Gold has rarely been a hotter trade, but the world’s two most important markets remain out of sync. In New York, the price of gold topped $1 750 for the first time in seven years on April 9. In London, it still hasn’t caught up.
The dislocation first blew out in late March, when disruptions from the coronavirus sparked concerns among traders about getting gold to New York in time to settle futures contracts. In a chaotic couple of days, the premium for New York futures over the London spot price rose above $70 -- the highest in four decades.
The disconnect has remained wide as some of the world’s largest banks, which are also the top gold dealers, have grown wary. Even though there is now plenty of time to get metal to New York for June delivery, the wild moves of recent weeks, and the potential for coronavirus-induced logistical headaches, have increased the perceived riskiness of trading the two markets.
“I would guess that the risk managers are not allowing these big positions to be run,” said John Reade, chief market strategist at the World Gold Council. “It’s moved from a concern about availability and transferability of metal to one of risk appetite.
There has been some progress. Having traded at as much as $60 in the past two weeks, by Friday afternoon the spread narrowed to about $20 an ounce. Yet that still compares with just a few dollars in normal times.
Some have stepped back from trading the so-called EFP, or Exchange for Physical, the mechanism by which traders switch positions between the New York and London market, according to executives at two leading bullion banks. Even the largest market participants are being more selective about adding new positions.
“Until the machinery of the world is largely functioning normally again, you have to think very carefully about selling the EFP until you are sure you can get material to cover,” said Tai Wong, head of metals derivatives trading at BMO Capital Markets.
The result has been a drop off in trading on both markets. Volumes on the most-active Comex futures market averaged 18-million ounces a day so far this month, some of the weakest in three years. The London Bullion Market Association’s LBMA-i service also reported a decrease in trading in the week ended April 5.
“You’ve taken basically the two biggest, most liquid individual gold markets and you’ve taken away the connector between the two,” says Reade. “It’s going to affect liquidity in the gold market for some time to come.”
In theory, it should be relatively easy for any trader spotting such a wide differential between the two largest gold markets to arbitrage it profitably -- by buying gold in London then selling it in New York and profiting from the difference.
One problem is size. The London market trades large 400-ounce bars, whereas only 100-ounce bars and kilobars are deliverable in New York. Nonetheless, gold refiners around the world produce kilobars, which are the type of gold that’s typically used to settle Comex futures and is popular with investors. This means it’s usually straightforward to get hold of them and deliver to New York.
The coronavirus outbreak has made that process more difficult. Gold typically flies around the world on passenger planes, and a vast number of flights have been canceled due to the pandemic. Even though Switzerland’s gold refineries have restarted since early April, the temporary shutdown made it harder to get hold of certain products.
“Everyone wants to get gold into the same airplane. There’s almost a fight,” said Drazen Repak, head of trading banknotes and precious metals at Zürcher Kantonalbank.
To be sure, it’s still possible to find kilobars, and there are options for flying gold around the world such as cargo flights and chartering planes.
“Things have gotten better. When passenger airlines were shutting down, there was a big question as to would charter flights be feasible?” Ruth Crowell, chief executive of the London Bullion Market Association, told Bloomberg Radio. Now insurers have confirmed they will cover gold shipments on charter flights, she said. “The ability to move the metal on charter really opens up a lot of possibilities on logistics.”
Indeed, millions of ounces of gold have flowed into Comex warehouses in the past few weeks, taking the total stock to a record high.
For CME Group Inc, the owner of the exchange, the wide spread between New York and London gold prices is a headache. It responded by launching a new contract that would allow 400-ounce bars to be delivered as well as 100-ounce ones and kilobars. But the new “enhanced delivery” gold contract has yet to trade.
The CME’s solution “is still not showing anything of any merit,” said James Gavilan, principal and adviser at Gavilan Commodities. “The solutions thus far have not caused any reduction in the dislocation.”
One reason the spread has remained wide is position limits, which effectively put a cap on how much any one trader can take advantage of the arbitrage. That means that even banks still willing to arbitrage the two markets are constrained in doing so. Last week, CME doubled position limits on the nearby gold contract to 6 000 contracts -- a move that the exchange says has already alleviated some of the dislocation.
While some banks are on the sidelines, others are looking to take advantage of the spread. The cost of moving gold by plane has more than doubled, but is still only around $1 an ounce. Swiss refiners are charging premiums of $5 to $10 an ounce for spot supplies of kilobars, according to one trader. While that’s exceptionally high compared to the normal level of $1 or less, it’s still far less than the $40 or more where the spread has traded.
Traders say there has been a rush of inquiries by investors -- who wouldn’t normally get involved in the nitty-gritty of gold shipments around the world -- looking to cash in.
“That opportunity for profit is there but somebody needs to do it,” said the World Gold Council’s Reade. “What you need is effectively more risk capital to come into this space to do so.”