Is The Comex The Next Madoff Disaster?

Byline:  Has fund manager John Paulson brought a butter knife to an automatic weapon fight?

To start, wouldn't it be ironic if now-famous hedge fund manager John Paulson, who made billions betting against the real estate using derivatives, gave most of those profits back if I'm right about GLD and GLD implodes like Enron?  Judging from Paulson's investment activity in the gold market, he has entered his "horse" into a lucrative race, only his horse is crippled.  His stock picks are pathetic and his choice of using GLD as a proxy for physical gold speaks volumns about his lack of understanding of the precious metals market.  I will circle back around to this after I address the accelerating train wreck at the Comex.

My colleague "Jesse" of Jesse's Cafe Americain has posted a must-read piece about how the Comex now permits gold/silver contracts to be settled using ETF's, like GLD, IAU and SLV.  Those of us who have been watching the Comex for many years have wondered with bewilderment, albeit horrified amazement, as the Comex and its regulators have allowed the short positions controlled by the big banks like JPM and Goldman to build up way beyond the ability of the Comex to settle those contracts with gold and silver, should there come a time when those holding those contracts from the long side decide to stand for actual delivery. This is the definition of a Ponzi scheme.  Keep issuing paper claims and hoping that those claims either expire worthless or enough of the holders do not ask for actual settlement, which has been the case all along.  But what if....?

It has long been suspected that the reported inventory at the Comex is being fraudulently reported such that the Comex would be in trouble even if a portion of the contract longs were to stand for delivery.  Recently, there has been some unexplained inventory occurrences which lend credence to the fraud theory.  More recently, the Comex issued a regulatory change which would permit ETFs to be delivered to contract longs instead of the actual metal.   This quote from Jesse's commentary sums up the situation nicely:

 "Comex is putting forward the offer of paper in the form of money or ETF positions very aggressively, and making it the much easier alternative. Delivery of physical gold from the Comex is no longer as straightforward or even as semi-convenient as it had been in the past. In fact, it is difficult, and one must be very persistent and wait long periods of time" Here is the link:  Exchange For Physical

I can attest from personal experience that the Comex has indeed made it very burdensome to stand for physical delivery.  We waited 7 weeks past "last delivery day" to receive delivery on one measely silver contract.  The person who manages our depository told us were lucky, that he has other clients waiting over 2 months for delivery.

The point here is, why would the Comex be doing this if they were not concerned about a "run on the bank" in which traders stand for delivery of more gold/silver than the Comex is able to produce?  The point of acquiring gold/silver on the Comex is that it enables the buyer to acquire a large quantity of gold/silver which meets specific size, weight and quality specifications at the spot price.  Why now offer paper instead?

My point here is that it is becoming more apparent on a daily basis that the Comex is yet another one of the many large Ponzi schemes operating in the United States financial system, some already busted and some yet to bust - many operating with the enablement of the U.S. Government.  It would seem that a bright light is now illuminating a reality that was once criticized as being pure conspiracy theory.

My next issue is with the idea of settling a Comex position with GLD.  I wrote a research piece last year, and several others have as well, based on a very close reading of the GLD prospectus, in which the validity of GLD's actual physical gold holdings were questioned.  Without going into details, and at some point I'll post my work, there is no possible way to force the Trustee, Sponsor and Custodian of GLD to verify and prove that they actually possess the gold they say they do.  In fact, GLD has been so openly criticized, and has so blatantly rejected calls to provide the market with an independent physical audit of its gold, that GLD's Sponsor, the World Gold Council, and its Trustee, Bank of New York, should feel thoroughly embarrassed.  The same SEC that let Madoff off the hook for several years is the entity which blessed the GLD prospectus, to the utter horrification of those who understood how exposed to fraud GLD investors would be.

As you can see, the fact that Comex would allow contracts to be settled using GLD in lieu of physical gold is absurd.  Essentially, when you get long a Comex contract thinking you are buying into the ability to take delivery of a 100 oz. ounce bar of gold, you are in reality buying into a piece of paper which in all probability is not backed by that bar of gold.  Then, when the Comex asks you to take delivery of the equivalent amount of GLD, you are getting whacked with another piece of paper, which not only is most likely not backed by gold, but you need 100,000 shares of it in order to convert into gold (GLD gold is only redeemable in 100,000 share increments, roughly $11.7 million in GLD stock at today's price).

Which brings me back to John Paulson, who made a big splash by announcing his new gold fund, in which he's investing $250 million of his own money.  Paulson's firm is the largest holder of GLD.  Ever since Paulson made his fortune shorting the housing/mortgage market, his investment ideas have been questionable (BAC, C, CGB).  His big mining stock positions are AU and KGC.  AU is currently sitting on an over 4 million ounce hedge position in gold.  If you look at its latest 10Q, the close to $600 million dollar loss it posted last quarter can be tied to this hedge - AU lost almost $600 million during a period of time when the price of gold was relentlessly going higher and its peers were recording huge profits.  This hedge will be very hard to close out without losing multiples of last quarter's loss.  Paulson's fund owns at least 12% of AU.  KGC has its own issues which make it an inferior large-cap gold mining stock investment.

Experienced gold market investors understand that the only true way to benefit from the attributes of investing in gold is to actually accumulate physical gold and silver and make sure it is held in your own custody or with a safekeeping custodian that is trustworthy.   GLD's custodian, HSBC, is not only NOT trustworthy but is one of the larger gold leasing entities in the market.  GLD is okay to use as a means of indexing the rate of return on gold, but GLD is definitively not an investment in the actual metal.  Someone please ask David Einhorn of Greenlight Capital, and formerly the largest GLD shareholder, why he suddenly announced in July that he dumped his GLD shares and bought physical gold that his firm safekeeps.  Apparently Paulson is arrogant enough to not look into this matter.

Here's the risk with GLD:  the instant that a very large investor attempts to convert his GLD shares into GLD gold, and GLD delays or defaults on this attempt, the price of GLD will plummet.  In other words, if myself and several others are correct about the true nature of GLD, it most likely leases out its physical gold holdings and uses derivatives with funds not used to buy actual gold - GLD could potentially collapse the same way as did Enron and Madoff.  Paulson's massive investment in GLD would vaporize, the price of gold would do a moonshot and everyone holding and investing in the physical metal would have a good laugh.


And finally, to come full circle, an argument can be made that the Comex has turned into just another massive paper Ponzi scheme.  To make matters worse the CFTC, as regulator of the Comex, appears to be looking the other way while a few big banks violate position and trading rules in gold and silver that the CFTC strictly enforces in other commodities markets.  With all signs pointing toward the Ponzi scheme view of the Comex, and in the absence of the Comex itself or its regulator providing any explanations to the contrary, it would appear that the Comex could be headed for the same graveyard as Enron, Refco, Madoff, et. al.  And anyone considering investing large sums of money into GLD or with John Paulson's new gold fund should make sure they engage in very thorough due diligence - the kind of due diligence that many of us have been doing over the 9 year duration of the precious metals bull market.