Tag Archives: COMEX

COMEX Gold Futures Can Be Settled Directly With Eligible Inventory

The 100-ounce Gold futures contract listed on the COMEX in New York can be traded in OTC market through which the contract can be “settled” with anything that resembles the underlying asset, for example gold recorded as eligible inventory in COMEX approved depositories.

Make sure you’ve read GOFO And The Gold Wholesale Market before continuing.

It’s widely discussed COMEX gold futures contracts (GC) can only be physically delivered with gold recorded as registered inventory in COMEX approved depositories, which currently stands at multi year lows. In the same spirit it’s discussed the ratio between the open interest and registered inventory is at an all time high. I would say this is technically true. However, essential to mention is that the COMEX facilitates a mechanism through which trading in GC does not have to be “executed openly and competitively on the Exchange”. Effectively, “settlement” of gold futures contracts can be negotiated in the Over The Counter (OTC) market, at a different price than floats on the Exchange, and executed with anything that resembles the underlying asset; example given, eligible inventory. This settlement in the OTC market then circumvents normal physical delivery. In my opinion this insight is significant for our approach to COMEX trading.

Conventionally COMEX gold futures contracts are traded “on the Exchange” through CME’s electronic trading platform Globex or through the old fashion way of Open Outcry. Roughly 95 % of total GC trading volume is executed on the Exchange. Market takers can choose to sell short (or respectively buy long) GC contracts by submitting bid (ask) quotes at the Exchange, in order to make physical delivery (take delivery) of gold at a fixed date in the future, or for hedging or speculative purposes. If one has no interest in making (taking) delivery the short (long) position must be closed or rolled before delivery date is reached. When traders open new positions (short or long) the open interest is increased, when traders take opposite positions to existing positions they hold, or when physical delivery is made, positions are closed and the open interest is decreased.

The mechanism through which GC contracts can be traded in the OTC market is called Exchange For Physical (EFP). EFP can be seen as a forward swap whereby a futures contract is opened combined with the reverse spot trade. I will try to describe this phenomenon to the best of my abilities, supported by quotes taken from official documents by CME Group (of which the COMEX is a subsidiary). The sources that I used for this post are The CME Group Risk Management Handbook, CME’s Market Regulation Advisory Notice RA1311-5R, The CME website, CME’s helpdesk (phone and email), the LBMA OTC Guide and The Gold Market by Grabbe.

To understand EFP trading in the OTC market and how it can increase or decrease the open interest we must start by establishing some nomenclature. All off-exchange (OTC) negotiated trading in CME’s contracts is what is referred to as Ex-Pit trading or Privately Negotiated Transactions (PNT). Ex-pit trades and PNTs can be subdivided in more specific types of which we will only discuss Exchange Of Futures For Related positions (EFRP) and EFP, as the rest is irrelevant for now. From The CME Group Risk Management Handbook we can read:


… there are some circumstances in which a privately negotiated or ‘‘ex-pit’’ trade may be warranted. The term ex-pit trade refers to any transaction that is executed on a noncompetitive basis and outside of a traditional open outcry or electronic trading environment. The several varieties of ex-pit transactions serve slightly different purposes and may be subject to somewhat different rules. These transactions are known by a variety of names including exchange for physicals (EFPs), exchange for risk (EFRs), block trades, and cleared-only, or ClearPort, contracts. Whatever the nomenclature, they may collectively be referred to as ‘‘ex-pit’’ transactions.

…Although traditionalists in the futures industry are accustomed to referring to EFPs, … Over the years, these practices have been adopted in the context of futures markets and generalized as exchange of futures for related positions (EFRPs).

Let’s say EFP is a form of an EFRP (which both are types of ex-pit/PNTs).

On the homepage of GC at the CME website we can see it’s disclosed this contract can be traded off-exchange (OTC) through CME ClearPort.

Screen Shot 2016-02-04 at 5.25.10 pm
Courtesy CME Group

What is ClearPort? Again, we’ll read a little in The CME Group Risk Management Handbook to understand: 

CME ClearPort should not be thought of as a trading platform or as a clearing service. Rather it is best understood as an Internet or web-based gateway. The CME ClearPort system currently provides traders a wide degree of latitude to conduct transactions in literally hundreds of energy, metals, and other contracts. These transactions are executed off exchange in a bilateral transaction directly between buyer and seller. This is much like the execution of any other OTC derivatives contract.

… By submitting OTC transactions to the CME ClearPort process, one enjoys the financial sureties afforded by the Clearing House.

Ok, so ClearPort is a gateway through which market participants can use EFP to trade GC contracts OTC style.

For an overview of what was just discussed,  let’s head over to CME’s website and look at the volume page of GC. We can see PNT/ClearPort volume (framed in red in the screen shot below) is the sum of block trades, EFP, EFR, EFS and TAS, and Total Volume (framed in green in the screen shot below) is the sum of Globex, Open Outcry and PNT/ ClearPort volume. Have a look at the headers and the numbers below.

Screen Shot 2016-02-05 at 5.51.32 pm
EFP participants are required to submit their trading volume to CME, not settlement prices or the offsetting positions. (Green and red frames added by Koos Jansen.)

Again, Total Volume of GC consist of Globex, Open Outcry and PNT/ ClearPort trading.

The next step is to understand what EFP is. According to the most recent formulation by CME Group (Market Regulation Advisory Notice RA1311-5R, 2014):

An Exchange for Related Position (“EFRP”) transaction involves a privately negotiated off-exchange execution of an Exchange futures … contract and, on the opposite side of the market, the simultaneous execution of an equivalent quantity of the … related product … corresponding to the asset underlying the Exchange contract.

One party to the EFRP must be the buyer of the Exchange contract and the seller of (or the holder of the short market exposure associated with) the related position; the other party to the EFRP must be the seller of the Exchange contract and the buyer of (or the holder of the long market exposure associated with) the related position. …

(I will quote from the above paragraph later on.) 

The related position component of an EFRP must be the cash commodity underlying the Exchange contract or a by-product, a related product or an OTC derivative instrument of such commodity that has a reasonable degree of price correlation to the commodity underlying the Exchange contract. The related position component of an EFRP may not be a futures contract or an option on a futures contract.

Where the related position component of an EFRP is a physical transaction … the transaction should be submitted for clearing as an EFP transaction type.

For the sake of simplicity we won’t discuss all varieties of EFP described by CME Group in the Market Regulation Advisory Notice RA1311-5R, but only what I believe is the common denominator: a forward swap. In a previous post I described what a forward swap is, how it’s executed in the London Bullion Market and that it’s usually referred to in short as a swap. When a (forward) swap is executed in the futures realm this is done through EFP, as James Orlin Grabbe wrote in the late nineties:

While forward gold is traded in the form of swaps, which combines a spot trade (buy or sell) with the reverse forward trade (sell or buy), gold futures can be traded in the form of EFPs (exchange for physicals), which combine a futures trade with the reverse spot trade.

The CME Group Risk Management Handbook (2010) also describes EFP to be a swap:

Technically, an EFP refers to a transaction in which a futures position is assumed in juxtaposition to an offsetting … spot transaction.

So, we’ll focus on the swap characteristics of EFP.

In EFP two parties sign a futures contract (short and long) and simultaneously make a spot transaction (buy and sell). One party sells short the futures contract and buys spot gold (the spot leg is referred to as the related position by CME), while the other party buys long the futures contract and sells the spot related position. EFP trading can increase the open interest, decrease the open interest or not change it, depending on the existing GC positions held by both parties before they enter into an EFP transaction.

Example given how EFP can increase the GC open interest: Suppose two traders, Mister A and Mister B, have no existing GC positions. Mister A and B connect through CME ClearPort and privately negotiate to enter into an EFP transaction. Through EFP Mister A buys long 1 GC (the buyer of the Exchange contract) and simultaneously sells spot gold (the seller of … the related position). Mister B sells short the corresponding GC (the seller of the Exchange contract) and simultaneously buys the corresponding spot gold (the buyer of … the related position). In this example the open interest is increased by 1, counted unilaterally, as both Mister A and B open a new GC position (1 short, 1 long). The movement in the related position (the spot leg) is irrelevant to the open interest.

Example given how EFP can decrease the GC open interest: Suppose, Mister A is short 1 GC to be delivered in December 2016 and Mister B is long 1 GC to be delivered in December 2016. Mister A and B connect through CME ClearPort and privately negotiate to enter into an EFP transaction. Through EFP Mister A buys long 1 GC December 2016 (the buyer of the Exchange contract) and simultaneously sells spot gold (the seller of … the related position). Mister B sells short 1 GC December 2016 (the seller of the Exchange contract) and simultaneously buys the spot gold (the buyer of … the related position). In this example the open interest is decreased by 1, as the existing positions by Mister A and B before entering into the EFP transaction have been offset by both taking an opposite futures position through EFP and simultaneously exchanging spot gold. What happened is that Mister A and B settled their existing GC December 2016 position (short and long) through EFP. This settlement can only be performed if both parties agree in EFP. No short or long GC position can be forced to settle through EFP.

Naturally, EFP can leave the GC open interest unchanged if either Mister A or B has an existing position and the other one not before both enter into an EFP transaction.

Let us move further to the essence of this post. The COMEX publishes the amount of gold stock in its approved depositories in two categories: eligible and registered inventory. Factually, gold stock recorded as eligible or registered is required to respect exactly the same specifications and are both stored in vaults “within a 150-mile radius of the City of New York“. The only difference between the two is that registered gold has a warrant attached to it. From the COMEX rulebook we can read:

Eligible metal shall mean all such metal that is acceptable for delivery against the applicable metal futures contract for which a warrant has not been issued. Registered metal shall mean an eligible metal for which a warrant has been issued.

…A warrant shall mean a document of title … demonstrating that the referenced quantity of the covered metal, stored in the facility referenced thereon, meets the specifications of the applicable metal futures contract.

Courtesy Sharelynx.com. Registered inventory has almost dried up while there is ample eligible inventory.

Through the conventional process – without OTC trading – GC is physically delivered with “either one (1) 100 troy ounce bar, or three (3) one (1) kilo bars, … with a weight tolerance of 5% either higher or lower, … [assaying] to a minimum of 995 fineness”, which is located in a COMEX approved depository in New York and has a warrant attached to the gold. On the warrant the serial numbers of the bar(s) are written, and it is this warrant that changes hands when the gold is delivered from a short to a long. Because physical delivery is done with warrants, often only registered inventory is presented by analysts when comparing COMEX gold stock to the open interest or other economic parameters.

But, as we just learned GC can also be settled through EFP. The punch line of EFP is that the related position (the spot leg) can be anything that resembles 100 ounces of gold. Through EFP “the quantity of the related position component … must be approximately equivalent to the quantity of the Exchange component”. Therefor, the related position is allowed to be gold recorded as eligible inventory in New York, but it can also be Good Delivery bars or a bag of gold coins located anywhere on this planet. Yes, CME confirmed to me in black and white the related position in EFP has no geographical limitations. The physical gold used in EFP for settlement of GC does not have to be located in New York.

Does CME generally inspect what these related positions are? Well, CME can ask EFP parties to show their offsetting (/related positions) accounts. From The CME Group Risk Management Handbook we can read [brackets added by me]:

The … spot … position that is traded opposite to the futures contract must be a product that represents a legitimate economic offset.

After the two counterparties consummate the [EFP] transaction, the futures position is reported to the CH [CME Clearing House] through a clearing member via electronic systems. The cash position [/related position] continues to be held in appropriate accounts established by the EFP counterparties and is not reported to the exchange upon execution. If called on during the course of a periodic audit, however, clearing members may be required to produce statements that show the offsetting position was transacted and meets exchange standards as a valid offsetting position.

What about the price at which EFP is executed? Again, these trades are OTC so the price is privately negotiated between the EFP participants – and are not likely to be in line with prevailing prices on CME’s Globex. A CME representative told me over the phone that EFPs are usually quoted by brokers in dollars that reflect the difference in price between the spot (related position) and the futures leg. From the Market Regulation Advisory Notice RA1311-5R we can read:

EFRPs may be transacted at such commercially reasonable prices as are mutually agreed upon by the parties to the transaction.

… The price of the Exchange leg of an EFRP transaction is not publicly reported. EFRP volumes are reported daily, by instrument, on the CME Group website.

From The CME Group Risk Management Handbook we can read:

An EFP may be transacted at any time and at any price agreed on by the two counterparties. Two customers may transact an EFRP among themselves provided that the resulting futures position is subsequently submitted to the CME Clearing House (CH) through the facilities of a clearing member.

Last but not least; below is a chart showing EFP volume, clearly this concept is not something unusual. On average 4 % of total daily trading volume in GC is performed through EFP. If EFP volume is 8,000 a day the lower bound is that the open interest is decreased by 8,000 contracts, the upper bound is that the open interest is increased by 8,000 contracts.

gc efp gold futures

This concludes the introduction of EFP. More will be discussed in forthcoming posts.


Btw, this is helpful as wel. From CME:

113102.E. Termination of Trading

No trades in Gold futures deliverable in the current month shall be made after the third last business day of that month. Any contracts remaining open after the last trade date must be either:

(A) Settled by delivery which shall take place on any business day beginning on the first business day of the delivery month or any subsequent business day of the delivery month, but no later than the last business day of the delivery month.

(B) Liquidated by means of a bona fide Exchange for Related Position (“EFRP”) pursuant to Rule 538. An EFRP is permitted in an expired futures contract until 12:00 p.m. on the business day following termination of trading in the expired futures contract.

Strong Withdrawals Mainland & Hong Kong Gold Vaults

From June 8 – 12 withdrawals from SGE certified vaults in China mainland and CME Kilobar vaults in Hong Kong accounted 76 for tonnes.

Withdrawals from the vaults of the Shanghai Gold Exchange (SGE) and Shanghai International Gold Exchange (SGEI) came in elevated for this time a year at 46 tonnes in week 23 (June 8 – 12), up 41 % from the previous week.

Shanghai Gold Exchange SGE withdrawals delivery 2015 week 23

Shanghai Gold Exchange SGE withdrawals delivery only 2014 - 2015 week 23

Year to date a staggering 1,061 tonnes have been withdrawn, up 20 % y/y (2014), up 7 % y/y from 2013.

SGE withdrawals have lost their accuracy since the launch of the SGEI in September 2014 – withdrawals in the Shanghai Free Trade Zone (SGEI) can distort Chinese wholesale demand measured by SGE withdrawals (SGE withdrawals disclosed in the weekly reports capture both SGE and SGEI withdrawals). From numbers available in 2014 we knew that not much of SGEI trading was withdrawn by foreign SGEI members; most of the withdrawals in the Shanghai Free Trade Zone were imported into the mainland by SGE members.

For more information please read The Mechanics Of The Chinese Domestic Gold MarketChinese Gold Trading Rules And Financing Deals ExplainedThe Workings Of The Shanghai International Gold Exchange and SGE withdrawals in perspective.

At this stage total SGE withdrawals, as disclosed by the weekly SGE reports, are difficult to analyze as we didn’t get any hints lately from the Chinese as to what is composition of the demand side of withdrawals, how much are SGEI withdrawals that are not imported into the mainland, and what is the composition of the supply side, how much gold is imported into the mainland and/or recycled to supply SGE withdrawals. Technically, all trades (volume) on the SGEI can be withdrawn and exported to, for example, India. This is not likely, but we don’t know. Attempts from my side to obtain the latest data regarding SGEI withdrawals have resulted in little intelligence.

In week 23 (June 8 -12) total SGEI volume was 35 tonnes; international gold trading in renminbi slowly comes to life.

SGE & SGEI contracts bullionstar

The iAu99.99 contract is traded on the SGEI; Au99.95, Au99.99 and Au(T+D) are traded on the SGE.

Hong Kong Kilobar Withdrawals

In March 2015 the Chicago Mercantile Exchange (CME) launched a gold kilobar futures contract, which can be physically delivered in Hong Kong. The contract can be traded over exchanges (CME Globex, CME ClearPort, CME Direct, New York open outcry) and in the Over The Counter (OTC) market.

The kilobar volume over exchanges is insignificant and I’m not aware if any delivery is made from these trades. However, if we look at the physical gold throughput of the Hong Kong vaults, we must conclude this contract is a popular trade in the OTC market. This has been confirmed to me by a CME representative. Note, withdrawals from the Hong Kong vaults transcend the volume disclosed by the Merc, so the physical settlements must happen in the  OTC market.

I would like to emphasize kilobar withdrawals do not have the same significance as SGE withdrawals. The mechanics of the gold market in Hong Kong are completely different from the market in the mainland. Hong Kong has been a trade hub for centuries; gold is imported and exported in vast amounts. Kilobar withdrawals do not reflect gold demand; it does illustrate how much is going through the Chinese Special Administrative Region (Hong Kong).

Kilobar withdrawals

In week 23 kilobar withdrawals in Hong Kong accounted for 30 tonnes. On June 8 a record 16.61 tonnes in 9999 kilobar gold was withdrawn from the Brink’s vault in Hong Kong.

Hong Kong monthly gold trade January 2013 - March 2015
This chart is an example for the amount of gold flowing through Hong Kong.

Thoughts On The Price Of Gold

Withdrawals from the Shanghai Gold exchange (SGE), which equal Chinese wholesale gold demand, in week 12 (March 23 – 27) accounted for 46 tonnes, down 14.5 % w/w. Year to date total withdrawals have reached 607 tonnes, up 9 % from 2014, up 33 % from 2013.

Screen Shot 2015-04-03 at 11.23.15 AM
Blue (本周交割量) is weekly gold withdrawn from the vaults in Kg, green (累计交割量) is the total YTD.

Shanghai Gold Exchange SGE withdrawals delivery only 2014 - 2015 week 12 x

Shanghai Gold Exchange SGE withdrawals delivery 2015 week 12 dips x

Ever wondered why Chinese demand doesn’t move the price of gold substantially higher? A much perceived analysis in the gold space is that (central) banks suppress the price of gold. While it certainly is in their interest to control the price of gold and there are many clues they do intervene, in this post I would like to approach this subject from scratch, from what I believe is basic economics, hopefully sparking debate.

Thoughts On The Price Of Gold

In any market where goods are traded there is supply and demand. For this post we’ll look at the gold market to examine the relationship between both; there can be people offering gold for sale (supply), meeting people who are willing to buy gold (demand). If a transaction is agreed at a certain price the amount of gold sold (supply) is always equal to the amount of gold bought (demand), it’s impossible supply and demand are not equal by any measure – or one would use different metrics to measure either one.

When demand increases relative to supply (economic agents are willing to buy more gold at prevailing prices), the strength of demand will transcend the strength of supply. As a result the price of gold will rise until a new market equilibrium is found. The volume of gold bought in itself does not indicate the price will rise, for if an immense flood of supply would be unleashed that is being met by equally strong demand the price of gold will not change. No matter how much gold is sold, it won’t tell us anything about the strength of demand relative to supply, only the price can tell. The price unveils the forces of supply relative to demand.

In the graph below we can see how an increment in demand relative to supply can move the price.

Supply Demand curves

  • P – price
  • Q – quantity of good
  • S – supply
  • D – demand

In this example demand increases from Q1 to Q2, while supply remains constant; the price moves up from P1 to P2 for a new market equilibrium.

Technically, if India buys (or imports) 4,000 tonnes a year this doesn’t necessarily mean demand is strong, nor does it mean the price will go up or would have gone up in the process. If supply to India was stronger than demand from India, the price can go down while thousands of tonnes cross the globe (given India has no domestic mine production).

The gold market is quite unique and cannot be compared to other markets, like the potato market. The primary difference lays in the fact that gold can’t be consumed, as it doesn’t corrode all gold is immortal and can be recycled indefinitely. We humans can lose gold, but it can’t vanish. Therefor, all gold mined is added to the total above ground stock. In contrast, potatoes have a limited life span of itself and when eaten are digested. Yearly supply and demand of potatoes is determined by what is produced versus human trends that set our need for consumption.

Gold supply, on the other hand, is less determined by mining output, as this is effectively only a small percentage of the total above ground stock. It’s estimated yearly mining output is 1.6 % of the total above ground stock. In theory the total above ground stock is potential supply at the right price. The willingness to sell largely depends in which category the owner of the metal can be classified. Yearly mining output is likely to be sold no matter what the price is; above ground bullion can be sensitive to price movements; ancient gold artifacts are likely never to be sold; jewelry can have emotional value for owners, etc. Furthermore, no one is ever forced to sell – aside from government confiscation that have occurred in history. In short, the volume of yearly supply is elastic, but for sure it’s more than mining output.

Additionally, many other aspects determine the volume of supply and demand (the price). To name a few: technical analysis, trust in central banks, financial stability, real interest rates, stock market performance, inflation (expectations), the yield curve, disposable income, the strength of alternate currencies, industrial applications and supply and demand data (for example, if China buys 2,000 tonnes of gold per annum, but analysts worldwide state – for whatever reason – the Chinese buy 1,000 tonnes, this leads to distortion of sentiment as the market will react on false assumptions).

Next to physical supply and demand, the price is affected by gold derivatives – futures, options, forwards and unallocated gold – and the London Gold Fix. Derivatives are leveraged a multitude of physical supply and demand volumes and therefor have an equally greater impact on the price and sentiment, especially in the near term. In derivative markets the price of gold can be easily moved up or down to the likes of big traders in the short to medium term.

Terry Smeeton of the Bank Of England stated at the Australian Gold Conference in March of 1994 (from Frank Veneroso’s Gold Book 1998):

…at least 20 central banks are engaged in swaps, options and futures. This is double the number of banks who were regular players a few years ago.  

CME Group, the world’s biggest derivatives marketplace located in the US, launched a program in July 2013 to incentivize central banks outside the US to trade in a number of products, a few of which are Metals Futures Contracts traded on CME Globex, by offering them a special discount (click here to read the details from CME Group). I would be surprised if central banks don’t trade gold futures at this moment.

The London Gold Fix is set twice a day in the London gold market through an electronic, auction-based platform, at which currently seven bullion banks participate. The auction has been under scrutiny as its opaque nature is vulnerable for manipulation.

Gold Fix Chart

It should be noted that the volume of gold traded in the London OTC gold market is unknown, but estimated to be a few times the size of the futures market in New York (the COMEX).

Derivatives can be used by hedge funds, speculators, bullion banks and central banks to influence the price, subsequently influencing technical analysis and sentiment on which the rest of the market reacts. People can be scared to sell, however, when the price in the paper markets (derivatives) moves up or down, no physical gold owner is forced to sell at the paper prices except for miners. If the paper price goes down and physical demand increases this has to be met by equal physical supply, that is, if the price for physical gold follows the paper price. If the physical price disconnects from the paper price, premiums will appear at one location.

Reality Check

In 2013 the price of gold made a spectacular nosedive, which was followed by an even more impressive flight of physical gold from Western vaults to China. The UK net exported 1,424 tonnes of bullion, China net imported 1,507 tonnes.

Screen Shot 2015-04-02 at 9.56.46 PM
BulionStar charts

According to my logic and textbooks the fall in the gold price and the physical moving east was a stronger force of supply than demand. We could quantify Chinese demand as “strong”, but apparently supply was stronger.

In the Gold Demand Trends Q2 2014, by the World Gold Council we can read:

The rapid 25% drop in the gold price during the April-June period of 2013 sparked a leap in gold demand that we have heard described as a ‘once in a generation’ event.

My point being, if central banks suppress the price of gold, this can only be done if physical gold is supplied to the market. So the question is, who is currently selling gold to China? (Or in the free market since the London Gold Pool collapsed in 1968.)

China is the largest miner of gold at 450 tonnes a year, though to satisfy domestic demand additional gold is imported; in 2013 Chinese net import exploded to 1,507 tonnes, my estimate for 2014 is at least 1,250 tonnes and year to date China has imported well over 400 tonnes. Is this sold by institutional investors in London (the LBMA system) or by central banks? Eventually time will tell. In the meantime I will continue to research how much gold is flowing to Asia and if there is any gold left in Fort Knox (read this and this post for my Fort Knox research).

Booming SGE Withdrawals In Week 2, 2015: 70 Tonnes

Withdrawals from the vaults of the Shanghai Gold Exchange (SGE) in week 2 of 2015 (12 – 16 January) accounted for an incredible 70 metric tonnes. Aggregated withdrawals in the first two weeks of this year stand at 131 tonnes.

Shanghai Gold Exchange SGE withdrawals delivery 2015 week 2, dips

Shanghai Gold Exchange SGE withdrawals delivery only 2014 - 2105 week 2, dips

Corrected by the volume traded on the Shanghai International Gold Exchange (SGEI), withdrawals in week 2 were at least 65 tonnes (read this post for a comprehensive explanation of the relationship between SGEI trading volume and withdrawals). Year to date withdrawals corrected by SGEI volume were at least 122 tonnes.

The numbers just mentioned are truly amazing, 70 tonnes withdrawn in one week is the third highest amount ever. Only in January 2014 when the Chinese were also buying gold for the Lunar year – but the gold price in renminbi was lower, and in April 2013 when the price of gold fell of a cliff, were withdrawals stronger than last week. This is important, as illustrated in the charts above the Chinese tend to buy gold when the price is declining, last week they bought like there was no tomorrow while the price was rising sharply. Now that’s strong demand! Perhaps some investors in the mainland read the recommendations from ICBC, world’s largest bank, regarding physical gold hoarding:

ICBC gold buy reccomendations

In perspective; 65 tonnes demand (the bottom limit) can only have been met by mine supply, scrap supply or import supply. Domestic mine production was 8.7 tonnes; gold was not trading at a discount, but at a premium to London last week, which means scrap couldn’t have been abundant; estimating scrap that supplied the SGE at 4 tonnes leaves import to have been at least 52.3 tonnes (in one week). Nothing unusual if this would occur sporadically, but since 2013 China has net imported 2,838 tonnes for just non-government demand, continuously draining global above ground gold inventory – as world mine production is not sufficient. How long can this go on? Deutsche Bank estimates the PBOC imports an additional 500 tonnes a year, according to a report released in November 2014:

…But there have been a number of examples of publicly flagged large-scale official gold transactions that have had a limited market impact. In the IMF example above, gold prices rose steadily despite the IMF being a reliable seller of almost 20 tonnes each month. In another example, the Chinese government’s open market purchases of roughly 500 tonnes per year have not prevented the gold price from plummeting in recent years.

The world Gold Council (WGC) estimates there is about 170,000 tonnes of above ground gold. In my opinion it’s impossible to know how much gold has been mined in the history of humanity, though I suspect it’s more than 170,000 tonnes, also because of what we are witnessing these years regarding amounts of gold moving from West to East – the WGC started counting from 10,000 tonnes since the Californian gold rush. 

The Shanghai International Gold Exchange

To my advantage for estimating Chinese wholesale demand (that equals SGE withdrawals), SGEI trading volume has been insignificant since the SGEI was launched in September 2014. SGE management of course was aiming for substantially more volume at their new subsidiary. In order to boost liquidity they took a bunch of measures. On December 29, 2014, the SGE announced free storage and no load-in and load-out fees from January 1 to June 30, 2015.

All international members and customers:       

With a view to encouraging international members and customers’ participation in trading and delivery activities on the International Board and meanwhile reducing their cost, the Shanghai Gold Exchange determines to further exempt international members and customers from fees including inventory fees, load-in and load-out fees, vault transfer fees and other service fees generated from trading contracts listed on the International Board. The exemption period shall be valid from January 1st to June 30th, 2015.  

Two days later they exempted traders from paying transaction fees on the SGEI physical gold contracts iAu99.99, iAu99.5 and iAu100g.

All Members,

With a view to promoting the liquidity and enhancing the investment function of Au(T+N) products, the Shanghai Gold Exchange (the “Exchange”) determines to reduce the transaction fees of Au(T+N1) and Au(T+N2) by 50%, from the current 2‰ to 1‰. In addition, the Exchange shall also exempt all its members from transaction fees of contracts listed on the International Board including iAu99.99, iAu99.5 and iAu100g, so as to boost the trading activities on the international board. 

The above-mentioned preferential policies shall be valid from January 1st to June 30th, 2015.

Then on January 15, they decided to collaborate with the WGC to promote SGEI trading:

Today, the Shanghai Gold Exchange and the World Gold Council, the market development organization for the gold industry, signed a ‘Memorandum of Understanding’ regarding a ‘Comprehensive Strategic Cooperation Agreement.’ The Shanghai Gold Exchange is the largest physical gold exchange worldwide and the World Gold Council is the global authority on the gold industry. Together, these two organizations are joining hands to support the development of both domestic and international gold trading in China by leveraging the opportunity provided by the internationalization of the Chinese gold market, through the Shanghai Free Trade Zone, to support market expansion. The agreement will support the development of gold investment products and solutions for the industry and investors both regionally and globally.

I’m holding my breath on the collaboration with the WGC. In my experience they could have started by making the SGEI more accessible. Since September I was trying to become a customer through a number of Chinese banks, but I didn’t succeed. Enrollment wasn’t particularly easy.

Gold Trading Volumes

Total SGE trading volume has been declining for a few weeks, in week 3 (January 19 – 23) volume accounted for 238 tonnes, down 19 % w/w.

Shanghai Gold Exchange SGE weekly gold volume

Volume on the Shanghai Futures Exchange is moving in the opposite direction, volume has been increasing since December 26. In week 3 volume was 778 tonnes, up 10 % w/w. The open interest closed at 124 tonnes at the end of the week.

On the COMEX 3,054 tonnes of gold in futures contracts changed hands, down 13 % w/w. The open interest closed at 1,403 tonnes.

COMEX vs SGE + SHFE gold volume

SGE Withdrawals A Whopping 61t In Week 51, YTD 2016t

Withdrawals from the Shanghai Gold Exchange (SGE) came in very strong in week 51 at 61 tonnes, year to date the counter has reached 2016 tonnes.

Screen Shot 2014-12-27 at 12.18.55 PM
Blue (本周交割量) is weekly gold withdrawn from the vaults in Kg, green (累计交割量) is the total YTD.

Some SGE data lags one week, some not; in this post all data is up to week 51 (December 19).

Withdrawals from the vaults of the SGE captures Chinese wholesale demand, however, to get a more precise view on demand we have to add SGEI volume to the equation (read this post for a comprehensive explanation on the relationship between SGE withdrawals and volume on the Shanghai International Gold Exchange – SGEI). If we subtract SGEI volume from SGE withdrawals, at least 51 tonnes was withdrawn in week 51, at most 61 tonnes; year to date, at least 1,963 tonnes was withdrawn, at most 2,016 tonnes.

I could speculate on why Chinese wholesale gold demand is likely to be more in the area of the upper limit or bottom limit, fact is I have little evidence to back it up; all I know at this stage is that it’s somewhere in between.

Shanghai Gold Exchange SGE withdrawals delivery 2014 week 51, dips

Last week I wrote I expected withdrawals to be strong in the coming weeks, as December and January are seasonally the strongest months, but the Chinese are often aiming to buy their physical on the dips. In week 49 and 50 withdrawals were a bit held back because of the rising price of gold in renminbi. In week 51 the price was declining, so withdrawals were up.

Shanghai Gold Exchange SGE withdrawals delivery only 2014 week 51, dips

Year to date SGE withdrawals – 1963 tonnes, the bottom limit – were supplied by (my best estimates):

  • 442 tonnes mine production
  • 1,172 tonnes import
  • 349 tonnes recycled gold

If we use the upper limit – 2016 tonnes, import and/or recycled gold had to be more.

SGE premiums have been hovering in between 0.51 and 0.76 % above London spot throughout week 51.

Total SGE (gold) trading volume was down 14 % from the previous week at 410 tonnes. The uptrend is still intact as we can clearly see from the next chart.

Shanghai Gold Exchange SGE weekly gold volume

On the Shanghai Futures Exchange (SHFE) volume traded in Au futures accounted for 786 tonnes in week 51 (1,196 tonnes SGE + SHFE volume), on the COMEX 2,527 tonnes changed hands.

COMEX vs SGE + SHFE gold volume

Will Chinese Gold Demand End 2014 With A Boom?

Shanghai Gold Exchange (SGE) withdrawals in week 50 (December 8 – 12) accounted for 50 tonnes, year to date 1,955 tonnes have been withdrawn.

Screen Shot 2014-12-20 at 3.38.15 PM
Blue (本周交割量) is weekly gold withdrawn from the vaults in Kg, green (累计交割量) is the total YTD.

SGE Withdrawals In Perspective

I have written about this before, but I just want to make sure I have clearly shared my view on this subject (if you’ve read all my previous posts regarding withdrawals you can skip this chapter).

Many blogs are tracking SGE withdrawals currently, using it as the yardstick for Chinese wholesale gold demand. While partially true, I would like to emphasize this yardstick has become elastic.

Before the SGE’s subsidiary, the Shanghai International Gold Exchange (SGEI), was launched total SGE withdrawals provided us a clear view on Chinese wholesale gold demand, as the SGE is the exchange where all import and domestically mined gold is required to be sold first (in addition to scrap) before entering the Chinese domestic market. This clear view is now blurred.

The SGEI facilitates gold trading in the Shanghai Free Trade Zone (FTZ). Physical gold trading in the FTZ is completely separated form the Chinese domestic gold market, which is a closed market; bullion exports are prohibited and only 15 banks are licensed to import bullion. The banks that enjoy a PBOC bullion import license are:

  1. Shenzhen Development Bank / Ping An Bank
  2. Industrial and Commercial Bank of China
  3. Shanghai Pudong Development Bank
  4. Agricultural Bank of China
  5. Bank of Communications
  6. China Construction Bank
  7. China Merchants Bank
  8. China Minsheng Bank
  9. Standard Chartered
  10. Bank of Shanghai
  11. Industrial Bank
  12. Bank of China
  13. Everbright
  14. HSBC
  15. ANZ

The gold traded on the SGEI can be withdrawn from the vaults in the FTZ by foreign enterprises and shipped abroad, these SGEI withdrawals are captured in the total SGE withdrawals (only aggregated withdrawals are disclosed) and thus distorting our view on Chinese wholesale demand.

Would we get our clear view back if SGE and SGEI withdrawals would be disclosed separately? No. This is because Chinese domestic banks are also trading on the SGEI, when they withdrawal from the vaults in the FTZ they can import this gold into the mainland without it being required to be sold (again) through the SGE.

The trading volume/purchases on the SGEI (contracts iAu100g, iAu99.99 and iAu99.5) can be:

  • Not withdrawn at all and thus not distorting our view on Chinese wholesale demand.
  • Withdrawn by foreign traders and thus distorting Chinese wholesale demand. If we knew how much these withdrawals accounted for we could subtract them from total SGE withdrawals to have a clear view on Chinese wholesale demand. Unfortunately we don’t know these numbers.
  • Withdrawn by Chinese domestic banks to be imported into the mainland and thus being part of Chinese wholesale demand.

This is what we (I) know at this stage. Concluding weekly Chinese wholesale gold demand is at most total SGE withdrawals, at least total SGE withdrawals minus SGEI trading volume.

For example, in week 50 total SGE withdrawals accounted for 50,027.5 Kg. Total SGEI trading volume accounted for 6,159 Kg. Meaning Chinese wholesale gold demand was somewhere in between 50,027.5 Kg and 43,868.5 Kg (50,027.5 – 6,159). Year to date Chinese wholesale gold demand is somewhere in between 1,911,230 Kg and 1,955,090 Kg (at least 1,911 tonnes). 

Needless to say, if more information is disclosed by the SGE I will report about it as soon as possible.

Furthermore; Chinese wholesale gold demand is supplied by import, mine and scrap. The amount of mine supply we know from numbers of the China Gold Association (CGA), in 2014 it will be approximately 451 tonnes. The composition of the other two supply flows is not known, for this we have to make estimates based on numbers from previous years. In 2012 scrap (through the SGE) was 232 tonnes, in 2013 it was 247 tonnes. This year scrap is likely to be substantially higher. How come? By way of measuring Chinese wholesale gold demand as described above, it was at least 1,841 tonnes in the first eleven months of this year. The Chairman of the SGE said on a conference import was (approximately) 1,100 tonnes over this period and mining had to be 416 tonnes, setting scrap at 325 tonnes.

Nevertheless, China will import far more than 1,100 tonnes in 2014, added to 451 tonnes of domestically mined gold, the Chinese people will add about 1,700 tonnes to their reserves. Assuming the PBOC doesn’t buy gold through the SGE.

Will Chinese Gold Demand End 2014 With A Boom?

Seasonally December and January are strong months for Chinese gold demand, but will they be this year? To answer this question let’s have look at the next chart.

Shanghai Gold Exchange SGE withdrawals deliveries 2014 week 50, dips

We can see elevated withdrawals every December and January. Additionally, it’s clear the Chinese rather buy gold when the price is declining than when it’s rising, unlike Western gold investors. This thesis is also supported by the fact SGE premiums often move inverted from the price of gold.

Shanghai Gold Exchange SGE gold premium 2009 2014 moving averages

Now let’s zoom in on the former chart.

Shanghai Gold Exchange SGE withdrawals deliveries only 2014 week 50, dips

Though withdrawals are strong, in my opinion demand is somewhat held back by a rising price of gold in the past few weeks. How withdrawals/demand will develop around New Year is (of course) partially determined by the direction of the price of gold. If the price of gold continues to rise in renminbi I expect it will further dampen Chinese demand around New Year and Lunar Year.

Chinese Gold Trading Volumes

Worth mentioning is that SGE gold trading volume is going up exponentially since a couple of weeks. The biggest drivers are the Au(T+N1) and Au(T+N2) deferred contracts. On November 3, 2014, the SGE adjusted the specifications of these contracts – that hadn’t been traded at all since October 2013, after which volumes skyrocketed. In week 50 the volume of these contracts combined accounted for 95 tonnes, which is 20 % of the total SGE gold volume traded (474 tonnes).

Screen Shot 2014-12-21 at 5.18.56 PM
Red: trading volume of Au(T+N1) and Au(T+N2) counted bilaterally. Purple: total SGE gold trading volume in week 50 counted bilaterally.

Shanghai Gold Exchange SGE weekly gold volume

Total gold volume traded on the SGE combined with the total gold volume traded on the Shanghai Futures Exchange (SHFE) accounted for 1,309 tonnes in week 50. This amount was more than half the gold volume traded on the COMEX in the same period (2,507 tonnes). I don’t see a trend of declining volumes on the COMEX, but I do see a trend of surging volumes in China, that are now starting to near COMEX volumes.

COMEX vs SGE + SHFE gold volume

Guest Post: The Gold Market, Part 4

Look in the side bar of this website for the first three parts.

Written  by James Orlin Grabbe in the late nineties.

Part 4

“There’s been a bomb at the World Trade Center.”

We all looked over at Kelley, one of the gold traders. She was quoting the Telerate news ticker off the monitor on her desk. There was no further information.

We then looked past Kelley, out the seventh floor windows of 222 Broadway, and down the half block of a side street to No. 4 World Trade Center (WTC). The COMEX, where gold futures are traded, was on the 8th floor of No. 4 WTC, and Kelley and one of the other gold traders had open phones lines to the trading floor.

The background voices at the COMEX, heard over the speakers where we were, sounded normal. The street scene outside looked normal also.

“Why don’t you ask the floor if there’s anything unusual over there,” I suggested to Kelley. We had two brokers on the COMEX floor.

Nothing out of the ordinary, they said. No bomb here. One opined he had felt a small shake of the building. The other one hadn’t noticed even that.

Those of us at 222 Broadway went back to work, filing away this interesting, but seemingly irrelevant piece of information: a bomb at the World Trade Center. It was, in fact, another hour before smoke began to fill the elevators at No. 4 WTC, and COMEX traders were ordered to evacuate the building. In the meantime, Kelley kept us updated as more news hit the ticker.

“It was centered in the garage area,” she announced.

For the first time, someone looked concerned. “I’m parked over there,” he said.

Tom wandered by my desk. “Want to go take a look?” he asked. Tom was a PhD chemist who had turned option trader. He had a natural curiosity about explosions.

I declined the invitation. Where there is one bomb, there may be two, and I preferred to wait until the excitement was over. If the bomb was in the parking garage, I doubted there was anything to see, anyway. Tom shrugged and left by himself. He returned with a report: the bomb had collapsed the lobby floor of the Vista Hotel on the ground floor of the tower at No. 1 WTC, as well as the floor below that, and a 20- foot crater now extended out to the street beside the tower. From our windows, we couldn’t see the activity taking place because No. 4 WTC blocked our view. I reflected that I had passed through the Vista Hotel lobby the previous day, en route to the walkway connecting the World Trade Center to the World Financial Center located on the other (wharf) side of Manhattan’s Westside Highway.

As it turned out, the WTC bomb had been planted by an FBI informant, whose FBI handler had insisted he use real explosives, and not fake that part of the “sting”. This was reported in the New York Times before Louis Freeh’s media handlers went to work and quashed reports of the FBI connection, and diverted all attention to the supposedly purely foreign nature of the “Middle Eastern terrorists” (with U.S. intelligence connections) whose operation the FBI had been assisting under the guise of conducting a “terrorist sting”.

It was claimed the bombers had intended to bring down the tower at No. 1 WTC. Though in fact the van filled with explosive (alleged, but not shown, to be urea nitrate) had done no damage to the building structure. Explosive pressure drops off approximately with the cube of the distance, so to do serious damage with a low-power explosive, you need to attached it to the building columns.

What the explosion had done was to take out two floors in a particular area vertical to the van location, and to fill the building cavities with smoke. Most of the 1000 or so injuries resulted from smoke inhalation, and were basically confined to those taking the commuter trains from New Jersey into the train station in the basement of the WTC. That is, to passers-through trapped in smoke, and not to people actually working at the WTC.

By the end of the day, Tom and I were discussing ANFO bombs instead of options. Where I had grown up in Texas, ammonium nitrate was widely used as fertilizer. It was just one of those things prevalent in the environment, like gasoline and butane, that you used and treated with respect. I had never known anyone killed with ammonium nitrate, although I had known two people, including one neighbor, who had blown themselves up welding “empty” butane tanks.

No, the FBI-assisted terrorists hadn’t done much damage to the World Trade Center, relatively speaking, aside from the Vista Hotel. But for a few hours on Feb. 26, 1993, they had shut down the COMEX, and– London trading having finished for the day–most of the world’s gold market along with it.

Gold Futures

Gold futures are traded at the COMEX in New York (which merged with the NYMEX on August 3, 1994, and is now known as the “COMEX Division” of the New York Mercantile Exchange), at the TOCOM in Tokyo, and–until recently– at the SIMEX in Singapore. Gold futures are also traded at the Chicago Board of Trade (CBOT) and at the Istanbul Gold Exchange. (The latter is mostly a market for spot gold. For example, over 8 million ounces of gold were traded spot at the Istanbul Gold Exchange in 1997, but only about 43,000 ounces were traded through the futures market.)

Gold futures are priced much like the gold forwards we discussed in part 3. That is, in their relationship to the spot price, futures show little difference from forwards. But there are many other ways in which futures contracts differ from forwards, and it is important to understand what these are.

Forward gold is traded for contract settlement at standardized intervals from spot settlement, in intervals that correspond to foreign exchange forward contracts: 1, 2, 3, 6, and 12-month forwards are typical. Spot gold traded on Wednesday June 24 will settle on Friday, June 26. A one-month forward trade on June 24 will take us to July 26, which is a Sunday, so settlement of a one-month forward will be on Monday, July 27. A two-month forward trade on June 24 will take us to August 26, which is a Wednesday, so settlement of a two-month forward contract will be on August 26. And so on.

Futures, by contrast, are traded for fixed dates in the future. At the COMEX and CBOT, gold is traded for settlement in February, April, June, August, October, and December, as well as the current and next two calendar months. Istanbul trades the next six months for Turkish lira-denominated contracts, or the next 12 months for U.S. dollar-denominated contracts. The last trading day for a futures contract is the fourth to last business day in the delivery month (at the CBOT or Istanbul), or the third to last business day (at the COMEX). That is, the August 1998 COMEX gold future trades until the third to last business day in August 1998. At the TOCOM, there are futures for the current or next odd month, and all even months within a year. The last trading day is the third to last business day, except for December, when the last trading day is December 24.

Despite the different trade date conventions, however, if futures and forward settlement dates happen to correspond, forward and futures prices are the same, subject to slight differences related to delivery grade or location (Manhattan, say, versus London).

How Futures Markets Deal with Credit Risk

The main different between futures and forwards is the way futures markets handle credit risk. In the forward market, a credit evaluation must be made of the counterparty–evaluating the counterparty’s ability to pay cash if gold was purchased forward, or the ability to deliver the gold, if gold was sold forward.

The futures market don’t worry about such customer credit evaluations. Instead, a futures contract is configured as a pure bet, based on price change. So one is asked to post a security bond, called “margin”, which covers the typical variation in the value of a contract for several days. Going long a futures contract is a bet that the price is going up, while going short is a bet the price is going down. Cash flows from price changes take place daily. So those who post the required margin against possible losses (and who replenish this margin if necessary) are considered credit-worthy, while those who can’t post margin aren’t credit-worthy. Customers post margin with member firms of the futures exchange, who in turn post margin with clearing member firms. The clearing member firms post margin (on the customer’s behalf) at a clearinghouse. This way of dealing with credit risk is a much cleaner structure than in the forward market world of customer credit evaluations, accounting reports, and other types of intrusive financial reporting. (Of course, exchange member firms and, especially, clearing member firms still have to undergo the usual sorts of credit checks.)

To close out a long position, one sells (goes short) an off-setting contract. To close out a short position, one buys (goes long) an off-setting contract. The opening and subsequent closing of a futures position is referred to as a “round turn”. Brokerage fees are usually charged per round turn, at the time the future contract is closed out.

At discount brokerage firms in the U.S., in June 1998, the typical customer margin on a 100 oz. gold futures contract was about $1350, while there was a typical brokerage charge of $25 per round turn.

The size of the futures bet depends on the stated size of the futures contract. The cash flow will be the change in price multiplied by the contract size.

At the COMEX, CBOT, and the SIMEX, the contract size is 100 ozs of gold with a fineness of .995. So if gold (of that fineness) went from $299/oz at contract opening to $297.50/oz as the day’s futures settlement price, a long contract would lose $150, while a short contract would gain $150. (The calculation on the short position is $299 minus $297.50, multiplied by 100.)

The TOCOM trades 1 kilo bars (32.148 ozs) of .9999 fineness. The price is stated as yen/gram. So the daily change in value of a single contract is the change in the yen price per gram, multiplied by 1000 grams.

The Istanbul gold futures contract is for 3 kilograms of gold of .995 fineness, quoted either in terms of U.S. dollars per ounce, or Turkish lira per gram. The daily change in value of a U.S. dollar- denominated contract is the change in dollars per oz, multiplied by 96.444 ozs. The daily change in value of a Turkish lira-denominated contract is the change in the Turkish lira price per gram, multiplied by 3000 grams.

The “initial” margin that must be posted as a security bond is large enough to cover several days expected/loss or gain, and is thus related to the standard deviation of daily contract value changes. The margin is held by a clearinghouse which thus “guarantees” that the losing side of the daily futures bet pays the winning side. For every customer that goes long a contract, the clearinghouse takes the other side, going short. For every customer that goes short a contract, the clearinghouse takes the other side, going long. The clearinghouse thus is in a position to move cash from the losing side of any futures bet to the winning side.

If the initial margin is depleted by losses, it eventually reaches a “maintenance” margin level, below which the customer is required to replenish the margin to its initial level. For example, at discount brokerage firms in the U.S. in June 1998, a typical maintenance margin level for gold futures contracts at the COMEX was $1000 per contract. So if the posted margin dropped below $1000 per futures contract, additional margin had to be posted to bring the total back to at least $1350 per contract (the typical initial margin level).

Customers typically may post margin in the form of cash, or U.S. government securities with less than 10 years to maturity. Clearing members may post cash, government securities, or letters of credit with the clearinghouse. The details differ at different exchanges.

The Equilibrium Futures Price

The equilibrium futures price is that point where the market clears between longs and shorts. Arbitrage, however, forces the futures price to track the forward price (and vice-versa). Similarly, arbitrage between the futures market and the spot market on the final day of trading forces the futures price to converge to the spot price. On the final trading day at the SIMEX, where no gold can actually be delivered on a futures contract, the settlement price is set as the loco London price of the A.M. London price fix. This forces convergent of the futures price to the price in the London spot market. At the COMEX and CBOT, the open longs take delivery of spot gold, which accomplishes the same thing.

(On January 9, 1998, the SIMEX removed trading of its gold futures contract from the floor of the exchange. The contract is still available on the SIMEX Automated Trading System.)

Delivery at the COMEX and the CBOT is one 100-oz bar (plus or minus 5 percent) or three 1-kilogram gold bars, assaying not less than .995 fineness. (Note that 3 kilo bars is about 96 ounces of gold. The dollar amount actually paid at delivery depends, of course, on the specific amount of gold delivered, which must be within 5 percent of the hypothetical 100 ozs per contract.) Delivery at the CBOT takes place by a vault receipt drawn on gold deposits made in CBOT-approved vaults in Chicago or New York. Gold delivered against futures contracts at the COMEX must bear a serial number and identifying stamp of a refiner approved by the COMEX, and made from a depository located in the Borough of Manhattan, City of New York, and licensed by the COMEX. As noted previously, there is no delivery at the SIMEX. The futures contract is purely cash- settled, with the final settlement price determined by the London A.M. gold fix.

In part 3, we saw the U.S. dollar forward price of gold would be related to the U.S. dollar spot price of gold by the relationship

F(T) = S [1 + r (T/360)] / [1 + r* (T/360)].

where the spot price is S, the forward (or futures) price is F(T) for a time-horizon of T days, the eurodollar rate is r, and the gold lease rate is r*. If the eurodollar rate r is higher than the gold lease rate r*, then the forward (futures) gold price will be higher than the spot gold price. Historically gold lease rates have always been lower than eurodollar rates, so forward gold (or a gold futures contract) always trades at a higher price than spot gold. The same is not true, for example, in the silver market. During the year 1998, silver lease rates have frequently exceeded eurodollar rates, so forward silver has traded at a cheaper price than spot silver.

Different terms are used to refer to the relationship between forward or futures prices and spot prices. If forward gold (or a gold future) has a higher price than spot gold, the forward gold or gold future is said to be at a premium, or (in the London market) in contango. If forward gold has a lower price than spot gold, the forward gold or gold future is at a discount, or (in the London market) in backwardation.

As we noted before, forward gold has in recent history always been in contango, or at a premium, because dollar interest rates have always been above gold lease rates. We saw in part 3 that the difference between the forward price and the spot price, F(T)-S, is the swap rate. Since the forward price of gold has always been at a premium in recent years (since 1980, in particular), the swap rate has always been positive. A related term that is used in the U.S. futures markets is basis. Basis is the spot price minus the futures price, or S-F(T), which is just the swap rate with the sign reversed. The gold basis has always been negative in recent years. The Federal Reserve Bank of Cleveland, for example, publishes monthly charts of the gold basis. Reverse the sign on their chart, and you are looking at the swap rate.

Exchange for Physicals

While forward gold is traded in the form of swaps, which combines a spot trade (buy or sell) with the reverse forward trade (sell or buy), gold futures can be traded in the form of EFPs (exchange for physicals), which combine a futures trade with the reverse spot trade. EFPs are traded for the same months as gold futures. The EFP price represents the difference between the futures price and the spot price for the combined trade.

For example, a marketmaker may quote the August EFP at the COMEX as $1.10-$1.30 in 100 lots. This means the marketmaker’s prices are good for a standard trade involving 100 futures contracts (10,000 ozs of gold). The marketmaker will “buy” the EFP at $1.10/oz, or “sell” the EFP for $1.30/oz.

This quotation implies that for $1.10/oz. the marketmaker offers to buy from you 100 gold futures contracts, while simultaneously selling to you 10,000 ozs of spot gold. For $1.30/oz. the marketmaker will sell to you 100 gold futures contracts, while simultaneously purchasing 10,000 ozs of spot gold. To summarize: the marketmaker’s bid price is the price he will buy futures versus selling spot, while the marketmaker’s asked price is the price he will sell futures versus buying spot. The EFP price is thus simply a different way of looking at the basis or the swap rate.

On June 24, 1998, the mid-market price (average of bid and asked prices) of the EFP associated with the August 1998 COMEX gold contract was a positive $1.25, while the mid-market price associated with the Dec 1998 COMEX gold contract was a positive $5.60. By contrast, the EFP associate with the July 1998 COMEX silver contract was a negative $2.00. This reflected the fact that gold lease rates were below eurodollar rates, while silver lease rates were above.

Interest rates in the gold market are a principal concern of gold dealers and gold mining companies.

In Parts 3 and 4, we saw how two interest rates– gold lease rates and eurodollar rates–determine the relationship between the dollar price of spot gold and the dollar price of gold forwards and futures. In the forward market, these two interest rates give rise to the swap rate, while in the futures market they determine the EFP price. Both swaps and EFPs involve a spot sale or purchase of gold, along with the reverse trade in the forward market (if a swap) or futures market (if an EFP).

Because eurodollar rates have historically always exceeded gold lease rates, gold forward and futures have always traded at a premium (have always been in contango). There is nothing inevitable about this relationship, however.

But there are many contracts in the gold market that do not involve the spot, forward or future price of gold, but rather are simply written in terms of gold interest rates. These include gold forward rate agreements (FRAs), gold interest rate swaps, and gold interest rate guarantees (IRGs). Let’s examine each of these contracts in turn.

James Orlin Grabbe

More On The West To East Gold Exodus

The most significant parameter to measure the gold distribution from west to east is the trade vein that runs from the UK through Switzerland through Hong Kong, eventually reaching Shanghai.

The UK Source

In October the UK has net exported 90 tons of gold to Switzerland, – 16 % m/m, year to date the Swiss have net received 1199 tons. The UK net exported 1326 tons in total in the first ten months of this year, of which 477,9 tons were sourced by GLD. The unusual outflows remain elevated throughout the entire year. Also note, the UK is hardly importing any gold this year, as if physical gold is difficult to source.

UK Gold Trade 10-13

UK Gold Trade 2008-2013 10-13

GLD inventory 10 2013

From 1 January until 31 October GLD lost 15.3 million shares. Can it be the Chinese redeem physical gold from GLD through “agents” like Blackrock that have sold huge amounts of shares this year and possibly redeemed these shares for physical gold through GLD’s authorized participants? Just a theory..

This is a picture taken on 25 November 2013.

Xie Blackrock

On the right we can see Mr. Xie, president of China’s third largest Sovereign Wealth Fund NSSF, on the left Mr. Lawrence Fink, chairman and CEO of BlackRock.

Pass The Swiss

The Swiss only publish their total gold trade numbers every 3 months; last data was from September. As we can see from the chart, all the gold that is being imported into Switzerland this year is being remelted and exported; this was also confirmed by a Swiss refinery. Exports stand at an all time record this year at 2184 tons, and there are 3 months left on the calendar. Annualized exports would be 2912 tons, which is 1362 tons more than what the Swiss exported in 2012. We may assume this difference in exports is additional supply for the east.

Switzerland Gold Trade 2013-Q3

The bulk of Swiss gold export is heading east, some directly to Shanghai, some first to Hong Kong. From the Hong Kong Census And Statistics Department we know 779 tons were net imported from Switzerland into Hong Kong year to date. 651 tons more than what was net imported in total in 2012.

HK Swiss gold trade 10-2013

The Hong Kong Trading Hub

West East gold ditribution 2013

We can see a correlation between the net amount of gold that comes into Honk Kong from Switzerland and the net amount that goes out to the mainland. Concluding, most mainland net gold imports through Hong Kong are being supplied by Switzerland.

We can also see strong UK net export of gold to Switzerland prior to April (in April the price of gold crashed and Chinese physical buying exploded), but this not unusual as we can see from the “UK Gold Trade” chart ranging from 2009-2013. Often huge volumes are shipped between the UK (LBMA) and Switzerland (refineries).

If SGE delivery is mainly supplied by import from Hong Kong, demand is certainly not waning. In November 168 tons were withdrawn from the SGE vaults, up + 21 % from October.  (compared to 0.121 tons of physical delivery at the COMEX in November. More information on the differences between physical delivery at the SGE and COMEX can be found here and here)

SGE vs COMEX ™ Nov 2013

A remarkable phenomenon that has happened in Honk Kong trade earlier this year was this:

Hong Kong - China gold trade monthly 10-2013

There was a huge spike in gold export from Hong Kong to the mainland in March. As if someone knew there was going to be immense demand for physical in April in the mainland. But why would anybody import expensive gold  in March to sell it for bottom prices in April? The answer: Chinese import doesn’t have to work like that. Like I  described in this article gold can be consigned by, in example, HSBC and ICBC.

This is how it works; the consigner HSBC (Hong Kong and Shanghai Banking Corporation) can ship the gold to the Mainland, without selling it at this stage. On arrival it has to be registered within 7 days at the SGE and move into the vaults. The gold is now merely transported, not sold.

The consignee ICBC will then ask HSBC for a quote in USD/oz (International Spot) and then decides the offer RMB price at the SGE. The SGE Premium is based upon freight costs, insurance costs, customs declaration fee, storage fee, ICBC’s profit, etc.

After the gold is sold on the SGE, ICBC must pay HSBC in USD within 2 days and also needs to let the State Administration of Foreign Exchange verify the payment.

I am aware that there was an arbitrage opportunity  in early 2013 that could have explained some of the high volumes of gold trade between Hong Kong and the mainland. Though this couldn’t have explained the record net gold export, just before the price dropped in April and the SGE was stormed for physical gold.

Shanghai Gold Exchange gold withdrawn from vault week 50, 2013

week 16 sge

In between 22 and 26 April 117 tons of physical gold was withdrawn from the SGE vaults. That is an exceptional amount of gold to hold in stock, unless one knew demand would rise significant and had made pre orders accordingly. Just a theory..

In any case, the main vain has brought the mainland 957 tons of gold in the first ten months of this year, annualized 1148 tons. But Hong Kong is certainly not the only port through which the mainland is importing gold,  my analysis shows the mainland’s total net gold import can reach up to 2000 tons this year.

Hong Kong - China gold trade 10-2013

Hong Kong net imported 510 tons of gold in this period. Further research should point out how much of this was smuggled into the mainland.

Hong Kong gold trade 10-2013

In Gold We Trust

Smuggling Gold Into The Mainland

While I’m still researching all the other ways of how the Chinese may be smuggling gold from Hong Kong into the mainland, I came across an interesting video from CCTV in which is exposed how smugglers dig tunnels underneath Honk Kong borders in order to transport “goods” to places where there is demand for “goods”.

There are a little more than 7 million people living in Hong Kong, though this special administrative region of the People’s Republic Of China has net imported 510 tons of gold year to date.

Hong Kong gold trade 10-2013

I think everybody who has just one IQ point more than Ben Bernanke can figure out that the Hong Kong population can never “consume” this immense amount of gold by itself. The main reason for these mass net imports is because Hong Kong is used to store gold for bullion dealers from all over the world. Another reason is that half of all jewelry sold in Hong Kong is bought by mainland tourist that bring it home undeclared simply by wearing the jewelry on their bodies.

But now it seems there are other ways to bring gold to where gold is in demand. If we look at the video we can see a tunnel of 80 cm high and 100 cm wide. Not particularly big enough for cars and boats to pass through, but excellent for small valuable goods like gold (and drugs). So maybe, just maybe, a small part of the 510 tons was exported to the mainland through tunnels like these by people that were not so fortunate to have a PBOC gold trading license.

In Gold We Trust


Week 42 SGE Physical Delivery And It’s True Context

When I speak of physical delivery at the Shanghai Gold Exchange (SGE), I mean gold that is withdrawn from the vaults – the SGE is an exceptional exchange because it publishes these numbers. Technically, “Delivery” is a misnomer by me (and the SGE). On all other futures exchanges “delivery” actually means the amount of gold in the vaults that changes ownership after settlement between short and long contracts. “Delivery” happens in the vault, it tells us not much about the amount that’s being withdrawn. SGE delivery does tell how much is withdrawn, and gives u great insight in Chinese overal gold demand.

On the SGE the amount of gold withdrawn from the vaults in this first 9 months of 2013 was 1672 tons (second number from the right 本年累计交割量 is gold withdrawn YTD).

The SGE doesn’t publish – that I’m aware of – the amount of gold in the vault at any certain time. It does publish the amount of withdrawals every week, and total deposits at the end of a year. This is the SGE summary of 2011.

An exceptional rule on the SGE is that all bars that leave the vaults are not aloud to come back in. I know, hard to believe, but this rule is in their rule book, it’s mentioned on the ICBC website, the SGE confirmed this to me on the phone and my contact in China confirmed it (what more can I do?). On top of this, mine and import supply in China are required to be sold over the SGE. The result is that the gold that leaves the SGE vaults reflects total supply, and thus demand.

The confusion about the differences between SGE and COMEX delivery is caused by the SGE who is somewhat inconsistent in its choice of words, or maybe its translations. I hope the difference in delivery at the SGE and COMEX is clear now.

SGE 100 gram gold bar

1. 上海黄金交易所标准金条 Shanghai Gold Exchange Standard Gold Bar.

2. 上海黄金交易所标志 Shanghai Gold Exchange Logo.
3. 品牌标志 Brand Logo.
4. 金条品牌 Gold Bar Brand (In this case, it’s 泰山 Mount Tai, which is produced by Shandong Gold).
5. 成色 Fineness.
6. 重量 Weight.
7. 金条编号 Gold Bar Number.

Now let’s turn to last weeks SGE delivery (withdraws from the SGE vaults) data.


– 41 metric tonnes delivered in week 42 (withdraws from the SGE vaults), 14-10-2013/18-10-2013
– w/w – 14.47 %
– 1750 metric tonnes delivered year to date
– weekly average 41.6 tonnes YTD, 2013 estimate yearly total 2125 tonnes.

Source: SGE, USGS

For more information on SGE delivery read this, on it’s relation to Chinese gold demand read this.


Screen dump from SGE trade report; the second number from the left (本周交割量) is weekly physical delivery, the second number from the right (累计交割量) is total delivery YTD.

Premiums based on the SGE week reports. Difference between SGE gold price in yuan and international gold price in yuan.

Screen dump of premium section; the first column is the date, the third the international gold price in yuan, the fourth is the SGE price, and the last is the difference.

O, one more thing. While Chinese demand for physical gold is still insatiable, this is what the CME just published.

Jewelry Demand Sluggish from India and China

India and China are the largest buyers of gold for jewelry in the world. India has been worried about its negative balance of trade and has been raising tariffs on gold imports to slow demand. And while for different reasons, both India and China have been in a growth deceleration period, which has also slowed the demand for gold. Absent a sustained period of accelerating economic growth, demand for gold from India and China is likely to remain much more subdued than it was in the previous decade, when they helped to drive the bull market for gold.