Alex Stanczyk of the Physical Gold Fund has just posted a transcript of an interview with an executive at a Swiss refinery about the state of the market. It is well worth a read or listen to the podcast. Below are some quotes and my take on them.
“How difficult is it to source the metal you need today? … It is truly difficult. This is also reflected by the price. It is getting more and more expensive to get material out of the market, and also there is less liquidity in the physical precious metals market than there used to be in the past.”
I think the statement that the difficulties “is also reflected by the price” needs to be clarified as later on he says “the price does not reflect the realities at all.” This is not a contradiction! The first reference is to the premium, the second is regarding the spot (ie metal) price.
When acquiring physical, the professional end of the market settles trades by unallocated account debits and paying a small dollar premium for charges, freight etc, rather than buying a physical form on the spot market with dollars. The references to “price” and “expensive” were to that premium above metal. See this post if you want more detail on this aspect of the market.
It was a bit frustrating that the interviewer did not pick up on this reference and drill further – was this a premium on 99.50% 400oz bars, if so were bullion banks refusing/delaying redemptions from unallocated accounts, or was it for other forms or was he referring to loco premiums reflecting freight and funding costs?
I would have also liked to know to what extent that refinery’s feed stock comes from newly mined gold or do they rely more on scrap and 400oz bars. Each refinery has a different mix of source metal and contractual arrangements for supply that can affect their perception of tightness. The Perth Mint is primarily a newly mined supply refinery with scrap being a swing form of supply for us, so we have a strong base of supply.
“The other point is that nobody is interested in any physical delivery at the end. These products are all cash settled. People are happy just to use the spot market as a benchmark, and the product itself never ends up in the physical market.”
He is obviously talking about Western markets here, and he makes an important point and will tie in with my future posts on fractional reserve bullion banking. He goes on to note that this is a dangerous set up as if everybody wanted the physical it “would not be around”. However, this is not a risk as “it looks very much like people are very confident in general financial markets”. The question of course is how much physical reserve exists against bullion bank unallocated accounts versus how much of an increase in physical redemption activity occurs.
“As long as market participants are happy for cash settlements, this can go on forever.”
So true. This was in response to a question about a mismatch between the spot price, which has been low, versus the tightness in the physical market. This idea of a disconnect between paper and physical is an argument that the money in the futures market or other paper markets is somehow not legitimate, that their “view” on price is not valid. Yes markets are more financialised these days, get over it.
I guess some people think that if only futures markets could be banned and everyone had to trade physical, the price would magically shoot up. They forget that if you ban all forms of paper gold you ban paper longs. And in any case, any paper contract can be synthesized using physical and borrow/lend. They also seem unaware that the net position of paper trading is, by arbitrage, reflected into the physical market, and vice versa.
“The flows of metal end up in Asia. It is mainly China, also India, and to some extent the Middle East.”
Same here in Perth.
“Then there is price-sensitive scrap – very opportunistic – coming every now and then out of Asian countries; not China or India, but other countries in the area.”
This is not something you hear talked about a lot, but yes the Asians do actually sell gold but are very good at it. Having a location advantage to Asia compared to the Swiss refineries, we do pick up a lot of this business but as I mentioned above, it is a swing or volatile source of material for us due to its price sensitive nature.
“since the last move up, a lot of scrap has already come to the market, so if the price moves up again, I don’t know how much scrap will be around in order to compensate for the lower volumes coming from the mining industry.”
I note that at the Denver Gold Forum CPM Group saw that a decline in mine production from 2018 was baked into the cake given the lack of exploration. If our refinery guy is right about scrap then the next leg up in the gold price could be quite dramatic. It is hard to call the scrap market as really high prices may be the inducement to get women to look in the bottom of their drawers for that last bit of out of date jewellery, and you can be sure the cash for gold business will be promoting hard in that environment. In any case scrap has not been/will not be a major source of metal sufficient to dent bullish demand too much, when it comes.
“If you see in one of these products a paragraph that references the possibility of cash settlement, keep your hands off.”
Good advice, I don’t think investors really pay attention to the contractual terms of the products and read between the lines, and often it is about what is missing rather than what is there.