Swiss Refiner: Physical Tightness in the Flow of Gold Is 'Reflected in the Price Not at All

"No correlation to the physical market.

On-going tightness in the physical gold markets.

physical tightness of flow is reflected in the price not at all.

Gold is moving in one direction from west to east with small exceptions over the last year.

The danger of less supply moving forward is more likely than the comfort of more supply."

I found this discussion between John Ward of Physical Gold Fund SP and an executive at one of the top Swiss Refiners highly informative, and suggest that you give it a listen.

The most difficult part I have found in presenting information is that once a group has amassed a great deal of data and putting it into some organized form of information, an arduous task indeed,  the next step of taking that information and putting it into a relatively simple and easier to understand format is a very important task and none too easy in itself.

I certainly learned that lesson through years of making presentations to the principal executives of Fortune 100 companies.  Most of the time they wish to have everything on one sheet or slide, with backup optional for their staffs or key questions they may ask in 'drilling down.' If you have ever worked at a large company I am sure you know the feeling.

I hope to have something out on this issue later day.

But this is quite interesting and stands alone.  We have been hearing about this 'tightness' from quite a few quarters recently including some bank analysts and Peter Hambro.


You may read about this and listen to the actual podcast at Physical Gold Fund.

The gentleman we are interviewing is part of senior management of one of the largest Swiss refineries. His refinery is one of only 5 global LBMA referees, which takes samples from other refineries around the world and certifies them to produce gold meeting the purity and form factor of the LBMA good delivery standard, which makes it part of the very core of the industry globally.

He has over 30 years experience in the gold markets and has in our view one of the most authoritative perspectives into global physical gold flows in the world. His unique outlook, formed from internal data on gold flows through the refinery, combined with colleagues throughout the industry including the largest bullion banks (versus news outlets) is an invaluable source of information and paints an important picture for the gold markets moving forward.


Topics include:

*Why trying to correlate physical flows with the price can be misleading;

*On-going tightness in the physical gold markets;

*There is less liquidity in the physical market;

*The physical tightness of flow is reflected in the price “not at all”;

*As long as the spot market is settled with cash settlement, the physical flows are not determining price;

*If investors dealing in cash markets begin to take delivery, the physical is just not around;

*The current pricing mechanism can continue indefinitely unless investor behavior changes to taking delivery versus cash settlement;

*The gold price has “no correlation to the physical market”;

*If this behavior changes (to taking physical delivery) it could become dramatically dangerous;

*Gold is moving in one direction from west to east with small exceptions over the last year;

*90% of the refinery’s business is currently supplying demand from the east (India, China) and 10% to western markets;

*China has imposed a new standard on the LBMA good delivery system of 1 kilo, 999.9 fineness;

*400oz bars being melted and refined to 1 kilo 999.9 fine bars and shipped into China are coming out of London and particularly the ETF’s such as GLD;

*In the next gold upleg, scrap may not be readily available – overall scrap has decreased remarkably;

*Declining investment in the mining sector and geo-political issues affecting mining viability will unavoidably reduce gold supply moving forward;

*The danger of less supply moving forward is more likely than the comfort of more supply.

Lions and Tigers and Deriding the Theory of Gold Tightness At the Comex, Oh My!

“Our clients will call up saying ‘I hear the Comex is running out of gold, what do you make of it?’ and our quick answer is that this is a non-issue,” Jeffrey Christian, managing director at CPM Group, said in a telephone interview.

“Even if you look at the fact that registered stocks have declined, the fact of the matter is most Comex futures contracts” are cash-settled, and traders don’t take delivery of the metal, he said.

While the percentage of Comex gold open interest covered by total Comex reported stocks has fallen over the past year and a half, it “remains very high by historical standards and presents no perceptible risk of imminent problems with deliveries,” CPM Group said in a report dated Sept. 14...

Barclays Plc said in a report this week that emerging-market demand for gold has shifted some metal into Asia, and that “coverage of physical stocks in Comex remains solid.”

Joe Deaux, Gold Shortage Theory Derided as Comex Seen Well Supplied, Bloomberg News, Sept 16, 2015


“Anything that has more upside than downside from random events (or certain shocks) is antifragile; the reverse is fragile.”

Nassim Taleb, Antifragile

Gold is anti-fragile. This is why it must be handled with care, and not with fragile systems. Gold is intractable to the kinds of manipulation by the financial system that can bend paper to its will. This is why they hate gold, and seek to paper over it with leverage and secrecy.

Above is a commentary on the physical bullion situation at the Comex as it was reported at Bloomberg News yesterday.   The 'deriding', which means ridicule and contempt, is coming from CPM group's Jeff Christian, and from a report from Barclays.

The title of the article is a bit odd, because I have not see any 'theories' about this subject at least here, just presentations of the facts using exchange provided information.  And as for deriding, it seems more like a sign of weakness and fear than solid reassurance.  But that is just my own experience in seeing that sort of thing when someone points out a changing situation that could pose a problem.

One thing the story fails to make clear is that only registered gold is deemed deliverable to fulfill futures contracts.  Yes, all the gold in all the warehouses could potentially satisfy demand, IF IT WAS UP FOR SALE.   But it is not.

The total supplies at the Comex have as much to do with the current demand for bullion as all the automobiles in your neighborhood have on the price that you are going to pay tomorrow for a used car, eg. the calculation cannot include items that are not up for sale.  Yes there are many cars that would satisfy your requirements.   But only those that are for sale are available for you to drive home.

Jeff Christian says that "even if you look at the fact that registered stocks have declined..."

Yes, 'even if' you look at the heart of the argument, 'registered stocks have declined,' and that is quite the understatement of the facts.

Here is the history of 'registered gold bullion' on the Comex going back to 2001.

And of course if almost no one asks for any of the gold, then there is no problem.   Yep.

This is the problem. For anything except speculating with paper the Comex is now significantly fragile, moreso than at any time it has been in the last twenty years at least.

Jeff goes on to say that "most Comex futures contracts” are cash-settled, and traders don’t take delivery of the metal,"

And that is correct.  Here is the history of deliveries, ignoring any cash settlements, on the exchange.

As should be easy to see, the amount of gold bullion deliveries is declining quite a bit.

The Comex lacks the market discipline of delivery of the goods and restraint on the potential hypothecation of available supply.  What is acting to hold leverage to some reasonable level other than 'nothing has broken yet.'

Let's take a quick look at the ratio of total contracts to registered gold, that is gold up for sale.

The Comex is a significant price discovery market for the global gold supply.  The data shows that it has diverged significantly from the physical bullion markets primarily in Asia.

While the inventories at the Comex remain flat overall and declining sharply with regard to deliverable bullion, the physical deliveries of gold into India and China are increasing steadily.

And I hasten to remind everyone that gold is truly a global market.

Nick Laird at sharelynx.com has created chart that tracks the known physical gold demand for what he calls 'The Silk Road.'

Even though I do not expect a default at Comex, as I have said many times before, the point is that if there is even a mild problem in one of the physical markets in Asia or London, the Comex is price positioned for a market dislocation and potential fails to deliver bullion on request.

The deliverable gold is a little under 6 tonnes.  But even if price were no object, the total gold held in private hands in all the Comex warehouses is about 6,716,000 troy ounces, or roughly 209 tonnes. That is all of it no matter who owns it or why.

Or less than one month's supply for the Silk Road countries.

Normally none of this *should* be problem, although one has to admit that according to historical norms the amount of deliverable gold is very thin by any measure.  Why is this?  Why are the better informed withdrawing their bullion from the deliverable category?  I read that they are afraid of the bullion being caught in a 'short squeeze,' but the trader who said that did not specify a short squeeze where.

This week I learned from an interview with Jim Rickards that some very large bullion banks were said to be using the Comex gold futures to hedge shorts in bullion delivery markets in London, called the LBMA.

That kind of a hedge might work to guard against paper losses, but against a genuine fail to deliver in a physical market you can see that the immediate deliverables at these prices are about 6 tonnes, which is a rounding error on the Silk Road.

It's the fragility, always the fragility.

What if something that is not completely normal and expected happens?  What if, instead of 2% of the contracts asking for delivery, a delivery short squeeze in London prompts 4 or 5 percent of the contract holders to attempt to exercise their contracts to receive physical bullion to cover their obligations elsewhere?

The fragility of such an arrangement is bothersome to anyone from outside who looks at it from a systems engineering perspective.

If some firms are using the Comex as a backup system for gold deliveries in London and points east, it is hardly equipped to take that role without a significant market dislocation in price.

If I was only working short term trades and would never mind a settlement in cash, then the Comex seems like a fine place to do the trade.

However, if my goal is to have a solid claim on physical bullion, even within some reasonable length of time measured in several months, it does not appear that the Comex is appropriate for that particular objective.

Do you see the potential problem here that is so blithely 'derided?'

I do not wish to alarm anyone. I am putting out the word because I do not think people understand the situation that has developed, over the past two years in particular, as shown by the potential claims per ounce.

Globally huge market with increasing demand, a market where the available inventories are exceptionally thin, and a price that is derived without a tight rein on leverage and the discipline of delivery. What could possibly go wrong?

The usual retort is 'it has not broken yet.' Yes, and in the light of our experience over the past ten years or so, some might find rather thin comfort in that.  The important thing is for traders and investors to be fully informed,  that they may use financial instrument in a manner that is appropriate to their objectives.

For example, using Comex as a backup for bullion positions on the LBMA might be fine, if you are not expecting to receive delivery of bullion that can be used to satisfy your obligations there.

The exchange might consider another look at their rules in the light of this unusual 'leverage' of potential claims to bullion, rather than count on price fixing all problems, and few standing for delivery, especially in a changing and very dynamic global market.

I do not have good visibility into the leverage and available inventories at the LBMA in London.  If those are in any way similar to the Comex, then I would take some action fairly quickly to secure my ownership of bullion given the potential for a misstep that spins out of bounds.

If you hold an allocated receipt that is as 'good as gold?'  Tell that to the investors who used MF Global,  and found their holdings sorted out in court against a lawyered up megabank.

I do not know Jeff Christian or the fellow from Barclays.   I am sure that they have good reasons for what they are saying and the advice they appear to be giving to their customers.  I am sure they can all work out all their concerns and particular issues among themselves.

Objectives amongst customers do vary and it is the fiduciary duty of any advisor to help them make an appropriate choice.  And I can see many uses for Comex positions that are entirely suitable for some.   A short term trader for instance, who in merely placing wagers that he expects to settle for cash.

But as for this article in Bloomberg, it is a bit of a gloss, heavier on the deriding and short on information for readers to use in making their own informed decisions.  'Trust us' and 'nothing has broken yet' are, as I said previously, non-starters these days.

I have set forth only a few of the oddities that are becoming apparent in the gold market.  There are quite a few more, including backwardation and tightness in the London physical market as noted by Peter Hambro and an analyst at Mitsubishi recently, and in articles by Koos Jansen and Ronan Manly.

How about the pivotal London market, is it 'well-supplied?'  How well supplied is it?  What is the potential impact on the Comex of a bullion shortfall at the LBMA?

Jim Rickards had something to say about the LBMA and its relationship with the Comex recently.  You may read it in a larger commentary titled On the LBMA and Their Unallocated Holdings - 'Tightness' In Gold Bullion - Backwardation.

Has there ever been a 'stress test' of what it would be like at the Comex if there were an afternoon failure to deliver physical bullion in London?  Or are you assuming as your baseline that such a shortfall could never happen in any non-Comex market?  Is the process at Comex for some event like that, besides halting the exchange and forcing cash settlements?

I do think that one can become so involved in a system, for so long a period, that when it changes, when the market dynamics start shifting, the old hands may be the last to notice the forest for all those familiar trees.  That is why companies bring in quality teams to inspect their processes for soundness and failure points.

What could have possibly changed in the global gold market in the past few years.  "Barclays Plc said in a report this week that emerging-market demand for gold has shifted some metal into Asia,"

How about this?  Some shift.  Some metal.

Here is what Kyle Bass recently had to say about the situation.  Maybe you can 'deride' him. Then again, maybe not.

Gold Backwardation: When Good People Make Bad Comparisons

You may have heard some talk lately of 'gold backwardation.'

Backwardation is a pricing phenomenon in the futures markets where the price of an asset now is higher relative to the price of that same asset in the future. 

The usual state of most assets is one of contango, where the price increases in the future. This is often due to the time value of money. But let's put that aside for now. Especially in times of ZIRP.

And there is the source of the term backwardation.  The pricing is literally 'backwards.'  I don't remember where the heck contango comes from, and don't care, but that is a shortcut in how I remember the difference between them. 

There are strong indications in the gold market of short term physical supply pressures. Gold Forwards prices are negative, and in a way that we have not seen in some time.   Registered or dealer inventories on the COMEX exchange are at record lows for this leg of the bull market, something that has signaled a change in price trend since the gold bull market began.  Reports of tight supply in the physical markets have been in the news especially in Asia.

The German people asked the NY Federal Reserve for the return of their nation's gold bullion that is being held in custodial trust, and the Fed said 'no can do, Fritz, come back in seven years.'  Are you shitting me?  If that does not get one's attention, you have to wonder what will.

But the fact remains there is not much 'backwardation' on the gold futures market at the COMEX. Below is a chart showing the contract pricing over time. What's up with that?

Furthermore, some astute market observers have pointed to the pricing structure in the oil futures market, and rightfully observed, 'Now THAT's backwardation!'

So what does all this mean?

First of all, one has to look at what is usual and customary for a given market, in addition to making cross market comparisons.

When one is comparing the body fat to weight ratio of a polar bear and a flamingo, for example, one might assume that the polar bear was rather unhealthy since in general too much fat is bad, and the polar bear has quite a bit more than a flamingo. Unless of course if one understands that what is normal for a polar bear may not be normal for a flamingo, because there are some basic structural differences between them.  One always compares a thing to itself, to establish the trend and the norm, in addition to something else, in order to accurately ascertain any changes in condition.

If the gold market ever goes into the type of backwardation shown in that oil chart above, I submit that you will not have look at a chart on the internet to figure out why. You will be more concerned with getting long bread, bullets, and bibles, because the economic system will be going up in the flames of some currency failure, barring some anomalous corner on the market such as we saw in silver with the Hunt Brothers and silver.

And yet with oil in that type of backwardation as we see above, nothing is particularly going on in the world.   One might assume that there is something particular with the oil market that is not indicative of the general economy and money.   Oil, while not perishable, has a cost of storage and delivery relative to the utility of a barrel available for distillation and sale as something else that makes for some natural arbitrage opportunities. Its more complex than that but you get the general idea.

So why are not seeing at least some greater degree of backwardation in gold than we see now, throwing out the awkward comparison with oil which is obviously different in character from precious metals?

Well if the problem is a shortage of supply of physical gold bullion, would one go to the COMEX to get it?  The COMEX is a locus of the supply problems,  being a paper market with record leverage or claims to available supply.  Why would you go to the source of the scarcity in order to relieve it? You would try to get the bullion from someplace else.   Do you go to the desert to find water to relieve a drought?  No, you go to where the water is likely to be found.

The backwardation thing, being specific to the futures paper market, is not all that important for gold, for the reasons cited above.

Thanks especially to Dave of Golden Truth for tracking the gold forwards for us.   I will continue to keep an eye on price and supply, and consider the technicals as they are appropriately applied.