Bloomberg reported on Sept 23, 2020 that JPMorgan is expected to pay a $1 billion fine for manipulating the metals futures and treasury markets. [Emphasis mine]
JPMorgan Chase & Co. is poised to pay close to $1 billion to resolve market manipulation investigations by U.S. authorities into its trading of metals futures and Treasury securities, according to three people with knowledge of the matter.
While we don’t have all of the details yet, and the formal announcement has not been made, this article will intelligently speculate on what affect the manipulation may have had on the precious metals markets and why that matters to gold and silver investors.
The Scope of the Price Manipulation Is Enormous
Whatever assumptions the market made on price during the time in which this manipulation occurred in the precious metals futures markets were wrong. This will have affected billions of dollars of trade in the precious metals.
Let’s examine how big the futures market really is when compared with the actual physical gold trade on an annual basis to get an idea for the implications of this manipulation.
On September 23, 2020 in the gold December 2020 contract alone, we had 411,558 contracts traded according to the CME Group. That represents 41,155,800 ounces, using a 100 ounce contract, traded in gold on that day alone.
ource: CME Group
According to the World Gold Council, gold mining adds 2500-3000 tonnes of gold to world supply each year. 3000 tonnes is roughly 96 million ounces (3000 x 32,150.7 ounces per tonne) of gold added to world stocks per year.
So on a single day this week, the futures market traded paper contracts of 42% of yearly production in gold. This is within a single month’s futures contract, not for the whole futures market trade in 2020.
At the current gold price of $1858 per ounce (as of Sept 24th 10am CST), on Sept 23rd the futures market processed $76.47 billion of paper gold trades. On a single day.
Now lets examine total gold volume for 2020, up to this point in time.
I drew a very rough mean line at about 360,000 contracts of 100 oz gold traded daily. Let those numbers sink in for a moment.
How much did the price manipulation affect the billions of dollars of assumptions made in the gold futures market, and for how long did this last?
Again we don’t know the details, but this simple exercise has given us an idea of how much money was potentially lost on trades in the gold futures market, and how much more than the $1billion in fines JP Morgan could have potentially made by manipulating it.
It appears the fine could be a slap on the wrist compared with their profits. In other words, manipulation of precious metals potentially could have provided JP Morgan a healthy ROI even given the fine.
But the argument gets more interesting when we consider most gold ever mined is also affected by this scheme.
All of Your Gold Price Assumptions Were Wrong
The COMEX futures market trades are the largest input in what determines the gold price that we all use on a daily basis.
Gold futures prices serve as the basis for the LBMA Gold Price… The COMEX is the world’s largest gold futures trading exchange.
The price of gold that is to be delivered immediately after purchase is called the spot price. If you were to average the net value of all currently traded gold futures contracts for the nearest month, you would get the gold spot price.
That means that every piece of jewelry, every ounce of gold used in computing, and every investment transaction on gold made during the extent of the manipulation by JP Morgan (and Scotia) were wrong.
The massive futures market trading documented above affects the price of all new gold mined every year plus the current value of gold mined throughout all of history.
Per the World Gold Council, 197,576 tonnes have been mined up through 2019. The current value of all of that gold, at $1858 per ounce, is $11.8 trillion. (197,576 tonnes x 32,150.7 ounces per tonne x $1858 price per ounce).
Why does the futures market affect all gold ever mined? Because the vast majority of gold ever mined is not “used up” in industrial applications, unlike other metals such as silver, copper, aluminum, palladium, etc. And because gold is so valuable, much of what is used in electronic applications is recovered in scrap.
Per the WGC,
Total above-ground stocks (end-2019): 197,576 tonnes
- Jewellery: 92,947 tonnes, 47.0%
- Private investment: 42,619 tonnes, 21.6%
- Official Holdings: 33,919 tonnes, 17.2%
- Other: 28,090 tonnes, 14.2%
- Below ground reserves: 54,000 tonnes
Source: Metals Focus; GFMS, Thomson Reuters, US Geological Survey, World Gold Council
At this point, does the $1 billion fine that is being paid adequate to cover for the price manipulation on all of that gold held? My response to that question is very obviously not, at least not on the aggregate level of all gold being held.
I don’t know all of the factors were taken into consideration by the regulators in calculating the fine amount relative to the length and effect of the manipulation scheme.
How that was calculated is likely never to be made public. But it does appear to be an order of magnitude less than the effects the manipulation scheme had in real physical gold price terms.
Physical Gold on the Exchange Becoming Scarce
I will explain why gold is becoming scarce on the COMEX by starting with a chart of eligible and registered gold stocks on the COMEX.
Eligible stocks are not posted for futures trades until a warrant is attached to them making them “registered”, and simply amount to warehouse storage. They can be titled to anyone and the only way they get put up against futures contracts is if the title owner decides to make it so.
So how do I come to the conclusion that warehoused gold is not completely liquid for futures markets transactions? Two reasons: a) because the chart tell us so over time and b) because the CME Group, which runs the COMEX, recently, and very discreetly, told us as much.
The chart clearly shows that since eligible gold stock category was created, the vast majority of gold in COMEX flowed into storage and not subsequent futures trades. Both the total amount and percentage of gold warehoused off of the futures market has increased over time, meaning that gold has largely not been posted for futures delivery again.
A lot of gold gets removed from COMEX after participants take delivery, which is evident in the daily depository reports, found here.
“Eligible” Gold Not Really Eligible for Delivery
As for the CME Group, there was a stunning announcement made earlier this year with respect to the supposed liquidity of gold stocks on the COMEX. On April 9th, 2020 the CME Group released a memo to the CFTC expressing doubt that all eligible gold inventories may not add to liquidity for futures market transactions.
On page 3, the memo notes that the CME Group would discount eligible gold stocks by 50% from deliverable supply. The memo goes on to note that [emphasis mine]:
While surveys conducted indicated no clear consensus as to how much gold is dedicated to long term investments, the Exchange, in an effort to represent a conservative deliverable supply that may be readily available for delivery, made a determination at this time to discount from its estimate of deliverable supply 50% of its reported eligible gold at this time.
In other words, the exchange has no idea how much gold in eligible could be made liquid at any given time for futures contracts, if any, because there is no “consensus” on it. The consensus was based from the opinions of the depositories that hold the physical in storage.
Nor is there any criteria given for future determination of such liquid eligible category gold which led to the following statement in the same paragraph [emphasis mine]:
The Exchange may, at a later date, determine not to discount such stock or to recognize a discount level that is more or less than 50% of reported eligible gold when calculating deliverable supply estimates.
Source: CME Group
In other words, without specific criteria having been established, the CME Group has no factual basis to warrant that any of the eligible gold can be made liquid at a specific point in time for use in futures contract trading.
That leaves the registered stocks which have increased significantly this year. As of now, long gold contracts standing for delivery appear to have reason to expect their gold to be delivered. But for how long as each delivery leads to gold exiting the COMEX, or simply being put into the warehouse for storage?
Implications of the Manipulation
There are two reasons for manipulation of gold on the futures market. One is to increase the price, the second is to decrease it.
Decreasing the price allows exchange members to pull the gold off of the exchange at discount to market prices. All of the recent spoofing of gold, including Scotia who was recently also fined $127 million for doing the same thing as JP Morgan in the gold market, has been to the short side.
We know this because the bullion banks have been net short of the precious metals for some time, as per the CFTC’s commitment of trader’s report.
Further, see this chart of the largest 4 & 8 largest short traders on the market, in terms of days of production.
Clearly, the short positions on the futures, together with the spoofing manipulations, indicate the bullion banks intended to lower the price of the commodities while taking possession of the physical metals with their longs contracts.
See the following chart on Scotia Mocatta, the gold trading arm of Bank of Scotia, and where the gold went while they were spoofing the price of gold down.
A different dynamic from JP Morgan, though no less telling. Lots of gold standing in the warehouse and not posted to registered for futures delivery, which would have had the effect of dwindling the eligible stores over time.
There does not appear to be a lot of data that indicates either Scotia or JP Morgan intended to increase the price of gold while it was acquired in their COMEX warehouse stores.
The only change to this trend was the increase on COMEX gold in 2020 in JP Morgan’s account, while the rest of the world dealt with physical supply shortages and before JP Morgan was fined the billion for spoofing.
Logic dictates the price spoofing the bullion banks have been fined for led to price-suppressed gold coming off the futures exchange and into the hands of the bullion banks and their clients.
Who are their clients? Perhaps only the CME group, the bullion banks, and the CFTC know the answer to this question. And so far, they have never divulged this information.