Humankind have been attracted to gold for millennia. Most obviously in jewellery form as a sign of wealth and status, but also as an investment as a long-term store of value, with the potential to help preserve purchasing power over time and also thrive in challenging markets in the belief that its price will stay steady or rise in periods of market turbulence.
Since the onset of the age of computing, we no longer tend to deal with the physical reality of investing. Sure, placing a trade on a screen still means there is a buying and selling process underway, which transfers an assets ownership from one party to another, but the days of dealing with anything even as tangible as a share certificate to store away in your safe under the stairs are a distant age away. In a world where digital ownership is standard, taking ownership of a physical asset, let alone physically storing it, is one step even further away from our minds too. Yet in commodity markets, whether it be oil, coffee, nickel, silver or gold – these are all as tangible an asset as you can get, which historically meant you were buying a ‘real-world’ asset.
For investors who had interest in the direction of the price of a commodity, such as gold, but zero interest in actually taking delivery of it, a large futures and options* market has evolved to broaden the market away from just producer and consumer of a particular commodity. Disruptor-in-Chief, Donald J. Trump has flown into this market and triggered a significant drain out of London’s vast vault network of both gold and silver. According to the London Bullion Market Association (LBMA), January this year saw 151 tonnes of gold shipped from London to the US. Likewise vaults of silver emptied at the fastest rate since records began in 2016, down to ‘just’ 23,528 tonnes of silver by the end of January.
London’s paths of gold: how it normally works?
Hidden out of site, 8535 tonnes** of gold are securely tucked away under the streets of London. This vast hoard tends to remain in situ, whilst ownership of part of this gold hoard changes hands frequently through the futures and options markets, as well as forming the underpin for physically backed gold exchange traded funds. Of course, the part of this gold tonnage which encapsulates the UK’s gold reserve is safely retained and not sold; the price is far too high for that***.
By retaining the physical gold in one place, but allowing the ownership rights of that gold to be exchanged in the marketplace, hey presto a highly illiquid and difficult to transport asset, becomes as liquid and accessible to investors as a share in Apple or BP. Enabling this, gold in London is stored in both commercial vaults as well as in Bank of England vaults (who hold it on behalf of other governments and institutions such as the International Monetary Fund).
The Trump Tariff Effect – a ‘Rory-explainer’
For fans of the Rest is Politics webcast – here’s my version of a ‘Rory-explainer’.
Whilst there is a huge amount of gold stored in London; the owners of that gold are not all based in the UK. Other central banks can store their gold in Bank of England vaults for safe-keeping where, for each gold bar they own, they are charged a small fee by the Bank of England for safe-storage. Commercial vaults operate in London too and gold stored here is often owned by gold exchange traded funds (ETF’s). These gold owners often lend their gold to commercial banks and trading desks and charge an interest rate in return. Just the same as taking a loan out, banks and traders that borrow gold must pay interest to the owner.
Commercial banks borrow this gold but do not try to profit from picking the direction of the gold price as these long and short positions offset each other. Instead, they can pick up a profit by selling the gold and investing the proceeds in interest-bearing assets at an interest rate higher than they are being charged to borrow that gold. Given a typically consistent premium in gold futures prices versus the current spot price, this is a trade that usually works fine and when the time comes to buy back gold in the market and return it to the original owner, the commercial bank has made a profit.
The recent fear that the Trump administration was set to apply tariffs that would impact gold has unsettled the gold market. Demand has risen from market participants to close out existing contracts before potential tariffs get imposed, meaning the amount of gold available to be lent in the market has fallen strongly, pushing up the short-term interest rate to lease gold. As commercial vault supplies reduced, this incentivised the official sector (central banks) to lend to precious metals trading desks at commercial banks. However, the lack of capacity to shift significant amounts of gold out of the Bank of England vaults to commercial vaults meant gold interest rates remained very high through January and February.
Whilst moving gold out of Bank of England vaults to commercial vaults is normally an orderly process, this recent trans-Atlantic gold rush stretched the ‘vault-system’ and created a friction between supply and demand. Complicating this further, gold being transferred to the US from London, not only has to be safely and securely transported across the Atlantic but must do so via refineries in Switzerland and elsewhere to be transformed from 400oz bars to the 1kg bars that are accepted as deliverable into US COMEX vaults (which back those futures contracts). This slowed the whole process for moving gold from the UK to the US and meant commercial banks may not actually receive physical delivery of the gold before the date the settlement date of the contract.
Consequences and Impacts
These recent events within the gold market show how small changes can have over-sized impacts in the real world. In this case, just the risk of tariffs, not even the threat nor actual imposition of them, has seen both the gold price dislocate from one region to the other, but also the disruption to the established order of how the gold market operates.
The continuing angst from the unpredictable President Trump and his tirade of tariff threats continues to dissipate through the gold market. Risks abound, both in over-extrapolating the real-world impact in some cases, and of under-estimating in others. As the impact in the gold markets begins to diminish as we pass quarter end, they shine a light on the risk on how unexpected surprises are rarely conducive to delivering good outcomes.
* Futures and options are contracts that essentially allow you to buy a commodity but not actually worry about ever receiving it on your doorstep. It fits well inside a computer screen and is handy if you are trading thousands of barrels of Brent Crude and don’t have a very big bathtub.
** Again, using LBMA data to end January 2025.
***More asterisks! The last big sale was by Chancellor Gordon Brown when the UK government sold just shy of 400 tonnes for £4.63 and a packet of Haribo****.
**** Asterisks on asterisks are probably not allowed. The average sale price was $275, which is somewhat lower than it is today. Plus, there were no Haribo.
