The End Of Paper Gold And Silver Markets

Quantifying gold derivatives

We know from the Bank for International Settlements’ statistics that at the end of the second half of 2020, gold forwards and swaps totaled $530bn, which at the then price of $1898 was the equivalent of 8,685 tonnes of gold in paper form.[iv] But other than a triannual survey, the next being due in 2022, according to the BIS this figure is culled from dealers, mainly banks, in only twelve jurisdictions. With respect to commodities and foreign exchanges, these twelve jurisdictions have been found to capture roughly 80% of the total, so grossed up the gold tonnage rises to an equivalent of 10,806.

The LBMA positions are just part of the BIS total. The LBMA only records monthly settlements in London (Loco London) reported by the four clearing members that own and operate London Precious Metals Clearing Limited. They deal solely with LBMA members. The daily average settlement for December 2020 was recorded at 18.9 million ounces or 588 tonnes. This is only one-eighteenth of the BIS figure quoted above. The first thing to note is that daily settlements are not the same thing as outstanding obligations. Furthermore, the BIS statistic includes swaps and forwards not recorded in London nor, for that matter, are they necessarily settled through the LPMCL. But even taking these factors into account the difference between the BIS and LBMA figures still need further explanation.

In an analysis for Hardman & Co published in January 2020, Paul Mylchreest identified two other sources of turnover not included in the LBMA figures: trade between LBMA members and non-members, and central banks dealing in unallocated gold.[v]

Now let us assume that the new Basel regulations have the effect of bringing unallocated bank trading in gold to an end. From the value of outstanding OTC contracts recorded by the BIS adjusted for the trends of its triannual surveys, we can take it to be about 10,800 tonnes. Assuming LBMA members on their own account run relatively minor net positions in the context of this enormous figure, we can assume this outstanding balance is mostly split between central banks, other non-LBMA users of the unallocated market, and OTC trades recorded in other centres.

We have no idea what the central bank position is at any one time, but it would be surprising if they took long positions. Instead, they can be expected to attempt to bolster market confidence in fiat currencies, and in particular the US dollar by selling gold. And by shorting paper gold, they also would seek to encourage physical supply by shaking out weak holders in ETFs. That being the case, not only has the central bank cohort no reason to be long of gold derivatives, but if they have positions, they are almost certainly short. The only likely exception is when a central bank which has leased gold sold into the market might hedge the price risk of not getting it back.

The ending, therefore, of London’s forward settlement market would remove an artificial supply of gold, which we can estimate to be the equivalent of over 10,800 tonnes of gold. To this we should add the net short Swap position on Comex, comprised of bullion bank trading desks, which is currently 486 tonnes. From the main sources of derivative supply, we can therefore see roughly 11,300 tonnes of paper gold supply being withdrawn from the markets if the bullion bank cohort ceases trading in derivative gold. We should now examine the position of central banks further.

Central bank leasing — yet to be resolved

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