A Record Amount Of Physical Gold Was Just Delivered On COMEX, Here's Why

From Zero Hedge:

Traders on the main gold futures exchange in New York just issued the largest daily physical delivery notice on record.

In the latest sign of how the market's norms have been upended by the price disconnect that struck in March, Bloomberg reports that traders on Thursday declared their intent to deliver 3.27 million ounces (over 100 tonnes) of gold against the August Comex contract, the largest daily notice in bourse data going back to 1994...

Source: Bloomberg

While millions of ounces of gold trade on the futures market every day, typically only a tiny fraction of that goes to delivery. But in recent months, huge amounts of bullion have flowed into New York and the COMEX has seen record deliveries.

Source: Bloomberg

As Jan Nieuwenhuijs of Voima Gold explains, three elements cause physical delivery on the COMEX to have reached record highs this year:

1. strong demand for futures in New York,
2. a persisting spread between the price of futures in New York versus spot gold in London,
3. and arbitrage.

Physical delivery on the largest gold futures exchange in the world, the COMEX in New York, has reached all time highs this year. Usually, delivery is “negligible.” What has changed?

An important change in the global gold market occurred on March 23, 2020. On that day the price of gold futures in New York started drifting higher than the price for spot gold in London. Ever since, the spread has persisted, though it continuously widens and narrows. The reason for this disturbance in the market can be read in my previous article “What Caused the New York vs. London Gold Price Spread and Why it Persists.”

To understand the shift in deliveries, first let's have a look at how the global gold market operated before March 23, when things still ran smoothly.

The Global Gold Market Before March 23, 2020

The world’s most dominant gold spot market is the London Bullion Market, where mostly “loco London” gold is traded. Meaning the metal is physically settled within the environs of the M25 London Orbital Motorway. The most dominant gold futures market is located in New York, where metal can be physically delivered within a 150-mile radius of the City of New York.

Before March 23, the price in London (spot) and the price in New York (near month futures contract) always traded in tight lockstep because of arbitrage. If, for example, the futures price would trade above spot, arbitragers would “buy spot and sell futures” until the spread was closed. Arbitragers would hold their positions—long spot, short futures—until maturity of the futures contract, because at expiry the price of the futures contract was guaranteed to converge with the spot price. In this example we can see that strong demand in New York would be translated into spot buying in London.

Worth noting is that when a futures trader rolled its position into the next month, and his initial futures buying was translated into spot buying in London by an arbitrager, on a systemic level the arbitrager would roll its position as well.

Of course, the opposite happened as well. When futures traded below spot, arbitragers would “buy futures and sell spot” until the spread was closed.

So far, a simplified version of the market before March 23.

The Global Gold Market After March 23, 2020

Since March 23 of this year, futures have persistently been trading above spot, though the spread isn’t constant. As a result, arbitragers aren’t assured the futures price in New York will converge with the spot price in London. An arbitrage trade as described above, through a position in both markets, incurs risk.

What arbitragers currently do to profit from the spread is buy spot, sell futures, fly the metal to New York, and physically deliver the gold. This is how the profit is locked in. If the spread between spot and futures is $40 per ounce, the arbitrager’s profit is $40 minus costs for transport, insurance, storage, etc.

Now you can see why the persistent spread between New York and London has increased physical delivery on the COMEX through arbitrage.

Conclusion

Physical delivery on the COMEX is elevated because of the current unusual situation in the global gold market. The gold delivered in New York has been imported from spot markets such as Singapore, Switzerland and Australia. U.S. imports directly from the U.K. are rare, because in London 400-ounce bars are traded and the main futures contract in New York requires smaller bars for delivery.

You might wonder who takes delivery from arbitragers that make delivery on the COMEX. Possibly, these are arbitragers, too. In the chart below you can see the spread between the “near month futures contract” and the “next near month futures contract.” This spread has also blown out on March 23. Arbitragers can buy the near month, and sell the next near month for a higher price. Subsequently, they take delivery of the near dated contract and make delivery of the further dated contract.

At the time of writing the near month (August) is trading at $1,973, while the most active month (December) trades at $1,994 dollars.

Arbitragers can buy long August and sell short December to collect $21 dollars per ounce.

One reason I can think of why the spreads persist, is because bullion banks are currently less active on the COMEX. Previously, bullion banks—having access to cheap funding—often performed the arbitrage trades.

What Caused The New York Vs. London Gold Price Spread And Why It Persists

Written by Jan Nieuwenhuijs for Voima Insight,

The spread between the New York futures and London spot gold price was initially caused by logistics and manufacturing constraints, and likely persists because of credit restrictions.

If you read into the economics of commodities, much of it is about geography. The Corona crisis and its effects on global aviation has disrupted large shipments of gold, and created price discrepancies geographically. Normally, bullion is transported in passenger planes, but as those have stopped flying, there is more friction in bullion logistics. Partially, this created the spread between the futures gold price in New York and the London spot price. In my view, the spread persists because arbitragers don’t have enough access to funding, and demand in New York remains elevated.

How it Started

On March 14, 2020, President Trump started curbing passenger flights between Europe and the US. Including those from Switzerland, where the four largest gold refineries of the world are located. This didn’t happen in isolation. Passenger flights all over the world were being curbed. One of the most important airports in London—home of the largest gold spot market by trading volume—is Heathrow. Since March 10, 2020, arrivals at Heathrow started declining from 600 flights per day, to 250 two weeks later.

On March 23, 2020, three refineries in Switzerland where temporarily shut down due to the coronavirus. Reuters reported:

Three of the world’s largest gold refineries said on Monday they had suspended production in Switzerland for at least a week after local authorities ordered the closure of non-essential industry to curtail the spread of the coronavirus.

The refineries - Valcambi, Argor-Heraeus and PAMP - are in the Swiss canton of Ticino bordering Italy, where the virus has killed more than 5,000 people in Europe’s worst outbreak.

Normally, airlines transporting gold and refineries manufacturing small bars from big bars, or vice versa, keep the price of gold products across the globe in sync. If supply and demand for gold in one region is out of whack relative to another, arbitragers step in (buy low, sell high). But with planes not flying and refinery capacity crippled, everything changed.

Making delivery at the New York futures market, the COMEX, wasn’t that simple anymore. As we all know, shorts and longs on the COMEX are mostly naked. They either don’t have the metal to make delivery (shorts), or don’t have the money to take delivery (longs). In normal circumstances this isn’t a problem because neither shorts or longs are interested in physical delivery. They trade futures to hedge themselves or speculate. However, when sourcing small bars from Switzerland—only 100-ounce and kilobars are eligible for delivery of the most commonly traded COMEX futures contract—became “more difficult,” the shorts became nervous.

Likely, after the refineries closed, shorts wanted to close their positions as soon as possible to avoid making delivery. Closing a short position is done by buying long futures to offset one’s position. These trades were driving up the price in New York, and the spread was born.

The white line is London spot, blue is New York futures. Normally, the spread is close to $1.5 dollars; on March 25, 2020, the spread was $60 dollars per troy ounce.

Usually, such a spread is closed by arbitragers (often banks). They buy spot (London) and sell futures (New York) until the gap is closed. If necessary, these arbitragers hold their position until maturity of the futures contracts, and make delivery to lock in their profit. But because flights were cancelled and refineries were shut down, the “arb” was risky and the spread didn’t close.

Bullion Banks Losing Money Through EFPs

Bullion banks often have a long spot position in London and are short futures on the COMEX. When a refinery in Switzerland, for example, casts big bars (400-ounce) and sells them to a bullion bank in London, the bank hedges itself on the COMEX. This makes the bank long spot and short futures.

“Exchange For Physical” (EFP) is an OTC swap. On the COMEX website it reads:

Exchange For Physical (EFP) allows traders to switch Gold futures positions to and from physical [spot], unallocated accounts. Quoted as dollar basis, relative the current futures prices, EFP is a key component in pricing OTC spot gold.

(The London Bullion Market is an OTC market.)

An EFP is usually a swap between a futures and a spot position. In banking jargon the word “EFP” also refers to, (i) having a position in both markets, and (ii) the spread in general (because the price of the EFP is equal to the difference in price between New York futures and London spot). A bullion bank that is “short EFP” is long spot and short futures.

As mentioned, banks are most of the time short EFP. When the spread widened their short EFP starting bleeding. To avoid further losses, some banks “were forced to cover,” which added fuel to the fire. (It can also be the banks themselves started the spread to widen.) Many banks suffered severe losses.

Currently, most refineries in Switzerland have reopened. So, why does the spread persist? After all, arbitragers can hire planes to transport gold to wherever. On April 30, 2020, the spread was still $15 dollars per troy ounce.

Because I couldn't figure this out myself, I asked John Reade, Chief Market Strategist of the World Gold Council, and Ole Hansen, Head of Commodity Strategy at Saxo Bank, for their views.

Reade wrote me:

I guess for two reasons: firstly, banks and traders probably still have large EFP positions that they haven’t been able to cover. And secondly, I doubt that risk officers and banks are prepared to allow large EFP positions to be run, so the usual arbitragers of this market cannot add to their positions, flattening the spread.

Which is in line with what Hansen wrote me:

While COMEX has now allowed the delivery of 400oz bars (the most popular bar size in London) and raised spot positions limits the problem has not gone away. This means that the mechanism that should balance the gold market still isn’t functioning correctly despite improving underlying physical conditions.

Market makers [banks] have suffered major losses last month and as they tend to natural short the EFP (long OTC, short futures) the risk appetite and ability to drive it back to neutral has for now been disrupted. 

Banks lost so much money, they are cautious not to lose more. They don’t access funds to close the spread.

Conclusion

Generally, just the threat of delivery keeps markets in line as well. Any trader that sees an arbitrage opportunity can take position without the intention of making/taking delivery, in the knowledge that New York futures and London spot will converge. Now this certainty doesn’t prevail, traders are cautious. If they take positions but the spread widens, they lose.

Another reason why the spread can persist, is because of strong demand in New York. Speculators that reckon the price of gold will go up will buy long futures, increasing the spread. Normally, this type of demand is smoothly translated into the spot market by arbitragers without increasing the spread. But not now.

In a nutshell, I think that logistics and credit restrictions prevent the spread to close. However, if anyone has a better analysis please comment below.

Addendum

It can be, as John Reade wrote me, “banks and traders probably still have large EFP positions that they haven’t been able to cover.” I noticed on Nick Laird’s website Goldchartrus.com that EFP volume cleared through CME’s ClearPort is decreasing since early March, to levels not seen in a long time.

Perhaps this is a reflection of a market that is slowly trying to heal itself. Perhaps when all losses have been crystalized, banks, or other financial entities with sufficient firepower to hire planes etc., will close the spread.

Another possibility is that when the new COMEX futures contract—that can be delivered in 400-ounce bars—becomes active, the spread closes. At the time of writing, the open interest of this contract is virtually zero. Time will tell.

Robinhood’s Trailing Stop Orders: Extreme Profitability, By Design

From Alphacution:

“They make it so easy.” – Richard Dobatse, Robinhood user (via New York Times)

“A fool and his money are soon parted.” – Thomas Tusser, poet

Imagine if you knew, ahead of time, exactly what bait to use?

Not only which bait to attract and influence the behavior of specific customers, but how to package the output of those behaviors – into an additional form of bait – in such a way as to leverage US listed market structure and maximize the probability of financial windfall. If so, chances are, you would share some of the vision that the founders of retail trading app and rising zeitgeist symbol, Robinhood, did circa 2013…

Now, the fact that Alphacution has been beating this drum for four weeks in a row (starting here, here and then here) is unintentional and unrehearsed. Certainly, we much prefer that our riffs come with a level of variety – and we will return to that variety shortly. However, as we have been grinding the numbers around order routing revenue, the new Rule 606 reporting format, provocative players (like, Robinhood) and secretive players (like, Citadel Securities, G1X/SIG or Two Sigma Securities, among others), we continue to learn more about how this puzzle fits together…

Our latest findings – and the thing that makes this next seemingly redundant drum beat necessary – relate to the economic value of trailing stop loss orders…

Most amateur traders are taught to use stop loss orders to do precisely what they say they are supposed to do: limit losses. For traders that aren’t able to watch their risks all day long, stop loss orders represent one tool by which part-time traders – like those who have other day jobs – can put their trades on autopilot. Moreover, in a zero-commission environment, there is no explicit cost to the trader if a trade gets stopped out. That trader can always get back into the trade, at no explicit cost.

Now, from an order flow perspective, it turns out that stop loss orders – and other variants, like trailing stop loss orders – are quite valuable. This category of orders is otherwise known as non-marketable limit orders (NMLO’s), and they are the type of order that high-speed market makers covet more than any other, as we will illustrate below:

Based on Alphacution’s current assembly of ~$490 million in order routing revenue for Q1 2020, NMLO’s represent 45.4% of the total – or, $222.9 million – and, the sum of marketable and non-marketable limit orders represent 67.7% of the total – or, $332.3 million:

That’s all fine and good, but here’s where the plot thickens:

When we break down the contributors to NMLO routing revenue, you’ll never guess who’s punching way above its weight class. Depending on how we account for TD Ameritrade – as two entities (including TD Ameritrade Clearing) filing two separate 606 reports, or as one large retail brokerage platform – Robinhood sits in the #1 or #2 slot, representing $46.0 million (or, 20.7%) in total NMLO routing revenue for Q1 2020 – and clearly larger on this analytic than E*Trade, Schwab, Interactive Brokers (IBKR) and Fidelity (which does not engage in PFOF in stocks, but does so in options):

But wait, it gets even better:

There are 4 categories of order types and 3 categories of products in the new 606 reports, which means that there are (potentially) 12 order type-product revenue pairs for each retailer of order flow. And, of the 12 order type-product pairs for Robinhood, non-marketable limit orders in options represent the largest category of order flow revenue. Not only that, at #2 amongst its peers, this category for Robinhood is within $2 million of being equivalent to the same option NMLO category for the combined version of  (the much larger by client assets) TD Ameritrade as of Q1 2020. In other words, Robinhood is close to being the #1 largest player in the ecosystem by this measure:

With this in mind, let’s return to the idea that the Robinhood figures above have been targeted in advance, by design:

A frictionless and highly gamified environment that is made easy for its users to be stopped out as often as possible (in OPTIONS!) turns out to be a coveted counterparty to those who seek to compete for fleeting slivers of alpha in closest proximity to the sources of listed liquidity. In Alphacution’s vernacular, this is known as the structural alpha zone. By Silly Valley vernacular, this is known – by last count – as $8.6 billion…

In the chart, below, Alphacution presents a detailed summary of Robinhood’s order revenue breakdowns by product category, order type, and broker-dealer:

Hopefully, we can take a break from this topic for a while, but no guarantees. I would not be surprised to see Robinhood’s IPO announcement arrive in the months to come while valuation insanity and historically-aggressive interventionism persist…

Until next time…

By Paul Rowady| July 15th, 2020|Alphacution Feed

Spot Gold Soars To Record High As Dollar Freefall Accelerates

Spot Gold is surging in Asian trading as the dollar is dumped.

Source: Bloomberg

Spot Gold traded above $1930, taking out the $1921 highs from 2011...

Source: Bloomberg

The dollar has crashed to 19 month lows...

Source: Bloomberg

Gold appears to be more and more in favor as an alternative place to allocate wealth amid the growing pile of negative-yielding debt (and note that cryptos are starting to get a bid for the same reason)...

Source: Bloomberg

As Jim Grant recently explained:

The Fed wants us to believe that we should believe that there will be no inflation out of all this and to me that is a vast unknown. We have America’s fasted peacetime money-growth coexisting with the all-time 4,000-year record lows in interest rates. It’s a most curious and troubling juxtaposition there.” 

Grant said aggressive moves by governments and central banks are unwise.

I think what we have is a monetary moment that is unprecedented and therefore calls for extreme caution and great humility on the parts of all of us.”

So is the "monetary moment" sparking a loss of faith in fiat?

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