What role do the CME and ICE depositories play regarding the futures contract? First let’s define a futures contract. A futures contract is a legally binding agreement to buy or sell a commodity at a later date. Futures contracts are standardized according to the quality, quantity and delivery time and location for each type of commodity.
Trading futures enables gold market participants to hedge market risk. Some participants are:
- Mine Producers
- Bullion Banks
This is the purpose of the futures exchange.
Now let’s define the term “Open Interest.” Open interest refers to the number of “open future contracts.” This refers to unliquidated purchases or sales and never to their combined total.
There is always a lot of chatter, or let’s call it a concern, that someday the amount of open contracts in a particular month coming up for delivery will exceed the amount of eligible bars to meet the demand. Historically only 2 to 4 pct. of the open interest stands for delivery. But, in the case of a shortage of product available for consumption, this arena could be tapped into for product.
Without going into great deal, for simplify, the Chicago Mercantile Exchange (CME) and Intercontinental Exchange (ICE) have in place stop gap measures that will not totally eliminate the possibility of a short squeeze, but would greatly mitigate the possibility. We will explain this at a later date.
Let’s briefly explain how the metals get into the depository. I will use as an example our CME and ICE depository, International Depository Services of Delaware (IDS).
For simplicity, let’s start at the refinery level. The gold or silver is either recovered from mine production, scrap jewelry or coins/bars to be melted into good exchange delivery bars. The refinery then manufactures these products and their brand (of course) is approved by the exchanges for delivery .
The CME Gold contract has 100 ounce bars with an allowable tolerance of 5 percent. Also 3 kilo bar contracts (32.15 ounces) can be delivered to satisfy the 100 ounce gold CME contract.
ICE has an active kilo bar (32.15 ounces) contract for delivery that competes with the CME contract.
The CME silver contract has 1000 ounce bars (5,000 ounce contract) with an allowable 10-percent weight tolerance.
If the owner of these bars wants to deposit these bars in an authorized depository like IDS for possible delivery against a short futures position, there are strict guidelines to follow.
Directly from the authorized refinery, he or she must use an authorized CME or ICE armored carrier to transport the bars.
A detailed weight list should accompany the shipment. As long as these rules are met when the bars arrive at the depository there are two categories the bars can be put in.
Eligible or registered:
- Eligible status: Bars are not put in position to be delivered to the exchange to cover a short position but are “eligible” to be put on receipt at a later date.
- Registered status: Bars are eligible at any time to be delivered (tendered) in settlement of a futures contract.
All exchange depositories must meet strict CME and ICE regulations before becoming an authorized depository.
I hope this brief explanation will give clarity to the relationship between the futures market and the authorized depositories.
Have a wonderful Monday.
Disclaimer: This editorial has been prepared by Walter Pehowich of Dillon Gage Metals. This document is for information and thought-provoking purposes only and does not purport to predict or forecast actual results. It is not, and should not be regarded as investment advice or as a recommendation regarding any particular security, commodity or course of action. Opinions expressed herein are current opinions as of the date appearing in this editorial only and are subject to change without notice and cannot be attributable to Dillon Gage. Reasonable people may disagree about the opinions expressed herein. In the event any of the assumptions used herein do not come to fruition, results are likely to vary substantially. All investments entail risks. There is no guarantee that investment strategies will achieve the desired results under all market conditions and each investor should evaluate its ability to invest for a long term especially during periods of a market downturn. No part of this editorial may be reproduced in any manner, in whole or in part, without the prior written permission of Dillon Gage Metals. This information is provided with the understanding that with respect to the opinions provided herein, that you will make your own independent decision with respect to any course of action in connection herewith and as to whether such course of action is appropriate or proper based on your own judgment, and that you are capable of understanding and assessing the merits of a course of action. You may not rely on the statements contained herein. Dillon Gage Metals shall not have any liability for any damages of any kind whatsoever relating to this editorial. You should consult your advisors with respect to these areas. By posting this editorial, you acknowledge, understand and accept this disclaimer.