There are massive discrepancies between the contracts based on gold price quotations at the COMEX and the price of physical gold. At the moment physical gold commands a premium of up to 20%. According to Paul Mylchreest the London OTC market trades 2,134 tonnes of gold every day. This is 346 times the daily production and close to the global annual production.

According to Jeff Christian, founder of CPM Group, the trade on the LBMA is based on a leverage factor of 100:1 . This means that physical gold is traded at a factor of 100. If a number of market participants were to demand physical delivery at the same time, the contracts could never be settled. Normally only a small percentage is actually delivered in physical terms, but physical delivery remains the core clause of the contract. This is some cause for concern given that gold is often bought as a safe haven.

From a historical perspective, a default would not be unusual. At the LME, the largest base metal exchange in the world, physical deliveries of nickel had to be suspended in 2006, which was equal to a default. The principle of “overbooking” is well-known from airlines or restaurants, but the situation of gold and silver is of course much more dramatic.

The volume of gold derivatives is worrisome as well. According to the Bank for International Settlements, the nominal value of all gold derivatives at the end of 2009 amounted to USD 423bn. The value of all OTC derivatives (as of the end of December) increased to USD 615 trillion. According to OCC the aggregate volume of derivatives at the end of 2009 in the USA amounted to USD 212.8 trillion. Only five banks account for 97%% of the market.

OTC gold derivatives



Sources: BIS Dec 2009, Erste Group Research

CFTC hearing / position limits

Although limits (caps) on positions on the future exchanges are currently subject to discussion, their introduction would not have much of an impact. The markets would probably adjust quickly. In a historical perspective, the main gold exchanges were based in Spain, Antwerp, Amsterdam, and most recently London and New York. On top of that the trend is intact: according to the Futures Industry Association (FIA) trading volume in Europe and the USA has fallen by some 9%, whereas the futures turnover in Asia has increased by almost 26%. Turnover on the MCX (Multi Commodity Exchange of India) increased in 2009 by 273%, while the Shanghai Futures Exchange reported an increase of 210%. Asian futures exchanges nowadays account for almost 35% of global trading turnover.

The equity market has already seen the paradigm shift: Shanghai passed the Tokyo stock exchange last year in terms of turnover. Only the NYSE trades higher volumes. Therefore we believe that the relevance of the COMEX will shrink in the future. The benchmark exchanges for gold will probably be located close to the biggest demand: in Shanghai and Mumbai.

By. Ronald Stoeferle of Erste Group

Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.