Taking delivery of gold and silver from a futures exchange isn’t as difficult as you have probably been led to believe. Despite what you may have read elsewhere, gold and silver futures contracts are routinely exchanged for physical gold; in this interview with Jennifer Ropiak, NYSE LIFFE US vice president, we discuss the process and the timeline, from establishing your long position to holding the bullion in your hand.
From the vantage point of a retail trader who has decided to take delivery, the first step is to establish a long position. And in order to do so, a trader must pay initial margin and maintenance margin to their futures commission merchant over the life of the contract, Ropiak explains.
“As the month you are long approaches, you have to notify your broker of your intentions. If you are a retail client, some brokers may require full payment up to five days before first notice day — which is the first day you could take delivery — whereas a professional trader, a Morgan Stanley, a Goldman Sachs, they wouldn’t have to prepay their account. If you’re retail and a relatively new client, the brokers will want to protect themselves by having the full value of the contract in your account,” she says.
Assuming that you are long and that you have funded your account appropriately, you are then waiting for notice day. Notice day is the day prior to the day you are going to get delivery.
The exchange matches buyers and sellers; for the rest of the process the sellers are in the driver’s seat.
“It’s the seller that decides what day of the month they are going to deliver,” Ropiak explains. “So if they are short June gold, they can deliver anywhere between the first business day of the month to June 30, and the buyer has to wait until they receive the notice. And they will receive that notice of delivery one day before settlement. Most of the time, for economic reasons — meaning the shorts want their money as soon as possible — those deliveries take place right at the beginning of the month, the first or second business day of the month.”
Once the seller, known as ‘the short,’ indicates that they want to deliver in, a three day process begins.
“A trader is short one June gold; she notifies NYSE LIFFE US: ‘I want to deliver against my short.’ That’s day one. Day two, NYSE LIFFE US notifies the buyer, who is long one, that on day three, the next business day, the transaction will settle. Day two is the notice day and day three is what we call settlement day. On settlement day, the short’s broker delivers to the clearing house an NYSE LIFFE US reciept, which is backed by gold. The short would expect her funds to show up in her trading account, which would have been paid to her broker from the clearing house. The clearing house would expect to receive the funds the long has paid to their broker to pay for the contract. The clearing house would pay the short’s clearing broker and the money ends up with the short. But the short could decide not to settle until the end of the month for some reason. The short is in the driver’s seat with respect to the delivery date.”
One of the benefits of trading on exchange is that buyers know exactly what they are going to receive. While contracts are not based on specific bars, the NYSE has in its rules established standards of quality for the bars, including certain brands.
“The brands are the brands of the refinery, like designer brands of clothing. There is a list of brands that are acceptable. There is a weight tolerance that is acceptable; a 100 ounce gold bar not only has to be of a certain brand, it also has to be plus or minus 5% of 100 ounces. So it can weigh as little as 95 ounces or as much as 105 ounces,” Ropiak says, and the value of the bar is adjusted accordingly.
“That is why you have that day two notification, so the long will know exactly how many dollars they owe. They will use that day-two notice-day settlement price so that the next day you are fully equipped to make payment. You know the price of the gold that you are going to use to settle this trade and because the exchange has notified you exactly how many ounces you are buying, 102.75 at $1,160, you know exactly how much money is going to be taken out of your account.”
Physical delivery from an exchange is very different from what a retail client might think physical delivery is. There is a vocabulary associated with the process that can be confusing to the unstudied and as one would expect, there are other fees associated with removing the gold from the vault.
“When the exchange has matched the short and the long, and the clearing house has settled that transaction, that one bar of gold that was sitting in an exchange approved vault, is transferred from the short’s clearing member’s account to the long’s clearing member’s account. The exchange then sees the physical delivery as being complete,” Ropiak says. “The ‘deliverable’ in physical delivery on the exchange is the receipt that backs the metal. So, now the long’s clearing member has this receipt in its possession, which represents the fact that you own that gold. If you want to remove gold from the vault by using mini gold futures, you must do so in bundles of three; in mini silver, in bundles of five.”
There are five vaults that have been approved by NYSE LIFFE US and CME Group. In the fall, HSBC decided that it would no longer send out individual bars and would no longer work with retail customers. Instead, HSBC will focus on institutional traders.
In order to remove the gold from the vault, the buyer would instruct their broker, the FCM alerts the clearing member and the clearing member alerts the exchange and the vault. The clearing member has to endorse the receipt, which represents your metals, over to the vault. The vault cancels the receipt from the system and then you have various shipment choices, such as by mail, Brink’s or personal pickup, depending on the vault.
Once a gold or silver bar has left the vault, there are safe guards to prevent fraudulent gold from being introduced to the circle of trust that includes the vault and the exchanges.
“How do I know that your evil twin hasn’t drilled the center out of that bar?” Ropiak asks. “If you want to deliver it back, you would need to get it assayed.”
Next: Reselling your bars on exchange