The prices of commodities on the commodity exchanges refer to the price of delivery of a specific amount of good on a specific date in the future (and at specific terms). For example the price of oil that is so frequently quoted in the news actually refers the price of one barrel of West Texas Crude delivered to the oil refineries in Cushing, Oklahoma. Unlike the stock market, the commodities markets actually have a physical good that is delivered at the end of the day. If you purchase a futures contract and don't sell it before expiration, you will take delivery of "stuff." Commercial users may actually want the coffee beans or corn, but most financial participants will simply take delivery of stuff via accounting entries in shared warehouses. However, sometimes a market participant will take physical delivery and request the product leaves shared warehouse.
For silver, there has been a shrinking supply of registered silver since 2007. "Registered" means that the silver meets all of the specific criteria to be deliverable and is also classified as such so that it can be transferred from one owner to another inside the warehouse (or can leave the warehouse).
The chart above shows the registered silver inventory at the COMEX until April 26, 2011. The most recent report (May 19) shows that the level of registered silver has fallen to 32.2 mm oz. Since silver futures trade in contracts of 5000 oz each, that means that the COMEX warehouse could only fulfill 6437 contracts if they stood for delivery today.
As of yesterday, the COMEX had 121,495 contracts outstanding. There were just a few still open for May and June. However, July shows 62,481 contracts still open. I don't know how many of these contracts will stand for delivery. In any case, using the most recent information, the COMEX would only be able to deliver enough silver to cover 10% of the outstanding contracts for July.
So, what happens if the COMEX doesn't have enough physical silver to meet the delivery requests? I don't know. I would expect it's partially a legal/contracts question and it's partially a market mechanics question.
From a purely theoretical standpoint, the silver market would adjust prices until an equilibrium is reached. Prices would head north until enough sellers decide that they don't really want their silver at the market price. Supply could come from new entrants or from silver owners who have eligible but un-registered silver already stored in the warehouse.
Another possibility is that the COMEX forces people to settle in cash rather than default. This seems like a likely path -- but then opens up the possibility that silver futures prices and physical silver prices diverge. This seems highly problematic for the exchanges and all the market participants. If your silver future doesn't really buy you silver, when what are you buying? This divergence seems to be a popular theme on the internet, but I don't think it's likely. There is too much reputational risk on the line for the exchanges to let this happen.
There are a lot of practicalities at play. It's unclear what will happen, but I expect that we will start to see it happen in the next few months. December has reasonably high level of open interest too. So if July doesn't give us resolution, it's likely that December will.
MONKEY BUSINESS:
Holding: AGQ ($159.70)
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