The average daily volume of gold cleared at the London Bullion Market
Association (LBMA) in November 2008 was reported to be 18.3 million ounces
(worth US$13.9 billion at an average price of $759.56 per troy ounce, still
substantially below the peak gold
price of $850 per troy ounce set in January 1980, which was not breached for 28
years, an extraordinary long period for a bear market for gold. The gold price
fell again to a historical low of $250 per troy ounce in July 1999 while
inflation was rampant.)
The November 2008 clearing volume meant that an amount equal to the annual
production of all gold mines in the world was traded and cleared at the LBMA
every 4.4 trading days.
As noted earlier in this series, (see
Labor markets delinked from gold, Asia Times Online, December 3, 2010)
the Gold Anti-Trust Action Committee (GATA) claims that net clearing data
substantially understates the gross trade volume in gold, due to the fact that
the calculation of clearing statistics shows only final net settlement of
linked trades. The pre-net turnover may actually be four times greater than net
clearing turnover.
That means that the LBMA handles a pre-net turnover equal to the annual
production of gold every trading day. Since all pre-existent gold has already
been traded and owned, LBMA daily volume means that every ounce of gold
produced by mines around the world is traded every trading day in London as
soon as it is mined.
The day will not be far off when the increase in daily pre-net trading volume
in gold trade at the LBMA will be larger than new gold produced by all the
mines in the world. With the rise of gold derivatives, gold trading is no
longer limited in volume by the available amount of unallocated physical gold.
Gold is traded on a notional quantitative amount of gold as an underlying asset
of gold derivatives. Gold trading is a transactional platform that expands or
contracts with rising or falling trade velocity regardless of price, which is
one of the structural components in the logic of an asset bubble.
Gold different from oil
Gold, unlike oil, which is sometimes referred to as Black Gold, is not consumed
by combustion for the production of energy. Oil trading is based on the
prospect of an eventual final delivery for non-renewable consumption, no matter
how remote; such a fate of final delivery for non-renewable consumption does
not exist for gold trading. Gold is consumed in the market mostly by owning,
which does not deplete gold quantitatively in the world. Unlike oil, which is a
transitional asset, gold is a final asset.
There is no such phenomenon as "Peak Gold", as the term "Peak Oil" is bantered
about in the socio-technical discourse on non-renewable energy. Physical gold
will continue to increase in quantity as long as gold mines continue to produce
gold. But if and when all the gold in the ground has been mined, including
those under deep sea beds, physical gold will still only stay constant in
quantity without quantitative decline. Gold consumption involves only a
transfer of ownership, not a physical depletion of gold. This is why referring
to oil as Black Gold is problematic. And why oil is only a commodity, albeit a
prime commodity, and why oil cannot perform as a reserve monetary asset.
London Gold Market not for individual traders
The London gold market is not accessible to individual traders because of two
big barriers: 1. Large transaction size - The standard physical bullion
accepted in trade is the London Good Delivery Bar, which weighs 400 troy ounces
each (12.4 kilograms). At a price of $1,400 per troy ounce, each Good Delivery
Bar is worth $560,000. This standard per trade module is too high in price for
most individual traders. Even if gold price falls to $400, and one London Good
Delivery Bar being worth $160,000, individual accounts are not large enough to
attract the attention of dealers, the business economics of which prefers
trades of $500,000 as a transactional minimum. That minimum is expected to
increase over time due to rising overhead cost. The day will come when the
trading unit of gold is 10 Good Delivery Bars. This high entrance threshold of
individual investors is what drives the emergence of gold exchange traded funds
(ETFs). 2. High regulatory qualification for opening gold trading accounts
- Even if an individual is able and willing to trade sufficient amount of gold,
most dealers will not accept an individual account except for extremely
high-net-worth individuals. Logistical, regulatory and business considerations
add to the high threshold of entrance to the gold trading game. Logistically,
storing and delivering gold are costly undertakings that continually discount
the monetary value of gold held. Regulatory requirements also place strict
legal obligations on firms that deal with the retail public, These facts make
individual accounts not a cost-effective business for profit-minded gold
dealers.
Gold trading account types
There are two types of gold trading accounts: Allocated Gold Accounts - These are accounts held by gold dealers
in each client's name on which are maintained balances of specifically
identifiable bars, plates or ingots of metal "allocated" to a specific customer
and segregated from other gold held in the dealer's vault. A client with an
allocated account has full title to the specific physical gold in it, with the
dealer acting as custodian holding the "allocated" gold on the client's behalf.
To avoid confusion, gold in a client's allocated account is separated from a
gold dealer's assets.
Unallocated gold accounts - These are the most common vehicle for
trading, settling and holding gold, as well as other precious metals such as
silver, platinum and palladium. Transactions may be settled by credits or
debits to an unallocated account without specific direct allocation in a
general pool of gold. The balance in an unallocated account represents the
indebtedness or financial obligations between the client and the dealer based
on an underlying notional amount of gold that is not expected to be delivered
physically.
Credit balances on an unallocated account do not entitle the creditor to
specific bars of gold, but are backed by the general stock of the gold dealer
with whom the unallocated account is held. A client with an unallocated account
is an unsecured creditor to the gold dealer for the monetary value of a
notional amount of gold the client bought or sold at a specific price. Profit
and loss in an unallocated gold account is calculated from the difference
between the transaction price and the spot price of gold. Unallocated gold
trading is a transactional platform that creates profit opportunities by price
volatility, which is one of the conceptual components behind the logic of an
asset price bubble and also behind the logic of the bubble's eventual burst.
Unallocated gold account risks
The total quantity of unallocated gold in the gold market is estimated to be
around 15,000 tonnes at the end of 2008. The 2,134 tonnes on a daily average of
spot gold traded through London represent 14.2% of the unallocated gold pool.
This amount of daily gold turnover is high compared with the average daily
turnover in UK equities of between 0.34% and 0.63% for the 12 months ending
September 2009.
While LBMA members are not required to provide information on the amount of
unallocated gold held in their books, the relatively high turnover in gold
trade suggests that gold dealers operate at a low fractional reserve system
where unallocated gold accounts are only fractionally backed by physical gold.
When gold is bought and sold by clients of LBMA member dealers with no
intention of taking delivery of physical gold, the amount of gold reserve
needed to back the volume of unallocated gold trade remains unaffected by the
volume of trade because a buy must be balanced with a sale simultaneously in a
trade.
Unallocated gold trades require gold reserve only as a notional value that
provides adequate backup for net balances, and not a physical reality because
the same non-delivery gold can be traded many times in the course of a trading
day. The gold market expands by increasing transactional velocity, unrelated to
the size of the pool of unallocated physical gold. Transactions that depends on
the velocity of trades generally contributes to the forming of price bubbles.
Since there is no minimum gold reserve requirement set by the LBMA for member
gold dealers, unallocated gold trading accounts are in fact fractionally backed
only by a notional amount of gold made credible by the collective credit
standing of the gold dealers, unrelated to the amount of physical gold actually
held collectively or individually by LBMA members.
Gold dealers can always meet requests for physical delivery of the gold they
sell by buying it in the gold spot market. The uncertainty involves only the
spot price at which dealers can acquire the gold for delivery, physical or
virtual. This spot price is a function of the balance between buyers and
selling. When the number of buyer exceeds the number of sellers, the spot price
of gold rises and vice versa. Since gold trade is mostly non-delivery trades,
the spot price of gold is determined by imbalance between buys and sells,
unrelated directly to the supply and demand for physical gold. This makes the
gold market highly susceptible to market trend imbalances.
Gold trading is a transactional platform on which price is determined by the
directional flow toward equilibrium between buying and selling, which is one
component way to define the logic of a trade bubble. Ironically, the
directional flow towards equilibrium in a reverse-resistant imbalance between
buying and selling will also lead to market failures when no seller can be
found at any price (inflationary bubble) or no buyer can be found at any price
(deflationary bubble). The gold market's detachment from physical gold
substantially increases the probability of such scenarios of market failure.
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