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:
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:
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.
Author Name: Walter Pehowich
Walter Pehowich is the executive vice president of precious metals investment services for Dillon Gage with over 38 years of experience in precious metals investment services. His career began in 1977 at Bache (which evolved to Prudential-Bache Securities and then Jefferies Investment Bank). While at Jefferies, he served as senior vice president with oversight of investment grade precious metal products. Pehowich holds a National Futures Association (NFA) Series 3 license, authorizing him to advise and sell alternative investments in commodities and futures markets.