Sunday, December 11, 2011

Implications of HSBC Gold Rehypothecation Lawsuit on Gold and Silver Prices

With less than an hour until gold and silver trading opens on the Globex, we will soon find out what, if any, HSBC's lawsuit against the MF Global trustee and Jason Fine has on gold and silver futures prices.
For those who missed it, Jason Fine, an MF Global client, demanded delivery for 5 gold contracts (500 ounces) and 3 silver contracts (15,000 ounces) from HSBC, the custodian of the metal.  Fine had used the warehouse receipts of his PHYSICAL METAL on deposit at HSBC as collateral for his account at MF Global.  MF Global's liquidation trustee James Giddens (i.e. Jamie Dimon) said WHOA THERE PARDNER!, NO CAN DO! MF Global rehypothecated your gold and silver collateral when it purchased CDS contracts from us, so we'll be taking the delivery of said gold and silver thanks to our SENIOR creditor status.
HSBC subsequently filed suit Friday against both Jason Fine and the MFG trustee, in effect to allow a judge decide who gets the phyzz.
This weekend has seen rampant speculation that the markets will open with a collapse in GLD, and a spike in gold and silver, as all the paper holders rush to get out of paper gold and into phyzz. 
Personally, The Doc disagrees. 
From how I understand it, the lawsuit doesn't mean anything- yet.  The real fireworks should come when the judge decides whether the phyzz belongs to the actual holder of the futures contracts, or the counter-party of the CDS contracts purchased with Fine's rehypothecated collateral by MFG. 
This could play out in 3 ways:

1. Judge orders Phyzz liquidated for cash, and all parties receive a haircut and a portion of the assets.  This is most likely in The Doc's opinion- and at this point, holders of futures contracts may well panic and dump futures positions for phyzz, causing a collapse in COMEX futures prices of phyzz, with a corresponding evaporation of physical inventory as the physical metal becomes unavailable. 
2. Judge rules in favor of Jason Fine, and all phyzz is delivered to the rightful owner.  JP Morgan instantly panics, crashes paper futures prices, and scoops up all available phyzz.  Least likely outcome in my mind.
3. Judge rules in favor of MFG Trusee James Giddens (i.e. Jamie Dimon, Blythe Masters, and The Morgue).  Jason Fine told to F*** off, you are an unsecured creditor as JP Morgan holds senior status to your rehypothecated collateral/ assets.  For aftermath, see No. 1 only magnified 100 fold. Futures traders instantly lose all confidence in the system, and the COMEX implodes not from a delivery default, but from a loss of confidence among futures traders.

I may be wrong, but I don't see an outcome to this that results in PAPER gold and silver prices rocketing.  All three possible outcomes seem to mean major sell-offs in the PAPER futures markets, while at the same time, physical inventory dries up and becomes unavailable.  Again, it appears to me that this is more likely to happen when the judge makes a ruling in the case, rather than imminently on the announcement of the lawsuit.   I could be wrong, as should a futures trader similarly think through the likely possible outcomes of this HSBC suit, the smart ones will get out now and not wait for a verdict.  We'll see whether the speculative futures traders panic now, or wait for the handwriting on the wall before they panic and attempt to get out.  My money is they'll wait for the handwriting on the wall, Belshazzar style, when it's too late to get out!

Your Paper is Weighed in the
Balance, and Found Wanting