In May we began a series of articles that examined the gold market and how the price of gold is determined globally.
It was clear from the outset of the gold price smash that there is a divergence happening in the gold market. Inventories of ETFs, funds, and futures market depositories collapsed by more than 5.5 million ounces ($7 billion), physical removals were reported by the COMEX of 1.4 million ounces and the SPDR Gold Trust (GLD) reported total inventory removal of nearly 4 million ounces.
However, investors in the East and emerging world were grabbing all of this unwanted gold.
Deliveries on the SGE reached levels never previously seen and delivery numbers remain elevated.
Yet despite this the gold price remains low. It was clear that demand for physical gold was not enough anymore, so we set about looking into the elements of the gold market.
Our first article in this series took an overview of the gold market; from the different financial instruments that allow investors to gain exposure to the gold price, to the supply of gold from refineries.
Whilst a very high-level look at the gold market, the research showed that the gold price is not the sum of several parts but is instead controlled by dominating elements – namely COMEX and the London Gold Market.
This finding was despite the size of the ETF market which had taken much of the blame for the gold price smash. The media had clearly confused ‘gold-backed’ ETFs’ effect on setting gold prices.
When comparing paper markets (GLD and COMEX) to the physical market we found that the volume and capacity of the physical market was significantly lower than that of the paper products, despite the comparable market caps. When we drilled down further we found that COMEX was twenty times larger than the GLD, in traded volumes.
We took a quick look at refineries and their annual capacity. Unsurprisingly we found that Switzerland dominated this scene, playing home to the top three largest refineries. The top refineries in the world have a total annual capacity of 8,000 tonnes, twice current gold supply. Despite this vast size, in the week that we examined COMEX, the volumes traded were 50% of annual refining capacity.
It was not difficult for us to conclude where we believed was the beating heart of price discovery – COMEX. However, we were quick to conclude with the thoughts of Kyle Bass who once explained, if the notional value of open interest at COMEX is too large compared to physical bullion lying in the COMEX warehouses, then ‘you go get your gold.’ It’s a confidence game… like most financial markets.