ROSS NORMAN : Gold Price – Out of this world ?
Visualise, if you will, a small comet passing through our solar system – without impacting.
Other than a collective “oohhh” and a change in our orbit only measurable in a NASA research laboratory, the effect would be temporary and largely insignificant. Let's scale that interplanetary object now to a significant size … something the size of a small moon. Here again the effect would be temporary, and while it would shift our trajectory in a modest way to a new orbit, the sun would continue its central role and things would stay largely the same.
Now let's scale it much further still … think more along the lines of a tenpin ball hurtling towards skittles … here the effect would be consequential. The 'out of left field' object has its own gravitational pull congruent with its mass, competing with the sun, ejecting some objects while spinning others onto a totally new orbit. Rather like the complexities of fluid dynamics, the results would be very hard to predict. Here the order of things will have changed dramatically for the planets in our solar system, some perhaps joining the orbit of the new object, while others stay with the sun.
The gold market – in my view – sits, somewhere between options 2 and 3. That is to say it is undergoing a change which is significant but whether it is temporary … or profound and permanent is unclear at this juncture. The out of left field object is derivatives trading in China on “Shiffy”or SHFE which commenced on 1st March 2024 (see below), with volumes rising as high as $40 billion / day in April 2024 – still less than half the size of London – but sufficient nevertheless to dominate price action for some months to come. Note that many of the Chinese options positions are actually on CME and some are OTC, but these are both hard to quantify.
Gold is currently ignoring most traditional relationships such as the US dollar, yields, rate expectations and a number of other market indicators. So it might go some way to explain why the night sky just now looks a little unfamiliar.
A similar picture can be seen in silver on Shiffy (and indeed copper) with an options wall locking it in a range of $29/$34 between a 'call wall' and a 'put wall' (see below) :
Being options, there is a scaling effect – the leverage on spot gold is zero at 1:1, on futures it is about 12:1 while on options it is hundreds to 1 ; you get the picture – multiply the one by the other and you get a very large interplanetary object capable of creating its own weather patterns... (I know they don't have weather in space, but you know what I mean).
The initial effect on spot gold – intended or not – was to bring about a 'gamma squeeze'. The Chinese buying gold calls (on the expectation prices would rise) leaves the other side to the trade (bullion banks) temporarily short (gamma) or gold and vulnerable to a rise in prices. Typically on granting those calls the bullion banks would purchase the equivalent to about half their exposure – problem is – if these positions are sufficiently large, then their buying/hedging itself drives gold prices higher and so they have to purchase more gold to more fully hedge themselves as gold moves towards the strike price – which pushes prices higher again – and so on. You become trapped in a self-fuelling cycle which pushes gold onto an entirely new orbit which is divorced from its fundamentals … or even reality. This might also explain why gold is yo-yo'ing in a range well above what most investors would consider 'fair value'... while physical demand is through the floor.
In short, gold is defying gravity
Take Germany – in 2022 gold demand was 180 tonnes of which an estimated 90% was fresh metal and 10% came from second-hand metal. So that's 162 tonnes of newly mined gold. Today Germany is awash with second-hand coins and demand has roughly halved. We estimate German demand will be just 80 tonnes this year but 90% satisfied by second-hand gold coins and bars. That is to say German demand for newly mined gold will have collapsed from 162 tonnes to just 16 tonnes.
A similar picture in the US – back in 2022 gold coins and bar demand was 116 tonnes and we estimate it will be down by two thirds this year to about 35 tonnes – and that 35 tonnes is more than sated by old bars and coins coming back to the market – this would suggest fresh metal demand from the US will have fallen from 116 tonnes at 90% fresh = 104 tonnes … to 35 tonnes which is 10% fresh gold = 3.5 tonnes. A fall of 97%.
Now if (and I am aware I am stretching the argument) you scale the US and German demand to the GLOBAL market between 2022 and 2024, then the picture would suggest 1200 tonnes of gold demand in 2022 might look more like 100 tonnes of fresh gold offtake this year.
That's quite a shortfall begging one question – why isn't gold much lower … and its because gold has been artificially supported by the Chinese options play.
So here we sit, in an unfamiliar and unfashionable part of our galaxy wondering what just happened.
Some in the bullion ecosystem will have benefitted from these changes, but others very much less so. The winners will be bullion dealers with a physical outlet … they have scope to buy back gold at one cash window and sell (hopefully) at another … and thus keep stock (and the cost of stock-holding) to an absolute minimum and simply trade the spread. Online bullion dealers are less well equipped to deal with buy-backs and so will simply observe buying volumes dramatically lower – life will be tough for them - expect closures. Gold refineries who were already very busy will remain flat out converting unwanted investment coins and bars into Asian quality kilobars.
Meanwhile the worst affected will be sovereign mints (many who had recently closed circulation coin businesses and invested heavily in a gold business) and whose business it is to produce freshly minted coins – for them, not only is demand weak, but they are plagued by secondhand coins of their own brand returning to market – especially so following some stellar years performance. That is to say, their biggest competitor … is themselves. Logically, if they have a refinery, they should buy old stock of their coins from the market (at close to spot) and melt them down, and thus protect the flow and indeed the premiums on their new coins.
The remaining question for me is when do these option positions roll off / expire and we perhaps we return to a normal market – or has this been a sufficiently profitable ruse for the Chinese that they might continue to do it again – in which case, expect the current situation to be maintained. Either way, this is unlikely to go away in a hurry and we expect range trading to persist and on low volumes
In most ancient societies comets inspired fear and portended war and famine, and were seen as a messenger from the gods as a harbinger of doom. Certainly the dinosaurs might have agreed. A more enlightened and contemporary approach might be to see it simply as a natural phenomenon and a symbol of change … but hold onto your hats.
Ross Norman
CEO
Metals Daily Ltd, London
ross@metalsdaily.com
www.MetalsDaily.com