So, Marku asks:
But aren’t most of those contracts never expecting to take physical delivery? Just gambling, er excuse me, investment hedging?
Or is the problem that given that Comex price is under the real, that all those contracts *want* to be exercised in delivery so they can arbitrage to China (who has a real price?)
I’ve always found futures confusing, thanks for any help.
Answer is complex by I’ll do my best to simplify. I’m going to base my answer on much of what Dario says in this video, so it might be worth a watch for anyone interested in how the contracts are viewed at the Comex versus SHFE.
All contracts traded on Comex are designed to take physical delivery. Understood? They are designed for industrial hedging so corporations can smooth out their expenses on needed commodities. That said, under Clinton and accelerating under Bush, the CTFC made a whole raft of rule changes that changed the PRIME AIM of the commodities markets from honest price discovery into something resembling a casino. I’ll spare you the details, but I was in the business at the time and I still can’t believe what they did.
As for arbitraging Comex prices over those on the SHFE. Rumor is someone tried it–a Chinese trader–and got hammered hard. Main reason: the cost of shipping and arranging for delivery, even if, as rumored, he made the trade when there was a $20 USD premium at SHFE, and all the subsequent logistics of physical delivery, added up rather too quickly. But as a former arbitrage clerk myself, kudos to the brother for trying. Fortune does favor the bold. Until she doesn’t: fickle bitch she is.
Futures are identical to stock options: calls-are the expectation a stock will rise-and puts are the opposite. On the commodities exchanges you buy long exepcting the price to go up, but your buying price of the long give you the right to exercise it at that price not its current high, if it did go up. Buying short means you expect the commodity to go lower. You can also combine the two into a hedging bridge of sorts, where you give yourself the right to exercise the contracts within a range. This is what hedging truly is. Not hedgefund bullshit. I used to know the head commodities trader at Pioneer Flour Mills here in San Antonio and how he explained it was elegant. One of the reasons I went into the business.
I’ve never mentioned this before but what made me leave was a long time ago I was sitting first class next to a former international business man. He asked most of the questions, but the upshot is I was sitting next to John Perkins and the questions he asked me opened my eyes to what I was truly participating in. It was only a matter of time til I left.
The US commodities exchanges were originally established, and this was hammered into me when I took my commodities trader’s exam, for price discovery and sanctity of the market mechanism. Used to be you had to own or expect to take delivery of the underlying commodity you were hedging/selling/buying. Now you don’t.
At the SHFE the rules are much similar to the pre-Clinton era rule changes. And Chinese regulators are hardcore. They’ve shutdown at least 25 trading groups accounts last week alone for breaking the rules, which Dario explains in his video.
Hope this helped.
marku
Thanks SPK. My understanding then is that. according to Dario, in less than 2 weeks, either Comex comes up with a bunch of silver it doesn’t have, or it blows up.
Interesting.
Sean Paul Kelley
@Marku: you got it in one. Summed up perfectly.
elkern
So, this time, a Gov’t Bailout would imply something far more drastic than giving the Banksters $T of Monopoly Money – the US would have to provide a boatload of very real, shiny silver? And most of that would get shipped to Shanghai?
Sam
I’d very much be interested in the Clinton/Bush changes if you wanted to write it up or point me to someone who already did.
Jorge
Here is the point of the futures market: controlling risk.
You are a gold mine. I am one of those chains that sells wedding rings in the mall. You mine gold and sell it, I buy gold and plate my rings.
We both want to be in business 3 years from now, so we use the futures market to attempt to control out business risk. I know that in 2029, I will be able to mine, refine and sell 10 pounds of gold. I could do a lot more, but this is my absolute minimum “of course I can mine that much”. Similarly, you project that in 2029 you will sell a minimum number of rings that use up 10 pounds of gold.
Here’s how it works: I promise to sell 2 (two!) pounds of gold in 2029 at the current futures price for 2029, which is maybe the current spot price plus 10%. You, similarly promise to buy two pounds of gold in 2029. Suppose the futures price is $6,000. I promise to sell at $5,800 and you promise to buy at $6,200. We are both sacrificing $200 to the degenerate gamblers who are trading futures. They are selling both of us the ability to operate with less risk in 2029. They are selling us business insurance. Note that we have only marked off 20% of our minimum business projection for 2029.
One year later, in 2027, the economy is down. We both decide that 9 pounds is our minimum for 2029 instead of 10. But since it is only 2 years until 2029, we both have more confidence in our predictions, and we both sign contracts for 3 pounds, leaving 4 pounds open for 2029.
Again, in 2028, we predict the economy for 2029 and tie up some more contracts to control our 2029 risk, leaving 2 pounds open. In late 2028 (6 months until 2029), we do another pound, leaving 1 pound open. We might buy the final pound 3 months before, or just wait until 2029 and buy it on the spot market.
So, we did a kind of Zeno’s Paradox, controlling our risk bit by bit as the calendar crept closer to 2029. The futures market in gold allowed us to have greater certainty that we could stay in business in 2029. We happily paid the $200 for each contract.