Why are contracts cash settling?
This article first appeared on SchiffGold.
Note: This analysis focuses on Gold and Silver physical delivery on the Comex. See the article What is the Comex for more detail. Additionally, numbers from Comex for December 1 are still preliminary as of publishing. Numbers may change some.
This Comex delivery analysis is usually published on First Notice day. This is directly after First Position day. The Open Interest on the close of First Position is usually a great indication of what delivery volume the month will see. These are when contracts must post 100% collateral for their futures contract.
For example, current margin requirements on gold is $7,500 or about 4%. This is why traders love futures contracts, they get massive leverage (25 to 1) on their investment. As the contract month nears expiry, traders start to roll their contracts. This can be seen in Figure 5 and Figure 11 of the Comex countdown. If the contracts do not roll by First Notice, the contract holder must post the full value of their contract. This means anyone holding a contract at minimum margin most post the additional $171,500 per contract. Thus begins the delivery process.
Once First Notice occurs, buyers and sellers are matched up. Note, this does not mean physical delivery actually occurs. The warrant from the seller is passed off to the buyer. The warrant is associated with physical metal in a Comex vault known as Eligible (not Registered). If the warrant holder now wants to take actual physical delivery of their Eligible metal, they go through a process and the metal then leaves the Comex vault. This is tracked in a separate analysis which have been showing relatively large drops in inventory.
The majority of the warrants transfer ownership in the first day or two after first notice. This December saw two breaks in trend for both gold and silver. First, the number of contracts standing for delivery saw a big increase relative to previous major months. Second, the bulk of actual delivery/warrant exchange took 3 days to occur. This article was delayed to try and get more data and understand the situation before publishing results.
The chart below shows the number of contracts delivered so far, now three days into the delivery window. December has broken the trend that has been in place for the last 7 months of continually declining delivery requests (except the Reddit silver squeeze in March). This chart does not include the 952 remaining open interest contracts, which would bring the total to over 9,000.
Figure 1: Recent like-month delivery volume
Figure 2 below shows a more complete picture. The green bars are the number of contracts on First Position that will be posting full margin requirements. The blue bar is the day before which shows the number of contracts that rolled in the final day when compared to the green bar. The orange bar shows the number of contracts delivered, while the purple bar shows the remaining open interest (only relevant for the most recent month).
The final red bar shows the change in contracts after First Notice. While small, this value is typically positive. This represents contracts that open mid-month posting immediate 100% margin to take delivery. Last month 741 contracts were opened for delivery. So far this month, 433 contracts have actually been closed and cash settled (up from 15 a day earlier). This means instead of delivering a warrant, the seller delivers cash, presumably at a premium (otherwise why would the buyer take the deal).
For reference, 1,015 contracts were cash settled in July, 107 last December, and 1,499 in May 2020. The past 4 months have seen contracts opened after First Notice, and December is seeing contracts close without delivery.
Figure 2: 24 month deliery and first notice
Another change in trend was the speed at which deliveries occurred. The chart below attempts to show the current situation relative to past major months. Based on the contracts outstanding at First Position, this chart shows the percent of contracts delivered on First Notice and the days following. As shown below, typically more than 50% of contracts are delivered on First Notice (green bar). By the day after, this number starts nearing 75% (orange bar).
For December 2021, only 26% of contracts were delivered on First Notice, with only 33% delivered by the day after. Even December last year saw higher volume by day 2 (51%) and December 2019 seeing 44% delivered by day 2. Then, yesterday saw massive surge in delivery, bringing the total to 85.4%. Why the delay and then the recent surge?
Figure 3: Delivery Volume After First Notice
Finally, the chart below shows notional/dollar deliveries for the month of December. 2021 is sitting at $905B. The remaining contracts represent $110M, which would be just shy of the December record set last year. A new record is not out of the question yet though depending on how many contracts are opened mid month!
A second analysis on this data will be done leading up to January delivery, so keep a look out near the end of December to see what happens!
Figure 4: Notional Deliveries
Speaking of January, the data there looks positive as well. Current open interest for the January contract is well above trend. In 2021, the minor months have bucked the historical trend, rising into First Notice rather than falling. To see the historical data or track the information in real-time, see the gold and silver dashboard. Data is updated daily.
Figure 5: Open Interest Countdown
As the chart below shows, delivery volume in the minor months has been trending down some, but remains elevated. It will be interesting to see if January comes in above November. November had looked very weak to start but saw solid strength mid-month as mentioned above.
Figure 6: Historical Deliveries
The charts below follow the same order as the silver charts above.
The trends highlighted above in silver are can also be seen in gold. So far, 29,197 contracts have been delivered, with 1,594 contracts still outstanding. This would come in just shy of the Feb high but above last December.
Figure 7: Recent like-month delivery volume
The chart below has more detail. The purple bar on the right shows how many contracts are still outstanding. Also important to note are the green bars. After being on a steady downtrend since February, December saw a large number of contracts post on First Notice. Has this caused more contracts to cash settle?
It may be hard to see, but the red bars show the contracts opened/closed mid-month. Three days into December, 740 contracts have cash settled, this is actually down from yesterday where 1,353 contracts had been cash settled. That means yesterday saw over 600 contracts open and stand for delivery. Will enough open in the coming days to reverse the 740 and turn the number positive? If not, this will be the first month since last December that has seen contracts cash settled. Every month in the last two years (excl Dec 2020) has seen contracts opened mid-month. Even Dec 2019 saw 2,454 contracts opened mid-month.
Figure 8: 24 month deliery and first notice
Similar to silver, the chart below shows the trend for the days following First Position. For December 2021, only 30% of contracts were delivered on First Notice, with only 38% delivered by the day after. That number surged to 92% in one day, now putting it above average. Why the delay to start the month? Why the sudden surge? Hard to know for sure, but maybe the data will reveal answers as it becomes available.
Figure 9: Delivery Volume After First Notice
Looking at December historically, 2021 will be well above trend. In fact, with the remaining 1,594 contracts open representing ~$280M, this December is on pace to eclipse last December.
Figure 10: Notional Deliveries
January gold is looking solid so far. On trend for post Covid. As mentioned above, the gold silver dashboard shows how the climb into the close is relatively new.
Figure 11: Open Interest Countdown
Delivery volume in minor months has been showing modest strength in recent months. March and November were very large divergences relative to trend in minor months. It’s still too early to gauge January the activity in December will probably play a part in trader behavior.
Figure 12: Historical Deliveries
Why are contracts in gold and silver cash settling? What has prompted a sudden increase in delivery requests? Gold has been on a bumpy ride in the last 10 days with the Powell renomination and a new Covid variant. $1800 appeared to be in the rear-view mirror, but it has been re-established as major resistance with 3 failed attempts in the last week. The price action is dictated by futures traders who are using massive leverage. However, someone is out there demanding delivery.
While gold saw a dip in annual delivery volume compared to 2020, silver proved more resilient with 55k compared to 58k last year. Regardless of the dip, it is clear more investors are taking delivery of metal when compared to pre-Covid. Which side is the smart money on, the short-term traders or the investors demanding physical metal?
Gold and silver have proven to be stable forms of money for 1,000s of years. As people lose faith in fiat, they will reach for tangible assets. When this happens, the raid at the Comex could unfold very quickly. Investors continue pulling metal out of Comex vaults. Physical precious metals offer the best insurance policy against a currency crisis, which looks more and more likely with each passing month.
Figure 13: Annual Deliveries
Data Source: https://www.cmegroup.com/
Data Updated: Nightly around 11PM Eastern
Last Updated: Dec 01, 2021
Gold and Silver interactive charts and graphs can be found on the Exploring Finance dashboard: https://exploringfinance.shinyapps.io/goldsilver/