In FT, John Dizard notes potential strain on paper gold


Strange GOFO Cry Heralds Trouble for Gold

By John Dizard
Financial Times, London
Friday, October 25, 2013

Something is unsettling the animals in the forest of the gold market. Usually there is a chorus of chirrups and squeaks that are significant, momentarily, for one species or another, such as a few cents of arbitrage between Zurich and London, or a dollar-an-ounce rise in India caused by a dealer's near insolvency. Then the noise settles down to the murmur of wind through the trees

However, the continuing high level of premiums for physical gold over the kinds you can trade on a screen suggests that the next move in the major gold indices or the various exchange traded funds could be discontinuous and dramatic. It would be much better for the financial world if gold were just bumping along, with only enough volatility and liquidity to keep a few dealers' lights on. That would mean electronic or paper assets have retained their essential credibility with the public.

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The "gold price" found in a box on the homepage, has, after bouncing off its June lows of around $1,150, had a depressed September and has begun to move up again, to Friday's level of about $1,300.

Much more interesting is that Indians are willing to pay about $270 above the world market price, when you add the "ex-duty premium" to the recently increased 10.3 per cent import duty. There is, of course, a black market price for those who are willing to take a chance with the Indian revenue that is a bit lower. The government wants to discourage "non-essential" imports such as gold, through levers such as taxation and restrictions on credit for gold dealing.

The Chinese government has no anti-gold retail purchases policy. There are no issues with importing, refining and fabricating, or distributing gold. Yet there is a Shanghai market premium that last week was fluctuating from a little under $7/ounce to a bit over. That is actually a lot of money for a location arbitrage. As my old boss at Mocatta told me: "If you do this right, it's a nickel-and-dime business." Well, maybe a $2 or $3 business.

John Brimelow, a gold analyst who has been deconstructing the Indian premiums for many years, says: "There was a collapse of Indian premiums in early August that was due to the collapse of the rupee and the rise in duty to the current level. The current 20 per cent premium has not been seen since gold import was made legal in 1990."

A third strange cry in the forest is the "negative gofo," or gold forward lease rates that effectively pay a higher gold price over the next three months than in the future. This "backwardation" is a common enough phenomenon for other commodities in short physical supply, but, given the much greater weight of above-ground supplies in the gold market, is supposed to be a nonexistent or fleeting occurrence for the metal. Yet the negative gofo, at least for 400-oz good delivery London bullion bars, has persisted for weeks.

As one of my gold refiner friends puts it: "The negative gofo is just a shortage of kilo bars. It is, technically, a backwardation, but I call it the convenience yield of having gold immediately available for physical delivery. Look at the huge premiums in the Shanghai exchange and in India. You think maybe the market will normalise and the premium will disappear soon. So you pay up for immediate delivery."

The 400-oz bars, though, are the only acceptable form of backing for gold exchange-traded funds, not to mention the London market. There is a shrinking supply, which has been gradually flown from London to Switzerland, where the bars are further refined, cast into kilos, and sent on to China, India, the Middle East, and elsewhere.

Say, what if there is a rise in the world gold price that leads to an increase in demand for gold ETFs and exchange-traded futures? Could the gold flow back from those kilo bars to recasting as good delivery 400-oz bars?

Not easy, my refiner says: "Much of that has been converted to jewellery. It would be a lengthy process. Those are pretty sticky hands."

He continues: "This could turn into a very violent wake-up for (screen-traded gold). People talk about 'fiat currencies,' but we also have fiat gold. Volatility is too cheap right now."

Taken together, this collection of persistent microeconomic signals in gold could flag macro trouble to come. These noises worried me in August. They worry me more now.

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