LME Seeking Rivalry with LBMA?

July 19th, 2017 by

When it comes to trading gold futures, there’s literally no place on Earth like London. While the commodities exchange (COMEX) division of the New York Mercantile Exchange (NYMEX) is the world’s second-largest platform for trading gold futures, it is a distant second place. Based on the volume of gold contracts traded, the London gold market is 40 times bigger than the one in New York!

Gold Capital of the World

world gold

There are several major gold hubs in the world: Switzerland refines as much as three-quarters of the world’s freshly mined gold; Dubai is a key source for the gold trade in the gulf region; and Hong Kong sees throughput for much of the gold that enters the Chinese market. For some reference, the size of the annual market for precious metals in London alone exceeds $5 trillion! In a single day in London, a greater volume of gold may change hands (at least on paper) than all the gold that has been mined in the entire course of human history.

Let that sink in!

This seeming impossibility is a function of how gold futures and gold hypothecation allow multiple different investors or banks to make claims on the same stock of gold. This is true all over the world, and rests upon the confidence that there will never be a “run on the bank” for the physical gold.

The London Metals Exchange (LME), which administers the largest platform in the world for trading industrial metals, has largely stepped back from the precious metals game. Instead, the London Bullion Market Association (LBMA), representing the largest and most influential trading firms in the industry, oversees the massive over-the-counter gold trade in London.

Getting Back in the Game

Source: truney.com

Source: truney.com

Accordingly, the LME hasn’t offered its own gold futures contracts since at least the mid-1980s. The exchange is now attempting (according to Bloomberg News) to compete with the LBMA by developing its own gold contracts, known as LMEprecious, over the past three years. While still nowhere near as prevalent or as popular (in terms of trading volume) as the OTC gold market in London, the new effort by the LME is starting to pay dividends. Slowly but surely, a larger proportion of traders are turning toward the more regulated LME option.

As explained by Bloomberg News in July,

“The LME, World Gold Council—representing miners—and partner banks hope to capitalize on regulators’ push for more scrutiny by allowing investors to trade contracts on an exchange where transactions are tracked and risks managed. Their LMEprecious venture including Goldman, Morgan Stanley, Natixis SA, ICBC Standard Bank Plc, Societe Generale SA and OSTC Ltd. will centrally clear daily, monthly and quarterly futures contracts using LME Clear.”

Although the vast majority of the global gold trade occurs via futures contracts, this manner of accumulating gold (or, more specifically, this acquiring of a potentially conflicting “claim” on a generic quantity of gold) poses greater risks than cutting out the paper intermediary and buying physical gold yourself. Holding physical gold eliminates any counterparty risk.

The fact of the matter is that futures contracts are virtually never settled with physical delivery of the metal; instead, sellers will simply settle their positions in cash. This also leaves them vulnerable to a short squeeze in the unlikely event that physical delivery is indeed demanded. You can avoid any of these headaches and risk by buying physical gold—coins or bars—rather than relying upon electronic contracts.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.