Price “Smackdowns” Do Not Deter Futures Longs From Standing For Physical Delivery

A few weeks ago I debunked a silly misconception – that exchanges raise margin to deter longs from standing for physical delivery (they don’t – to be clear).  There’s another myth going around Metals Land that “The Cartel” manipulates prices lower ahead of first notice day for futures for the same reason: to deter longs from standing for physical delivery.   This one is almost as easy to disprove, as long as you take a few seconds to put on your “logic” hat, along with your “rational thinking” socks and “real world” shoes.

Imagine an exchange where we trade physically settled futures contracts on cheeseburgers (ok – take off your “real world” shoes for a minute).  I happen to think that September Cheeseburgers (SepCheese), trading at $2, are a good value, because I know that there is a huge GrillMasters convention coming up and I think that there will be demand for Cheeseburgers, causing the price to rise.  Thus, I’m long SepCheese at $2 – I have done the math on supply and demand and I think it’s worth $3.50.

Now, enter the Evil Hamburgler, Anti-Cheeseburger Cartel member, to whack the price of cheeseburgers.  He sells lots of contracts for SepCheese, driving the price down to $1.50.   I now have a choice:  I can either a) hold my contract and stand for delivery of cheeseburgers, or b) liquidate my contract.  If I choose the latter, and liquidate my SepCheese, I’m accepting the price that the Hamburgler has set for me, and taking cash (at what I’ve decided is a temporarily “manufactured” discount to the true value) for an asset that I think is worth much more.  Why would I do that?  I wouldn’t – in fact, the Hamburgler’s actions here make me MORE likely to stand for delivery, not LESS likely – since I don’t want to get taken out of my position at what I think is a disadvantageous price.  Let me repeat that: when the price of the asset underlying my futures contract is depressed, it makes standing for physical delivery of the underlying asset more desirable, not less desirable.

Now, you can substitute “gold,”  “silver,” “diamonds,” or other underlyings instead of “cheeseburgers” – the reality is the same.


disclosure:  at the time of this writing I am long $PHYS and short $GLD.  My trade is that the premium to NAV for PHYS will expand. I have no net exposure to the price of gold


Postscript: Let me try another more concrete example, because like gold, silver, or diamonds, we don’t know exactly what cheeseburgers will be worth in the future.

Imagine an exchange which trades futures for a game where each contract gives you the right to come to me, flip a coin, and receive $1 if you win.  These contracts have an expected value of 50c, and will trade with some bid/ask spread around 50c.

Now, if, say, there is a hurricane, and all of the traders evacuate the building, and an evil Cartel member sneaks in and whacks the contracts down to 30c, it doesn’t make it any more likely that you’ll want to liquidate your contract – you still think it’s worth 50c.  In reality, you’d simply buy the contracts that this idiot is offering at 30c, and crush him in the long run.  It’s a stupid thing for him to do, and it has the opposite incentive from the myth that the Precious Metals Mafia asserts.

The difference here is that we actually know the expected value of the Coin Flip contracts, while we don’t know the definitive value of gold, silver, diamonds, AAPL, or anything else.  We estimate the values of these other things, and make our long/short decisions thusly.  When you’re long a futures contract on something, you think that it’s worth more, and when you’re short a contract, you think that it’s worth less.  So don’t lose site of the fact that if someone were to “manipulate” the price of your asset-in-question lower – even farther away from the “fair value” you’ve calculated for it,  then  it will make you want to own the actual underlying more, not less – and make you want to liquidate your contract (receiving cash instead of standing for delivery) at a lousy price less, not more.


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