In times of economic turbulence, gold has always been a haven for investors. A safe place to park their money while the markets swing wildly. However, this global pandemic has led to unprecedented circumstances in every industry, and gold is certainly no exception.
For a small group of gold investors with a lot of money wrapped up in precious metals markets, COVID-19 has created a demand for physical 100-ounce gold bars, the likes of which most investors have never seen before. The worldwide economic shut down set off a series of events that sent investors scrambling around the world in search of these hard-to-find 100-ounce gold bars.
An Elite Group of Traders Capitalizing on Price Distortions
There is a small group of gold traders who have historically always made easy money with a very specific trading strategy. Given that “paper” gold prices often diverge, however, small the fluctuation, from “physical” gold prices, these traders would short gold futures in New York while in London, they would be long on physical gold.
The reason this had been such a successful strategy is that these traders could almost always see the trade through to the end of the contract at which point, they had several options to get out while taking little to no loss. The price distortion would often be minimal, enough to safely arbitrage.
The coronavirus changed this dramatically. As the world’s economy came to a screeching halt and the markets started exhibiting severe volatility, these easy escape hatches went away all at once. This meant that at the end of the contract expirations, these traders would be required to deliver physical gold bars to buyers. This is when the short-sellers got in big trouble.
The Hunt for Gold Bars
These short-sellers faced a number of coronavirus-related problems that came together all at once to make their task of obtaining and delivering physical gold almost impossible and incredibly expensive.
The first logistical issue is that moving gold around the globe requires planes. With the global air travel industry virtually shut down, this became a major issue. If these troubled traders could get a flight, the next hurdle was that they specifically needed 100-ounce gold bullion bars since that is what New York futures contracts require.
A second problem: gold bars coming in from overseas are almost always a different size. This often requires traders to have them melted down and re-molded into the correct size.
And this led to problem number three. Many of the world’s gold refineries had shut down in the midst of the pandemic including a few of Europe’s largest ones.
Expense and Losses
All this led to a situation where swapping gold contracts became incredibly expensive. Trades that would cost almost nothing before jumped dramatically. At one point, swapping New York futures and spot physical gold in London grew to around $2. By the next session, that number had risen to an incredible $6.75. As this all happened, sellers dried up and traders were desperate to buy any gold they could find. By the next opening in London, there were almost no sellers to be found.
By the time the panic subsided, 5 days after it started, the potential losses were estimated at $1 Billion. This left the small group of traders who only represented 4% of the total open interest absolutely crushed.
During this frenzy, traders resorted to cold-calling owners of gold bars who might have bars in the required size. Some had to pay huge fees to the refineries that stayed open to get their bars minted correctly.
Gold futures made huge price swings during this time and signaled uncertainty going forward. However, as March came to an end, June futures settled in and cost around $30 more than April futures which seems to signal that this frantic demand has calmed for now.
As we reported in another article, gold bars and coins are also short in supply. But what we’re seeing here is the internal dynamics of supply and demand as it pertains to a particular scenario in trade--arbitraging paper against metal. The gravity of the COVID-19 crunch hasn’t yet set in. And when it does, the bigger picture of supply and demand will likely take another unprecedented turn. And that turn is likely to be in favor of the physical metal holders.