A decade after the global financial crisis, gold has shone again as the must-have safe haven during the covid-19 pandemic. Adrian Ash explains its rise and rise.
As the yellow metal helped to steady Sharpe ratios for hedge funds and real money alike, all those investment dollars pouring into gold from asset managers and private banks have in turn changed the shape of the metal's own global market.
Most notably, this has revived London's dominance over New York as a trading venue for precious metals, thanks to lockdown highlighting a location risk no one thought would matter before.
Gold's liquid quality becomes apparent and increases as uncertainty grows."
First, liquidity. A total daily average of $145bn in gold contracts changed hands worldwide in 2019 according to analysis by the mining industry's World Gold Council. That put gold behind only the very largest currency pairs, beating US Treasury bills, and only just shy of the 500 stocks in the S&P equity index.
Yet gold's average daily volumes have grown further in 2020 so far, expanding by more than a quarter and confirming what a senior official at the gold-heavy Banque de France noted when many other Western central banks were selling the metal back in 2000: "In circumstances of orderly financial markets, gold is not the most liquid of assets... But its liquid quality becomes apparent and increases as uncertainty grows. In situations of political turmoil or high global inflation, gold's liquidity is unchallenged."
If settled trade by trade in physical bullion, this year's daily gold volumes would equate to more than 3,200 tonnes of metal, around 90% of last year's entire (and record) global mine output. But rather than undermining confidence in tradable gold contracts, the pandemic has in fact sent futures contracts to record premiums over spot bullion, even as it has highlighted the importance of the physical stockpiles underpinning these markets.
London and Zurich dominate the world's refining and storage of gold respectively, forming the heart of the international market by building on the UK and Switzerland's long-stable property laws, free-trade rules, specialist vault facilities and - crucially - Heathrow and Kloten's central positions as global hub airports.
Yet since at least 2018, trading in Comex derivatives settled in New York (and almost always settled for cash) had been greater, averaging $48.5bn per day last year against $44.9bn in London and Swiss over-the-counter contracts.
That's why panic swept across the Atlantic when, on 23 March, the UK finally imposed formal lockdown just as three of the four big Swiss gold refineries suspended operations (many of their staff commute from northern Italy). Suddenly no gold bars would come out of Switzerland and no cargo could leave Heathrow to reach Comex depositories in and around New York to help settle contracts in the global gold market's largest venue. Or so it seemed at first glance.
Overnight, and with bullion trading in London's over-the-counter market at $1525 per Troy ounce, the April Comex future (then the most active gold contract on the CME's platform) jumped to a $70 premium, an unimaginable gap compared to the $1 or $2 typically needed to convert one into the other, an OTC contract known as "exchange for physical" (EFP).
Producers, merchants and banks using Comex derivatives to hedge their inventories in London or Switzerland suddenly realized that their price insurance sits on the other side of the ocean.
Speculators realized it too, effectively squeezing the sellers and leading HSBC, the biggest bullion bank alongside J.P.Morgan, to book a 1-day mark-to-market loss of $200m on its 1Q2020 earnings from the divergence between London and New York prices. That equals perhaps an entire year's net profits from gold trading on one estimate whispered to Bloomberg. (HSBC has since made it all back according to another.)
Did any of those Comex traders actually need any bullion? Like those industry players wanting to hedge their stockpiles against a fall in price, the speculators who typically take the other side of that trade don't usually want metal to change hands.
On the contrary, if they wanted to take delivery they could simply buy physical gold to start with, along with having to arrange and pay for storage and insurance rather than seeing the cost of carry hidden in the price of their futures contract. That's why physical settlement in normal times runs well below 5% of the expiring month's futures open interest, which by then has otherwise been rolled or closed out.
What's more, the "immediate conclusion" that the UK's lockdown would stop secure logistics firms moving bullion around the world was only apparent "to the outsider," says Allan Finn, director of global commodities at specialists Malca-Amit.
"This assessment was naïve and ill-informed," he says, because while gold typically moves in the belly of passenger jets, and while passenger flights in or out of Heathrow have dropped by 95% since March, the industry was already coping with vastly reduced air capacity before the formal lockdown was imposed, and it had begun switching to charter flights.
The result? Gold always moves where it's most highly prized, and while prices in the consumer giants of China and India sank to record discounts against London quotes, those record New York premiums attracted record inflows to Comex depositories. China vanished from HMRC's data for UK gold exports in March and April, and Swiss gold exports switched almost entirely from Asia to the US.
Comex stockpiles have now reached a record 970 tonnes, more than 4 times the level of a year ago, with two-fifths registered by its owners as available for settling Comex gold contracts. Equal to more than 25% of open interest in all current futures, that compares to a low of 0.3% as gold neared the end of its post-global financial crisis bear market in 2015.
Despite glutting New York depositories with gold, the Comex's sudden premium hasn't yet evaporated, with August futures (now the most active contract) currently trading around $10 per ounce above London spot.
But after squeezing the supply-side so tight in late March and into April - and despite physical settlement jumping to reach some 150 tonnes on the June contract as producers and merchants put their new State-side stockpiles to use - that premium has in fact caused a drop in Comex activity.
Comex gold volumes now "remain quieter than one would expect with prices near a 7-year high" in Dollar terms, as market strategist John Reade notes at the World Gold Council, while open interest remains well below New Year 2020 levels.
According to LBMA Trade Data in contrast, which aggregates London and Zurich activity among members of global trade body the London Bullion Market Association, the physical market's total volumes have grown strongly in 2020 so far, averaging $61.3bn per day so far in 2020 against $56bn on the Comex, with a fresh daily record in late May of $114bn.
Most notably, daily volumes in OTC swaps and forwards have risen by more than 25% so far in 2020 from the 2019 average. That suggests new hedging activity is moving away from Comex to OTC contracts on this side of the Atlantic. If so, speculative volumes will of course have to follow.
The global gold market's great depth and strong growth during this latest crisis hasn't yet overcome the challenge it faces in June 2021, when Basel 3 will require banks to hold 85% of required stable funding against financing, clearing and settlement of precious metals transactions.
Industry groups including the LBMA continue lobbying the European Banking Authority to reduce this figure, arguing that gold plainly represents an extremely High-Quality Liquid Asset, and one in which European central banks themselves are major holders and lenders.
Whatever that outcome, demand for investment gold and exposure to cash prices as a portfolio hedge has surged once again as volatility and risk have jumped, with gold-backed ETPs swelling at a record pace so far in 2020 alongside demand for lower-cost allocated accounts, vaulted and insured in London or Zurich for as little as 0.12% per year. The metal's physical appeal has only been burnished by lockdown.
Adrian Ash is director of research at allocated-gold exchange BullionVault.
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