices for various reasons.

The pricing of futures is very simple:

Futures price = spot price + carry cost

The spot price is the prices fetched by the underlying in the market.

Next, what is the carry cost? The carry cost is basically the cost to hold the underlying. One of the components that makes the carry cost is the opportunity cost of interest foregone when holding the underlying till expiry of the futures. For example, let’s say you want to hold 1000 stocks of a company at $1 (which is the spot price or market price) each for 12 months. What is the carry cost for holding those 1000 stocks? At 10% interest rate, the carry cost is $100 (or $0.10 per stock) over 12 months. Therefore, if a futures contract expires in 12 months time, then the futures price for that stock as underlying is:

$1 (spot price) + $0.10 (carry cost, which is the interests foregone for holding that stock over 12 months) = $1.10

If the stock pays dividend within the 12 months, then this dividend plus the interests associated with that dividend itself will be adjusted in the carry cost to arrive at the theoretical value of the futures.

For stocks, since it is an intangible thing, the carry cost is basically the interest foregone (and the dividends plus the interest on dividends). But for physical commodities (e.g. oil, gold, copper), the carry cost involves warehousing, insurance and other costs associated for physically holding them.

So, what if in actuality, the futures price deviates from its theoretical price? Keep in tune!

Introduction to futures

Sunday, May 25th, 2008

In our previous article, Who is to blame for surging food and oil prices?, we explained Michael Masters’ argument that the distortion of prices in the commodities futures market will affect the prices of commodities in the spot market (i.e. its real world market prices) and by extension, its inventory levels. If you can demolish that argument, you effectively demolish Michael Masters’ testimony.

We will not attempt to do that here. But today, we will introduce what futures is in order for you to have some understanding of the interaction between futures prices and spot prices.

First, what is a futures contract?

Basically, it is a contract to buy or sell something at a pre-determined price in the future. For example, if you buy a June futures contract for gold at $1000, it means you have entered a contract that obliges you to buy gold at $1000 in June. Conversely, if you sell a June futures contract for gold at $900, you are obliged to sell gold at $900 in June. In this example, gold is the “underlying” of the futures contract and June is the “expiry” of the futures contract. In the financial market, there are all sorts of “underlying” for futures, from stocks, bank bills, bonds, commodities and so on.

Thus, if you have an existing futures contract to obliges you to buy or sell an “underlying” in the future, you are said to have an open position. What if you want to absolve yourself from that future obligation? You need to enter an opposite futures position at the current market price to close out that position. For example, if you have already bought June futures for 100 ounce of gold, then you have to sell June futures for 100 ounce of gold at whatever the market price to close out your futures position. If you have already bought the futures at $950 per ounce and sold the futures (to close out your position) at $900 per ounce, then you have made a loss of $50 per ounce.

That’s all for the introduction to futures. For those who are un-initiated to futures, isn’t it surprisingly simple? Next, we will cover the basics of futures pricing.