paper gold default report - february edition, page-5

theendgame

Futures contracts aren’t the same publically traded stocks. (If you ever hear some say they are “investing in futures”, they don’t know what they are doing!)

When you buy or sell a share you acquire or relinquish ownership of a particular asset. When you buy or sell a futures contract, you notionally buy or sell the asset on a future date, but no consideration (settlement amount) changes hands. The only settlement prior to the expiry of the contract is the change in market value of the underlying asset.

Buyers don’t have to have the cash to pay for the asset, and sellers don’t have to own the asset. Very few are interested in settling the physical. Mostly they only want is to profit from the movement in the price of the underlying asset.

The only constraint to the open interest in a futures contract is the number of willing buyers and willing sellers. (There seems to be no shortage of either at a given price.) Last night there was an open interest of 430,158 contracts. That means there were 430,158 willing buys and 430,158 willing sells. (CME stands between the two sides and has no positions unless someone on eithere side defaults.) The number of buys always equals the number of sells!

Two observations:
1.The open interest is spread over many contracts with expiries as far out as 2017.
See: http://www.cmegroup.com/trading/metals/precious/gold_quotes_settlements_futures.html
2.Many of the buys and sells in any contracts are owned by the same traders. Because of the netting of margin requirements, some clearing members don’t bother to immediately close out buys against sells owned by the same legal entity.

If you are a gold trader, I think that it is unwise to ignore the futures market. You may say that the “tail shouldn’t wag the dog” but I would question which is the tail and which is the dog?

Good luck