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The recent story picked up in the media about Hugo
Chavez and the ‘calling’ of Venezuelan Gold held in London generated
a good deal of interest and drew attention to the little-discussed issue of
Precious Metals custody and ultimately, delivery.
Unlike the Venezuela delivery angle, however, an
even bigger and related story is emerging outside of the coverage of the
mainstream western press. China has recently launched a new Precious Metals
exchange in Kunming City, Yunnan province, called the Pan Asia Gold Exchange
(PAGE). I had the great pleasure of being part of a small group of interested
parties in London observing and participating in the opening ceremony for the
new exchange. We saw the clear support of central and regional government in
this venture, evidenced by the participants on the day and their comments.
PAGE has been steered at central government level by key economic ministers
and mavens and is a formal part of the PRC's present 5 year plan, one which
places Yunnan province as a new gateway to international trade. The photo on
the right shows the scale (and colour!) of the new
exchange building in Kunming City.
A Healthy
Market
Current
Precious Metals Price Discovery
The Future
of Precious Metals Price Discovery
This exchange is offering a new international-facing
allocated ‘Spot’ Gold and Silver contract, with an 8am
Beijing-time ‘fix’. The fix will only involve Chinese Banks;
indeed the owners and members of the exchange are in no way related to the
western banks that dominate the existing Spot and Futures Precious Metals
markets. PAGE is launching in Q4 2011 a new Spot Precious Metals contract to
challenge the emaciated LBMA ‘loco London’ system. International
investors will now be able to buy allocated and, crucially, Rmb-denominated ‘Spot’ Gold and Silver contracts.
The importance of this cannot be overstated. The Renminbi
will be accessible to international investors through this exchange, but in a
controlled fashion - using Gold as a synthetic choke on demand for the
currency. By buying an Rmb Gold contract on PAGE
and selling the equivalent $ denominated contract elsewhere, investors will
be left with Rmb exposure. One would imagine that
the incentive to own Rmb in the present climate is
by inference likely to lead to a whole lot of demand for Gold contracts through
this new exchange. Add to that the real demand for allocated Gold that will
migrate across from the existing Spot market and you are looking at something
that looks sure to have major implications for the Precious Metals market.
Historically the emergence of new Gold and Silver
exchanges is met with a collective yawn. The reason for this is that there
has never before been any expectation that new exchanges could/would affect
the price discovery mechanism. Each new exchange was effectively an extension
of the status quo. The mainstream has become dissociated with regard to this
issue of price discovery. Many assume that Precious Metals prices are
discovered in the healthy way one would normally expect - the body of the
market being the 'real' Spot market, where the forces of supply and demand
meet, with a small tail wagging merrily away in the form of a futures market
(see the Jack Russell illustration). In Gold and Silver the size of the Spot
market is ten or more times that of the futures market, so the use of a dog
as an analogy holds up in scale terms. The current price discovery mechanism,
however, as expressed by my Basset Hound illustration, works instead as
follows:
The body of the dog (the Spot market) has become the
plaything of its ‘tail’. Rather than the dog wagging its tail,
the dog is being wagged BY the tail. This is
achievable because the actors wagging the dog by its tail are some of the
same LBMA (London Bullion Market Association) members that effectively make
up the body of the dog. The LBMA system (aka ‘loco London’) has
held sway beyond living memory and countless nations rely on the system for
both price discovery and storage/custody. This system has not only allowed
itself to be corrupted by fractionalisation, it is
clear that the body of the dog actually welcomes being wagged, for fear of
the repercussions of being caught short were it not! The ‘spot’
dog has been reduced to shell of its former self, so much so that even
apologists for the status quo admit that the ‘spot’ market has
around 100 paper claims outstanding to each physical bar. At any cost the
existing mechanism will resist delivery, which is what makes the recent
demand by Hugo Chavez to repatriate Venezuelan Gold reserves so interesting.
This move towards delivery by the Venezuela leader plays into the same
important dynamic as the Pan Asia Gold Exchange.
My contention is that this new exchange represents a
far bigger challenge to the hegemony of the existing bullion banking system
and it price discovery mechanism than most realise.
Given the choice between being the unallocated and unsecured creditor of a
fractionalized LBMA market or holding title to deliverable and allocated bars
within the PAGE system I anticipate much of the ‘loco London’
business will migrate east, lured by the twin benefits of certainty of
outright ownership and long-awaited international market access to Renminbi.
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