12 January 2015

Why asian gold contracts/exchanges haven't been able to crack the London market

The idea that gold would be released from its manipulated western shackles if only a physically settled Asian gold market could be established had its fullest expression in the 2011 Pan Asian Gold Exchange (PAGE) hype/meme. PAGE failed because of the political naivety of its exponents that "there can only be one" in the Chinese gold market, namely, the Shanghai Gold Exchange (SGE).
In 2014 there was a flurry of activity in Asia with the SGE International Board, Singapore Exchange's (SGX) gold kilobar contact and now, the CME's announcement of a loco Hong Kong kilobar gold future contract.
The future for CME's new contract doesn't look bright, with Reuters noting that the "25 kg contract on the Singapore Exchange and the three new international contracts on the Shanghai Gold Exchange have failed to garner significant trading volumes." As Silver Watchdog tweeted, SGE announced they would be exempting international members and customers from all fees for six months "with a view to encouraging international members and customers’ participation in trading and delivery activities on the International Board". Not exactly something you need to do if your contract is successful.
The CME's new contact seems pitched a little better than the SGX's, being in lots of one kilo (versus SGX's 25 kilos) and in USD per ounce (vs USD per gram). I would note that CME's Comex contract, while for 100oz, can be settled in three kilobars (although it is a 99.5% purity contact compared to 99.99%) and this similarity would be behind the CME's promoting of it "providing spreading and arbitrage opportunities with other world gold markets virtually 24 hours a day", which seems a pitch directly targeted towards traders, not physical users.
However, no matter how well the contract specifications are designed, I think CME's new contract will go the same way as SGE and SGX and the reason is hinted at in the blurbs for the two contacts:
  • SGE: "there is an increasingly compelling need for a transparent and centralized Asian price discovery platform for the kilobar gold market"
  • CME: "will offer a liquid and cost-effective price discovery tool and a precise risk management instrument that accurately reflects the underlying kilo gold market in Asia"
A compelling need for price discovery by whom? The problem is that these exchanges are only looking at one side of the market - the demand side. Certainly importers, distributors and manufacturers large enough to trade a kilo contract would want more transparency on kilobar premiums. But it takes two to tango and these new contracts have little appeal to the supply side (which is not miners, BTW).
The mistake of the exchanges I think is that they thought that if they created a contract which appealed to the demand side, which is composed of many firms, that the supply side, which is composed of refiners but primarily bullion banks, would follow. The problem is that the supply side is dominated by a handful of firms and the banks, who intermediate most of the supply to consumers, are quite happy with an opaque kilobar premium market. Why would the banks want to disintermediate themselves out of this position?
The only way to break this would be for an exchange to get all of the demand side to insist on only buying via the exchange. Given the large number of participants, this is next to impossible as the bullion banks would hold out until defectors looked to get a jump on their competitors. I would note here that many of the consumers are also looking for finance/delay settlement with their purchases, something the exchanges don't offer. Bullion banks advantage is they can provide both physical and finance in one deal.
If we ignore the asymmetry of the number and size of the suppliers versus the consumers, there is also the practical realities of the kilobar market where demand at the various locations changes frequently. After doing a deal with a consumer, bullion banks can ship the physical from a refinery direct to the consumer. The exchange contracts however require physical to be shipped to their warehouses for settlement, and from there we have another shipment leg to the end consumer. This is not as efficient as an over the counter (OTC) trade where metal can be directed quickly to where it is needed. It is funny that in the CME's new contract FAQs that they acknowledge this sort of market structure when they say that "with OTC clearing through CME ClearPort, you can continue to negotiate your own prices privately and conduct business off exchange" yet the contract they propose works against the current kilobar market structure.
The exchanges were given a hint of the problem by this comment made at the LBMA Singapore conference (I didn't catch the person making it) "whether a benchmark can compete or become established depends not just on its volume but also whether there a big enough premium/discount due to fundamental difference between the location and existing benchmark locations from a physical point of view". The brilliance of this comment is that the person making it knew that the loco difference between London and these Asian markets just isn't big enough to suck liquidity to the new venues - and knew that the exchanges didn't know.
The current OTC kilobar market is highly efficient with the spot price being traded basis the liquidity and depth of the London market and just the kilobar premium being negotiated separately on a client by client basis based on location/shipment cost, finance and purity (99.50% and 99.99%). Trying to compete against that while imposing a need to ship into a warehouse instead of directly to client, and require exchange settlement and clearing (with margin), while the client still has to deal with the bank anyway for finance, is a hard ask.
In the end China is probably best placed to win this game as they can force all of their consumers to trade through the SGE but as Adrian Ash at BullionVault noted "only a truly liberalized gold trade, with foreign cash and gold flowing in...and out...right alongside China's domestic flows will challenge London's 300-year old dominance." And that is still some way off.


  1. I think you answered your own question. SGE sees a compelling need for transparency. London prefers secrecy, as price manipulation is that little bit easier.

    1. If SGE was so interested in transparency, why do they only report gold withdrawals and not deposits or warehouse stocks? Games being played on all sides.

    2. They do! In 2015 deposits accounted for 2,666 tonnes. https://www.bullionstar.com/blogs/koos-jansen/wp-content/uploads/2016/12/Screen-Shot-2016-12-05-at-4.03.13-pm.png

  2. will challenge London's 300-year old dominance." And that is still some way off.'

    Are you sure?

    "We are seeing gold flows circumventing the London market when, historically, gold would typically find its way to London and then out again. So we are seeing a bypass of the London market…"


    "I have to fly gold from Zurich to London, because there just is not enough gold on offer in London. You never used to have to do that."

    1. Still some way off was in reference to China fully opening up its currency and gold markets. The circumventing of London is exactly what my post is about, London is feeling it a bit more now because India (where most of Perth Mint's output went and "circumvented" London) is joined by China.

      What I didn't make clear in my post and what Adrian was saying was that while London may be circumvented physically it will still dominate in liquidity and clearing of the physical trades, which are all done with unallocated (ie, very little physical trades in OTC pro market are settled for full gold value in dollars - it is settled with unallocated gold and dollars only for the premium).

    2. "We are seeing gold flows circumventing the London market when, historically, gold would typically find its way to London and then out again. So we are seeing a bypass of the London market…"

      UK gold imports are way down in the last two years and their suppliers are also more concentrated... 75% from Canada, South Africa and USA in 2014. And there are months when gold from these countries flows to HK instead with very little reaching the UK. The result being that net 1800 tonnes have been drained from London in 2013/14.

      I've yet to calculate the numbers but it seems Swiss imports are also way down on prior years and that's including UK/US supply which has contributed 50% of total Swiss imports in 2014.

      The bad news from a bullish viewpoint is that a lot of gold remains in London... 5500mt net imported 2001-12 by my calculation from the trade data. So this exodus can potentially continue for years depending on the Western 'narrative' and holders willingness to sell.

  3. There will never be untrammeled and genuine price discovery in ANY of these markets as long as the "supply" of "gold" is being inflated through the inclusion of the multifarious unbacked and/or fractionally-reserved paper offerings - which are, perversely, permitted to contribute to the setting of "the gold price".

    It IS as simple as that. In the absence of a situation in which only the (completed) changing of hands of physical metal is allowed to result in price-setting at the margin we will just have to wait...

  4. Nutty Buddy is having some problem posting a comment and has asked me to put this up for him:

    That we are awaiting the arrival of a time of 'untrammeled and genuine price discovery' is as ingenuous a notion as the one which holds that some markets[Asian] are, or will become, genuinely free of backside interference from government and/or finance. Both are pleasant fictions predicated up an ideological premise that 'markets' exist as a priori principle - a la 'invisible hand' - which operate outside the actions of men, in much the same way that the concept of 'virgin birth' occupies a central role in the tenets of some religions. Given that the Chinese, or other Asians for that matter, are no slouches when it comes to embracing Dengs' "it is Glorious to get Rich!" principle...

    the manipulation of markets will continue to be a feature of life evidenced to and accepted by all parties except those who look on from the outside with a passion for describing the world as it should be - rather than how it is. Through paper schemes or other means... the duplicitous nature of Homo economicus will always outshine the appeals to his purer and finer and selves!

    On the subject of over-reliance upon the WORDS rather than DEEDS of our riches-seeking fellow human beings...

    finally gotten my response to your previous post arranged Bron - little larger than a mere comment could contain. See here for my take on the Turkish Banking Sectors Fleecing of its Golden Marks - and the Perils of Mistaking a telephone for a conduit to the truth... https://diaspora.podzimek.org/public/yunusemre

  5. Dear "Can't see the forest for the trees": What if "the world as it is" is an artificial construct predicated on fraud? Should it stand? Can - never mind 'should' - CAN it stand as such?

    You see, there IS something to idealistic 'free markets'. They are the normal state of affairs, they are the default position. The tend to reappear precisely when fraud becomes the most pervasive. They do not "work" for everyone, they are not "fair", and they are not amenable to those who wish to achieve 'social goals'. They don't even need to "work" for anyone. They are 'efficient' only in the sense that they function quite well without interference...the correct role of the state is only to regulate against fraud and theft, not to interfere for the benefit of some players. Yet that is what has been going on.

    What is an honest man to do in response to today's "markets"?

    He will withdraw into value investing.

    Fekete may be right. 'Permanent backwardation' is another way of expressing the idea that gold will disappear from the market. Supply will be less and less forthcoming at these "prices". Gold is going to go into hiding in the absence of a freely-determined price discovery mechanism. It will not happen overnight. It will be incremental. But it's the only honest response.

    There is a large section of the population which believes essentially that all humans are inherently untrustworthy, that nothing will change except through force, that 'technology will save us', don't fight the "markets", etc., and these people, being trend-following, chart-watching, stat-reading types disparage speculation.

    I suspect that, in our new, no-real-growth, manipulated Potemkin Economy, speculation - 'betting' - is already all we've got. Eventually the paper yield-seekers will, I think, be forced to cannibalize one another. Get ready for volatility...

  6. From http://ftalphaville.ft.com/2015/01/22/2097692/a-right-oil-hotchpotch/ re ICE the lesson for SGE/CME etc being that you need to get the providers of liquidity onside (and that may require you to pay them).

    Electronic trading became the dominant method, and the system which came to dominate the London Brent market was that devised by Jeffrey Sprecher of ICE. And the reason it won the platform race — when Enron’s internalising platform failed along with Enron — was precisely because it was set up, supported and invested in by the big banks in the game, who not only dedicated liquidity and flow to the platform, but began their “commodities are an asset class” chant from then on.