The Gold Market Becomes Slightly Less Opaque

A Veil Is Lifted In Zürich

According to a recent report by the Neue Zürcher Zeitung (NZZ), the Swiss government has decided to finally publish Switzerland's gold trading data, which have been kept secret for 33 years.

Zürich became one of the largest gold trading hubs in the world when the London Gold Pool collapsed in March of 1968. The gold pool was established by Western central banks in order to be able to continue to pretend that one ounce of gold  indeed represented the 'backing' for $35, as per the Bretton Woods gold exchange standard. The agreement stipulated that central banks outside of the US would use the US dollar as a reserve currency, while the dollar would be fully backed by gold held by the US treasury and could be exchanged at the fixed rate of $35 per ounce on demand. US citizens had no possibility to voice any disagreement as to the state of the 'backing' via their wallets, as they were not allowed to possess gold. Soon after FDR's gold confiscation/dollar devaluation combo, two groups of people took a step across the line from illegality to legality and vice versa. Suddenly someone owning a bottle of whiskey was no longer a criminal, while someone owning an ounce of gold was.

However, similar limitations were not imposed on the rest of the world and gold demand was brisk, as everybody soon realized that the dollar had been inflated way beyond its alleged gold cover. De Gaulle broke ranks with other nations, withdrew from the gold pool in 1967 and ordered the Banque de France to test the exchange standard promise by exchanging its dollar holdings for gold. This and the growing distrust elsewhere soon unmasked the whole scheme for what it actually was: a giant fraud.

The London gold pool turned out to be a doomed attempt to perpetuate this scheme. The idea was to use central bank gold reserves that were shipped to the Bank of England to manipulate the market – by buying and selling gold so as to keep the price pegged at the official rate. There were frequent runs on the gold pool, which in the end forced governments to declare defeat. They did so in time-honored fashion: Britain declared a 'bank holiday' and all gold trading in London was simply suspended for two weeks.

Gnomes of Zürich Lying in Wait

That was the moment Swiss Bankers had evidently prepared for, as the Zürich Gold Pool began to immediately operate, ostensibly to minimize the effects of the  turmoil in currency markets (the pound was devalued by 14.3% in one fell swoop as well) on the Swiss monetary system. With the London gold market closed, a lot of business suddenly went to Switzerland, and Zürich managed to henceforth establish itself as the second big gold trading center in Europe.

In the 1970s and early 1980s,  South Africa was the by far biggest gold producer in the world, controlling about 70% of all newly mined supply. Another large gold producer was the Soviet Union, which relied inter alia on gold exports to earn badly needed foreign exchange.

In the 1970s, one was still able to obtain the details on Switzerland's gold trade for a fee. This changed in 1980, after Western governments began to impose sanctions against South Africa. Interestingly, the economic sanctions never extended to South African gold in bar form. The reason was that one didn't want to put obstacles in the way of South African mine supply because it was widely (and erroneously we might add) held that the Soviets would benefit from such a ban. Nevertheless, anyone involved in trading with South Africa on a grand scale had to fear a political backlash. Thus it was decided to make the Swiss gold trading data a secret so as to 'protect the interests of sensitive countries' – of which South Africa was but one.

As you can see below, South Africa is no longer an important gold supplier to Switzerland, but business is booming more than ever. The reason: Asia's growing hunger for gold. Swiss refiners are melting gold into shapes desired in Asian countries (kilo bars, taels, etc.), and then ship it mostly to Hong Kong, Thailand, Vietnam, India, and so forth.

Swiss Gold tradingSwitzerland's gold imports and exports – business is booming nowadays like never before – Swiss refiners are melting gold into the shapes most desired in Asia and are shipping most of it there. Below you can see Switzerland's gold imports from South Africa. They rose sharply when the gold pool collapsed, and again from 1980 to the mid 1980s when South Africa became a pariah. The total collapse in Krugerrand imports had to do with the fact that the EU and the US did ban imports of the coins as part of their economic sanctions regime in 1985. However, gold in bar form continued to be exempt from sanctions, in a misguided attempt to harm the Soviets – click to enlarge.

Old Rumors and What's Worth Knowing

However, there was another event that occurred around the same time: in 1980 the Financial Times published an article voicing the suspicion that Saudi Arabia and the Soviet Union were demanding to be paid in gold for their oil exports. Zürich was rumored to be the place where these deals were taking place. The Soviets were reportedly not exactly pleased with the attention their gold dealings with Zürich received all of a sudden. However, neither Russia nor any Arab oil producing nation has ever admitted that such 'gold for oil' deals have actually taken place.

Indeed, it seems extremely unlikely that this rumor was true. It was typical for the kind of rumor that tends to crops up when there's a feeding frenzy in a market, and gold reached what had up until then been unthinkable heights in early 1980, after rising in parabolic fashion beginning in the latter half of 1979. There can be little doubt though that South Africa wasn't the only big exporter of gold to Zürich – the Soviet Union clearly exported a lot of gold to Zürich as well.

That was probably the only reason why it was unhappy with the attention the FT article created. The Soviets always kept their precious metals and diamond exports a state secret and likely wanted assurances from the Swiss that this secrecy wouldn't be compromised. By throwing a veil of secrecy over Switzerland's gold import and export data as well, the Swiss made sure that Zürich's status as an important trading center for gold and other precious metals was going to be preserved.

To this day rumors emanating from Zürich are very useful if one wants to know what's going on with supply in the palladium market. Note here that the annual mine supply of gold is largely irrelevant to the gold price – since it comprises a mere 1.4% of the total supply of gold (this is why we mentioned above that it was erroneous to believe that sanctions on South African gold exports would have been of much benefit to the Soviets, although there may have been a brief psychologically motivated blip in the market).

It is different with a small market like palladium, a metal that is mainly used in industrial applications and therefore at least partly 'used up'. In this market it is a very big advantage to know how much of the metal is moving from Russia to Zurich at any given time, as Russia is traditionally a 'swing' supplier – by varying sales from its stock piles. In fact, we reported in these pages on a rumor concerning Russian palladium deliveries in 2009. At the time, Swiss bankers leaked the information that palladium bars they received from Russia's state depository Gokhran (Гохран) were 'bottom of the pile' stuff, very old bars, partly identifiable by their stamps and also the fact that some were not conforming to good delivery standards and had to be remelted.

This was seen as an early warning indicator that supplies from Gokhran would soon decline. The only reason why we knew about this was that the information had been leaked to the CEO of a big PGM producer in South Africa, who in turn made an off-hand remark about it in an interview. We still recall that almost no-one took notice of this revelation at the time, and it is a good bet that it was actually a slip of the tongue on his part. While holding forth on the bullish prospects for palladium, he probably got carried away and gave away some insider knowledge by mistake (of course we are just guessing regarding this point  – it may no longer be seen as a big deal to reveal such information). Anyway, it sure turned out to be a valuable hint. While it was natural for palladium prices to recover once the effects of the 2008/9 crisis eased, it was certainly surprising to many just how strong the bull market turned out to be – the price rose almost 6-fold, from a low slightly above $150 to a high of $850 within just two years. The relentlessness of the advance (there was just one noteworthy correction) indicated that there was indeed a supply problem developing, as the increase in demand wasn't pronounced enough to explain such a strong move.

PalladiumPalladium's wild ride in 2009-2010 was probably mainly a result of dwindling Russian sales from the Gokhran stockpile. Nothing pushes commodity markets up as quickly as fears over supplies – click to enlarge.


An interesting piece of economic history has been revealed, and since the data will from now on be available on a regular basis, one can keep an eye on what is happening in one of the world's largest gold trading centers. It is quite interesting that Switzerland's gold trade has not declined one bit last year in spite of the sharp gold price correction – on the contrary, it has continued to grow at quite a strong pace. This complements the data regarding the increase in gold imports in several Asian countries last year, foremost among them China. In fact, Switzerland's import and export volumes exceeded new mine production by about 20% last year. This certainly shows that interest in physical gold remains high. Keep in mind though that reservation demand remains the biggest component of total gold demand, and that any attempt at forecasting future gold prices has to be based on an analysis of gold's main fundamental drivers, none of which have anything to do with measuring how much gold is changing hands at a given locale or is moving from A to B. 




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