The Real Asset Co: Unveiling the gold market’s working parts

The Asset Company’s Head of Research Jan Skoyles explains where the gold price is set by looking at the three different gold markets; the futures market, exchange traded products and the physical gold market

Via TheRealAsset.co.uk

On April 12th 3.4 million ounces (100 tonnes) of gold was sold in the US futures markets. This was just for starters, the main, side and dessert appeared over the following hours and the next session on the Chicago Mercantile Exchange (COMEX).

As those in the West holding paper gold stood frozen watching the price tick further downwards, those in the East and others looking to buy physical gold, went on a shopping spree. Premiums on physical gold in China, India, Vietnam and across Asia hit highs associated with economic and geopolitical crises. Dealers struggled to keep up with demand.

In the four weeks to April 24th reported inventories of ETFs, funds, and futures market depositories collapsed by over 5.5 million ounces ($7 billion).

The largest physical removals were reported by the COMEX of 1.4 million ounces and the SPDR Gold Trust (GLD), which reported total inventory removal of nearly 4 million ounces.

In their Q1 report, the World Gold Council referred to the ‘dichotomous nature’ of the gold market – this is clear as the paper gold market continues to tell a different story to the physical market.

Today we continue to see ETF outflows and COMEX gold futures have fallen once again this week. Meanwhile, premiums on physical gold in Hong Kong have climbed to $5 per ounce, having been $3 last week, whilst traders in Japan are pushing premiums up in response to Chinese gold demand.

But, what do people really mean when they talk about the ‘paper gold’ and ‘physical’ gold markets?

Gold futures, gold exchange traded products (ETPs) and physical gold are each different ways of gaining exposure to gold. Each form of gold exposure has its relevant gold market segment catering for investors, yet all are priced according to an international gold price.

The Futures Market

Futures contracts allow investors to efficiently trade gold, for delivery at a future date – they are one of the most efficient ways to buy gold.

The global gold futures market is worth around $75 billion, with liquidity, in the form of open interest spread, around the world’s major financial exchanges.

The 100 ounce gold futures contract on the COMEX dominates this activity and accounts for 85% of gold futures trading. COMEX has mild competition from 1kg gold futures contracts traded on the SHFE (Shanghai) and TOCOM (Tokyo) which account for 7% each of the futures market.

There is little doubt over which gold futures market enjoys the liquidity monopoly of these exchanges and thus has the biggest impact on setting the gold price.

This was no better seen than back in April when several large sell orders of the June futures COMEX futures contract appeared on the market, over 120% of annual gold production was traded in one day and the gold price plummeted to levels 30% below the all-time high of $1,920.

Exchange Traded Products

Exchange traded products, or exchange traded funds, allow investors to easily invest in a given asset class by buying shares in a security that tracks the price of the underlying asset. The gold ETP market has grown over the last 12 years to rival other gold market sectors.

Made up predominantly of gold-backed exchange traded funds, the gold ETP market is worth $81.2 billion. State Street’s SPDR Gold Trust, known by the ticker GLD, accounts for nearly 60% of this market, representing the main liquidity hub within the gold ETP space.

Together, the top physically gold-backed ETF products are worth over $59 billion, of which $48 billion is held by GLD.

Refineries and Supply to Physical Gold Market

After the two gold market parts above, we arrive at the physical gold market which is supplied by a range of refineries around the world.

The top refineries in the world have a collective refining capacity of 8000 tonnes, the equivalent to $354 billion. This is assuming that they are able to operate at full capacity and are constantly processing given mine and scrap gold supply.

However, supply of gold bullion to the market is on average 4,400 tonnes per year. This physical gold supply is made up of approximately one third recycled gold, with the rest coming from active gold mines. Supply of gold has remained relatively flat since the start of the gold bull market, twelve years ago, meaning that the world’s growing gold demand has to be serviced by this steady supply.

Global-Refinery-Capacity-V4

It is important to note the lack of mining and refining information in areas such as South America and China – hence why we don’t mention refineries from these areas.

At first glance the gold production capacity from refineries appears to more than match the value of assets traded in the futures and ETPs markets. The nature of trading in these markets is more difficult to compare though, and the paper markets are where the greatest daily volumes occur.

After looking at the size of the relative gold market constituent parts, we need to look deeper to establish where the gold price really gets set and how this happens.

The physical market, although larger, with its lower turnover and churn is less relevant at this time, with gold prices being set in the paper markets of COMEX, GLD et al.

We are thus focused upon COMEX and GLD, the largest liquidity hubs in their respective markets. How do their trading volumes compare?

In the last week, the value of the ‘gold’ traded on the COMEX, far exceeded that on the GLD – by over 20 times in fact.

To put this paper trading into perspective, the annual capacity of refineries is $374 billion. Therefore the last week’s gold trading volumes on COMEX were equivalent to 50% of total annual refinery capacity. Half the physical gold that could possibly be refined in a year was traded in paper form this week.

So, whilst the notional value of open interest on the world’s major futures markets is comparable to the market cap of the gold ETP industry, the volumes traded at the major two liquidity hubs within these different market segments is noticeably different.

The dollar value of trading volume at COMEX is far greater than its largest ETF competitor, GLD, meaning that COMEX continues to hold its place as the largest and most sophisticated meeting place for buyers and sellers to express their gold price opinions, in the form of bids and offers, on what the price should be.

COMEX remains the beating heart of gold price discovery.

Questions Being Raised About COMEX

Gold futures contracts are referred to as ‘paper-gold’ because the size of this market is said to be over 100 times larger than physical gold available. As we said previously, open interest on the COMEX, at the time of writing, accounted for over 85% of demand on the gold futures market, so COMEX receives the most examination here.

In theory investors are able to take delivery of the futures contract on expiry, although few do, instead choosing to roll the contract.

There has been some attention paid to the scale and pace of draw-downs of COMEX inventories. JP Morgan and Scotia Mocatta have seen the largest outflows of bullion in their repositories. Compared to withdrawals at JP Morgan’s storage facilities of 1.2 million in the first 3 months of 2013, Scotia Mocatta’s drainage of 650,000 ounces seems less remarkable in comparison. Until these recent drawdowns eligible gold stocks at COMEX had been increasing.

The speed and acuteness of recent drawdowns in COMEX inventories – over 2 million ounces since the beginning of the year – suggests that traders are increasingly standing for delivery of their futures position. It is argued that these investors are not exiting the gold market, but simply converting their efficiently entered paper position into physical form.

 Read the report in its entirety here.

GoldBroker Interviews GATA’s Chris Powell

As a part of a three part series GoldBroker’s CEO Fabrice Drouin Ristori will be asking the same market manipulation questions of Chris Powell, Egon Von Greyerz  and Jim Willie. Below is the interview with Chris via GoldBroker.com

Fabrice Drouin Ristori:How long can the manipulation of the precious metal markets last ?

Chris Powell: It can last as long as gold investors buy “paper” gold rather than real metal. The primary article of faith about gold is that it can’t be printed, but it CAN, insofar as “paper” gold can be printed to infinity. Gold investors who buy “paper” gold with the hope of price appreciation would do better to flush their money down the toilet. At least that way they’ll avoid commissions.

FDR: What will put an end to it –

CP: Probably only the discrediting of “paper” gold, or a futures market default.

FDR: What will be the signs proving that the manipulation is ending ?

CP: I doubt that we’ll get any signs, though maybe the decline in price of “paper” gold relative to the price of real metal is a sign of trouble for the manipulation. More likely the gold price suddenly will be reset to a much higher level that is more sustainable for manipulation by central banks with less drain on their gold reserves, at which point manipulation will resume at the higher level. I doubt that the manipulation will ever end, since, to preserve their power, governments probably always will try to rig the currency markets, and they’ll probably get away with it until investors around the world are far more informed than they are now.

FDR: Do you anticipate an overnight ending of the manipulation or a progressive process ?

CP: I think an overnight revaluation is more likely now. Of course currency revaluations are always done suddenly, aiming for surprise. No central banks are going to call us a few days in advance so we can arrange our portfolios for the greatest benefit. Only the investment banks that function as agents for central banks will get such calls.

FDR: Is the gold/silver paper spot price still relevant to value physical gold and silver ?

CP: It is if people really can find metal for purchase at the paper spot price. But the paper spot price may be losing some relevance as more shortages have been reported and there is rationing of gold and silver coins from government mints. Shortages and rationing are forms of higher pricing that don’t get included in nominal prices. Nominal prices are little use if the product isn’t available. But indeed, most gold-related assets are still taking their cues from the paper spot price and futures prices.

FDR: What direct consequences would a free gold/silver market have on people worldwide — not investors, people in general ?

CP: Free markets in the monetary metals would liberate markets and peoples generally, and reduce the power of governments and central banks, especially their power to control in secret the prices of all capital, labor, goods, and services in the world. Such liberation is really the objective of those who would expose the Western central bank gold price suppression scheme. We don’t really care what people use as money. We just want them to have options of valuation that are beyond the control of government. Here’s how von Mises put it: “It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights.”

Bitcoin selling out?

The 2013 San Jose Bitcoin Conference has proven to be rather controversial. While it is considered to have been a success, being well attended and attracting high profile speakers, it has brought up a very divisive topic in the Bitcoin community…regulation.

In his presentation at the conference Peter Vessenes, the executive director of the Bitcoin Foundation, announced that the Foundation will be hiring a lobbyist saying “It’s time to engage with regulators and have a good, productive conversation.”

High profile investors Cameron and Tyler Winklevoss declared that “Cooperation [with regulators] is really the way forward.” And expressed that recent moves towards Bitcoin regulation are a good thing saying “FinCEN acknowledges virtual currencies. They’ve given guidance, which is a big step.”

There are many in the Bitcoin community who worry that close co-operation with regulators will destroy what Bitcoin is meant to be, free from political control and anonymous. Lifetime Member of the Foundation, Mike Gogulski, has even called for the disbandment of the Foundation.

Late last year Jon Matonis, also on the board of the Bitcoin Foundation, published an article entitled Bitcoins Greatness not Realized by Succumbing to Regulation.  In the piece he express concern that compliance with AML & KYC rules will link names to transactions and has the possibility of “cumulatively degrading the privacy of all bitcoin transactions.” Adding that …

Bitcoin’s great promise lies in its potential ability for both income and consumption anonymity. It is this feature alone that allows users to maintain the same financial privacy as physical cash today and it is this feature that will also lead to liberating advancements such as a thriving and interconnected System D, unhampered and undiluted freedom of speech, and superior asset management that can truly be said to be off-the-grid.

I tend to agree with Matonis. The idea that embracing regulation will actually work out for the Bitcoin community is a bit of a fairly tail. As he reminds us…

Those who support the antithetical overlay of  bitcoin on the current financial system ensure us that it will only be temporary and that we must build bridges. That would be nice but it’s a fairy tale. It reminds me of the Marxist theory of historical materialism and the Marx-Engels ideology that if we only tolerate the bourgeois state during the transitional advancement to a higher phase, we will see the complete “withering away of the state.”

I don’t see this as a political debate, or smart business management, or selling out, I see this through the lenses of power. Those who have it don’t like to lose it. Bitcoin and commercial banking/monetary policy are incompatible. Crypto-currencies threaten the government/banking cozzie power sharing deal and if you think they will give up power voluntarily you’ve got to stop dreaming about sailing the Caribbean in your new yacht and wake up.

As c-net reminds us co-operating with regulator didn’t work for e-gold.

that didn’t stop the E-Gold online payment system from being shut down after a federal indictment on charges of money laundering. Not only did E-Gold chairman Douglas Jackson interact with regulators, he even testified before the U.S. Congress a year before the indictment took place.

I can’t imagine that US regulators will stand by and let Bitcoin succeed. This isn’t crazy conspiracy stuff; this is basic theory on incentives and human behaviour.  All those regulators have mortgages to pay and friends to impress…they don’t want to be rendered irrelevant.

 

Freemans Perspective: Bitcoin – The Tyranny Test

By Paul Rosenberg, FreemansPerspective.com

An increasing number of people have complained about governments and central banks in recent years, even using the word “tyranny” to describe them. They are, of course, called names in the establishment press: conspiracy theorists, mainly.

Calling someone a name, however, does not erase their argument (at least not among rational people) and both the governments and the big banks stand accused.

Up till now, however, these accusations were never accepted by the general public. The average guy really didn’t want to hear about the evils of government money. After all, that was the only thing he had ever used to buy food, clothes, gasoline, cars, and so on. He didn’t want to acknowledge the accusations because he feared what might happen to him without his usual money.

Now, however, we have a brand new currency (called Bitcoin) available to us: something radically different. This gives us a new way to directly address the subject of monetary tyranny, providing a clear test for the governments and money masters of the world:

If they are truly NOT tyrannical, they will leave this new currency alone.

If they ARE tyrannical, they will attack the new currency because it eats into their scam.

In other words, Bitcoin is a test for “the powers that be.” The way they deal with this new method of exchange will reveal their true nature.

If they ignore Bitcoin, they refute the charges of tyranny. If they attack it, they verify those charges.

After all, what honest reason could there be to attack an inherently peaceful tool for transferring value?

Prospective Reasons

Reasons to attack Bitcoin have recently appeared in the “public square.” Here are the three most popular ones, each followed with some analysis:

1. It can be used for money laundering.

Of course it can be used for money laundering — ANY currency can be used for money laundering. Currencies are neutral — that is their purpose! Currencies are valuable precisely because they can be exchanged for anything else — that’s why we use them!

Moreover, dollars and Euros and Pounds are used for money laundering every day. Consider the recent money laundering crimes of HSBC and Wachovia/Wells Fargo. These banks laundered hundreds of billions of dollars for violent drug cartels. And consider that this amount of laundered money is several hundred times the value of every Bitcoin in existence.

No one from either bank went to jail. Neither bank was shut down. Neither bank suffered more than a minor fine. So, how much of a concern can money laundering really be to governments and banks? Clearly not much.

But, since they accuse Bitcoin of being used for bad things, let’s be clear about the situation:

– Every mafioso uses government money.

– Every drug smuggler uses government money.

– Every terrorist uses government money.

– Every pornographer uses government money.

– Every criminal of every type uses government money.

They also use the telephone system and the mail and banks and a wide variety of government services. But government money is good and Bitcoin is bad?

The argument fails.

2. It could destabilize the current system.

A tiny, new currency is a threat to the long-established king of the hill? Comparing Bitcoin to dollars, Euros and Yen is like comparing an ant to a dinosaur. This is a threat?

Please understand also that no one is forcing anyone to use Bitcoin. If you don’t think it’s a great idea, you don’t have to use it. If its price movements (relative to dollars) bother you, you don’t have to use it. How is that destabilizing to the current system? It is entirely separate.

And what of the current system? It was falling apart on its own before the Bitcoin program was ever written. And I could go on at length on the insane levels of government debt, hundreds of trillions in derivatives, rehypothecation, and innocent people being forced to bail-out failed banks.

The current system has massive problems, but none of them can be blamed on Bitcoin.

This argument fails also.

3. Bitcoin provides no customer protection.

Well, no, it doesn’t. Bitcoin is a currency, not a legal system.

What is implied by this argument is that the government banking system does protect customers. That is an outright lie. People are ripped-off via the banking system every day. And more than that, consider what happened just a month ago in Cyprus: Thousands of innocent people were ripped-off BY the banking system — purposely — all at once and without recourse. This argument is, really, an insult to one’s intelligence.

And I should add something else: If Bitcoin is used properly, the crime of identity theft (a big problem with government money) vanishes — there is no identity available to be stolen.

So, again, the argument fails. Only those people who believe anything a government says will buy it.

In the End

In the end, it is said, we judge ourselves. Bitcoin has now put governments and banks in the position of judging themselves. They will write their own verdicts.

It should be interesting to watch.

EFF resumes Bitcoin donations “to Support Digital Liberty”

The Electronic Frontier Foundation, which aims to defend “your rights in the digital world”, has announced that they will again accept Bitcoin donations.

Via the EFF website

Today, we’re happy to announce that we will be accepting Bitcoin donations through our website. You can use them to make one-time donations, set up monthly donations or get an EFF membership (which includes awesome membership swag like EFF hats and digital freedom t-shirts).

While we are accepting Bitcoin donations, EFF is not endorsing Bitcoin.  EFF does not typically endorse products or services, and we certainly do not endorse any of the electronic payment methods that we currently accept (credit cards, PayPal, and now BitPay).

The EFF stopped accepting Bitcoin donations two years ago. They give the reasons for the reversal of this decision as…

  • “Censorship by payment intermediaries is an ongoing problem for free speech online – so it makes sense to start diversifying the available options.”
  • “You can now give Bitcoins to EFF in the same way that you can give stock.”
  • “Our research and FinCEN’s guidance removed a key risk to EFF.”
  • “Our members keep politely asking for it.”

WebMoney announces the addition of a Bitcoin purse

The Russian based online payment service  allows users to store their funds in different “purses”. For example WME for Euros and WMG for gold. The new purse, WMX, is denominated in Bitcoin where one WMX = 0.001BTC.

WebMoney has its own exchange to allow users to convert between the supported currencies. This change means that users will be able transfer Bitcoin(WMX) to any of WebMoney’s other denominations.

More details here.

The Mt. Gox Warrant

The problem here is that Mt. Gox is operating as an unlicensed money transmitter.

With their recent guidance, FinCEN decided that virtual currency exchangers are money transmitters.

“An administrator or exchanger that (1)accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN’s regulations.”

Mt. Gox is not a US company; however, it does a lot of business in the States and is not registered with FinCEN.

An informant working with a Homeland Security agent signed up for both Mt. Gox and Dwolla accounts. After making a few transactions, he was able to determine that his funds had gone through a Wells Fargo bank account owned by Mt. Gox and opened by the exchanges’ CEO Mark Karpeles. The account was opened by Mark in May 2011 who at the time signed a Wells Fargo form declaring that his business was not a Money Services business or a Money Transmitter.  Of course this was almost 2 years prior to FinCEN’s guidance on the issue.

The Warrant states that Mt. Gox is in violation of 18 U.S.C. section 1960. The punishment for this can include fines and up to 5 years in prison.

Ars Technica obtained a copy of the warrant which can be read here.