New COMEX Rule, Another Reason to Fear Gold, Silver and Commodity ETFs

By: Dr_Jeff_Lewis

Regardless of their expensive annual fees, frequent tracking errors, and the simple fact that you'll never be able to actually touch the gold or silver your ETF claims to hold, there are several more reasons ETFs should never be used by precious metals investors.  An important rule change by COMEX, the American commodity exchange, allows ETF substitutes for precious metal delivery.

Paper as Metal

To address a temporary problem of liquidity, COMEX has systematically created an even bigger problem for investors.  The exchange allows investors to make good on their futures positions with gold and silver ETFs rather than the real assets, thus opening up the door for hugely distorted market prices. 

How it Works

Under the clause 104.36 in the COMEX rulebook, exchanges can take place on the exchange as long as the products meet certain criteria.  After sorting through legalese, investors find that the criteria isn't as demanding as one would expect from a multi-trillion dollar exchange, but is actually quite loose.  COMEX requires that exchanges be made in economically equal products.  For instance, a 1000 ounce silver futures position can be used in the delivery of 1000 ounces of silver, despite their inherent differences. 

This creates immense problems for investors, as well as the exchange itself.  First, no silver actually trades hands, but only a silver derivative that has supposed claims to silver.  Second, the exchange-traded fund is economically similar in that it has equal worth to the same amount of silver; however, investors cannot receive physical delivery from the ETF issuer.  In essence, purely derivative investments are equal to physical metals in the eyes of COMEX, even though the reality is quite different.

Further Complications

Reading from the prospectus of the two biggest gold and silver exchange-traded funds reveals that through the COMEX marketplace, paper can really be turned into gold!  The popular SLV ETF discloses in its prospectus that there are times when the exchange-traded fund will hold cash, or cash equivalents, allowing itself the opportunity to issue more shares than the silver it actually holds in the trust. 

In addition, the exchange-traded fund has the ability to make claims against third parties (a derivative) to track the price of silver on the marketplace.  This opens the door for large manipulation in the silver markets, as investment dollars in the ETF can be placed on derivative bets.  Then the shares can be exchanged through COMEX to meet delivery on futures positions. 

The result is that derivative products owned by SLV can easily find their way into what is supposed to be a purely physical market, allowing for the opportunity of an oversupply of silver compared to what is actually in existence in vaults.

What it Means for Investors

ETF investors are clearly at a disadvantage, although the chance of manipulation is only a bullish signal for physical investors.  COMEX rules have allowed artificial inflation of the amount of silver futures available prices, and it is sure that physical metals will only gain in value as this comes to light.  There is simply no better investment than physical metals both for the short and long term.

By Dr. Jeff Lewis

Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of Silver-Coin-Investor.com and Hard-Money-Newsletter-Review.com

Copyright © 2010 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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