A key result of the grip of the coronavirus is the severe disruption to the commodity markets on both sides of the supply chain. A major issue that has affected gold has been the lack of airline flights, resulting in a false market tightness and bloated contangos. In terms of overall price action, during these times of distress (notably the equity markets' slump in March) gold has behaved in its normal way, as a source of liquidity, with lower volatility than in other asset classes, and making overall price gains. When we do revert to normality, gold should stand in good stead as economic, financial and geopolitical pressures will continue to inform market activity.
Gold came into 2020 off a hefty bull run in mid-2019 that had lifted its trading range from a base of US$1,300 per oz. to one centred on US$1,500 per oz., a gain of roughly 15%, and was still reasonably bullish at the start of this year. The price benefited from continued risk hedging over concerns about slowing economies, geopolitical tensions in the Middle East and uncertainty over the prospects for Phase One of the trade agreement between the United States and China, but it was arguable that most of the likely tailwinds were priced into the market and that the upside was probably relatively limited.
The spread of the virus has disrupted everything. Quite apart from the humanitarian tragedy, the impact on supply chains has been substantial, with oil taking the headlines as storage space has come under intensive pressure; prices have tumbled and WTI famously went into negative territory on April 20, as long position holders on NYMEX were scrambling to roll out of the May contract in order to avoid having to take delivery. The gold market was the other way around.
Gold's dramatic contango on the expiry of the April contract, and on occasions since, was due to technical tightness brought about by a lack of transport. The sophistication of the global trading market means that gold does not always have to change location when it changes ownership. Central bank transactions and Exchange Traded Funds, for example, are key elements in the market, but they do not always involve a huge amount of transport, as material can generally be held in different local vaults (provided they are accredited with the LBMA, for example). Physical fabrication, however, requires the metal to be at the appropriate place at the right time.
The recent dislocations have resulted from a dearth of airline flights. Most of the world's physical gold movements are by air, frequently as cargo in passenger flights, although the transport companies put limits on tonnage in order to contain financial risk. Five tonnes are probably the maximum in ordinary circumstances, although the gold price would be a key element in the equation.
Now, though, is not ordinary circumstances, and when logistics were at their tightest, it was extremely difficult to book space, and it is doubtful that even a five-tonne loading would have been possible. For example, there was only one gold-carrying flight per week from Singapore to New York, with the banks queuing to get metal on board. It has been equally difficult to ship metal (not just gold, the platinum group metals have been struggling also) into Asia from Europe, for example. Land transport is feasible, subject to availability, security etc., although obviously there is a massive time element here.
As the expiry of the April COMEX contract approached, the lack of flights caused a panic among market participants who held short futures positions in that contract. This is a common way of financing a physical holding, using the EFP (exchange futures for physical, which is an OTC trade between two counterparties, then reflected onto COMEX). While it is rare for even as much as 5% of open interest in a COMEX gold contract to come to delivery, there was an urgent need amongst these April shorts to avoid risk, and so April became a buyers' market with the EFP blowing out to disproportionate levels.
While several mines are shuttered, the majority of the world's refineries are working. Three of the big four Swiss refineries were on lockdown for a fortnight, but are operating again, at roughly 50% capacity, being deemed an essential industry. Similarly, the Royal Canadian Mint and the Rand refinery in South Africa are both working, as is at least one refinery in the United Arab Emirates. So, market tightness is technical; the metal is there, the problem is getting it to the right place. Massive deliveries into COMEX warehouses during April, notably in the first couple of weeks, have taken CME inventories to over 600 tonnes. Open interest in the June contract is roughly 1,050 tonnes. We are now somewhere between 50% and 60% capacity in terms of transport logistics, so the situation has eased, but varies by country.
The spot price has continued to rise as market participants hedge against economic, financial and political risk. It is still arguable that the tailwinds outlined at the start of this piece are priced in, but they are unlikely to evaporate even in the medium term. Lingering financial stress and rising corporate costs in the face of weaker credit ratings add to the risk in the equities. On the other side of the market is the complete lack of physical jewellery demand in Asia (and net resale in several places). This will return eventually, and when it comes, there may well be strong pent-up activity. For now, though, that is a remote possibility.
On balance, the outlook for gold is constructive on the back of risk management, but sharp pullbacks in equities will see bouts of gold sales to raise liquidity. While the road ahead is positive, it is unlikely to be a smooth one.
- Rhona O'Connell is the London-based head of market analysis for Europe, the Middle East and Africa (EMEA) and Asia, at INTL FCStone, a global financial services group.