Sunday Night Discussion
I recognize that sometimes the pages of comments here get a little overwhelming for some readers. However, there are times when great information is provided within but it gets overlooked by most visitors to the site. The previous thread contained another such gem so I thought I'd start this new thread.
Many questions abound over the LBMA and the spot/physical market. Yesterday, Turdite "71185208" asked the following question:
Submitted by 71185208 on April 21, 2012 - 2:36pm.
I get how futures exchanges work. But I'm confused about how the LBMA operates.
If the LBMA has a greater impact on price discovery and yet the LBMA is not an exchange like the COMEX is an exchange, but rather a trade association, then how does trading on the LBMA affect price? If information is not shared in real time as on an exchange, and it's all OTC, then I assume one LBMA member isn't supposed to know what another is doing in real time, i.e. at what price and what quantities gold is being sold for at any particular moment, right?
So how do buyers and sellers on the LBMA get pricing signals? Is any information shared between members?
Let's say I'm a sovereign wealth fund and I want to buy gold. Maybe I want some stored in London, maybe I want to take delivery. What advantage is there to using the LBMA over using the COMEX? Anonymity? Can I buy in far greater quantities? How do I know I'm getting a good price? How do I know what other players in the market are doing in the aggregate if there is not COT report for the LBMA?
I'm really confused about how pricing works on the LBMA. If trader/buyer A doesn't know what trader/buyer B is doing, and LBMA member A doesn't know what LBMA member B is doing, how on earth is price discovered????
Please would somebody kindly give an idiot's guide to MECHANICS of how the LBMA works (not just comments about it being a trade association, this doesn't clear anything up for me), as opposed to a futures exchange (COMEX).
Thank you in advance for knowledgeable comments.
"Tabberto" chimed in this morning with a thoughtful, reasoned response:
Its a complex issue, that centres on size and the Fixes, plus is a simple function of history. Just to clarify though, the LBMA is an association of all the big ugly banks loathed in Turdland, that trade and clear 'Spot' Gold and Silver, and the COMEX is a futures market. The fact that its called 'London' is a bit irrelevant and can prove to be a distraction when trying to understanding the meaning/role of the LBMA.
some more reading material for you below. A key takeaway is that the LBMA cleared $20bn per day in 2009 alone (for sure more than that now) which is because of the massive number of forwards, swaps and general paper crapola that pass for Precious Metals trades and absolutely affect the price discovery mechanism - this is also why the likes of Jeff Christian think its fine to be 100 or 300:1 paper to silver within the price discovery mechanism - I append his own damning 'Bullion Banking Explained' piece. It is also an issue of market depth, big players always want the deepest pond (or Dark Pool!!) to swim about in. The COMEX futures market is really a speculative market dominated by different forces than the LBMA 'spot' market and generally is a bit more 'whippy' in the way it behaves due to the different kind of investor. 'Spot' is where you go for delivery of large amounts (albeit 300:1 leverage inbuilt there), you buy at spot and then have a 'wholesaler' within that system make delivery for you, which is why COMEX contracts are so rarely delivered: they just need to be ABLE to be delivered in order for that market to retain a sheen of credibility. Be clear neither the LBMA nor COMEX have credibility, hence why the upcoming Deliverable and FULLY allocated 'spot' silver receipt exchange in China could be so interesting. Given the choice between the unregulated joke that is COMEX and the 0.3% backing offered by the LBMA any trader or big physical buyer of Silver would be likely to want to get involved in a new and more transparent entity versus either of the 2 other options. This could lead to bifurcation in the price discovery mechanism as the new exchange starts to 'make the price' as it could grow exponentially in size by attracting real longs while also forcing the existing shorts elsewhere (ie London and COMEX) to unwind their paper positions.
What I have written here is far from comprehensive and may contain the odd small point of inaccuracy as fwiw I don't actually use the LBMA or COMEX but have some understanding of the differences. Strongly suggest you and other Turdites read the links below though as they make for worthy background to the subject.
The bulk of global trading in gold and silver is conducted on the over-the-counter (OTC) market. London is by far the largest global centre for OTC transactions followed by New York, Zurich, and Tokyo. Exchange-based trading has grown in recent years with Comex in New York and Tocom in Tokyo generating most of the activity. Gold is also traded in forms of securities, such as exchange-traded funds(ETFs), on the London, New York, Johannesburg, and Australian stock exchanges.
Although the physical market for gold and silver is distributed globally, most wholesale OTC trades are cleared through London. The average daily volume of gold and silver cleared at the London Bullion Market Association (LBMA) in November 2008 was 18.3 million ounces (worth $13.9 billion) and 107.6 million ounces (worth $1.1 billion) respectively. This means that an amount equal to the annual gold mine production was cleared at the LBMA every 4.4 days, and to the annual silver production every 6.2 days.. The Gold Anti-Trust Action Committee claims that clearing data substantially understates the true amount of gold traded, due to the netting of trades in the calculation of Clearing Statistics. They claim the LBMA market is $5.4 trillion a year.
Allocated Accounts are accounts held by dealers in clients’ names on which are maintained balances of uniquely identifiable bars, plates or ingots of metal ‘allocated’ to a specific customer and segregated from other metal held in the vault. The client has full title to this metal with the dealer holding it on the client’s behalf as custodian. To avoid any doubt, metal in an allocated account does not form part of a precious metal dealer’s assets.
Unallocated Accounts represent the most popular way of trading, settling and holding gold, silver, platinum and palladium. Transactions may be settled by credits or debits to the account while the balance represents the indebtedness between the two parties. Credit balances on the account do not entitle the creditor to specific bars of gold or silver or plates or ingots of platinum or palladium but are backed by the general stock of the precious metal dealer with whom the account is held. The client in this scenario is an unsecured creditor.
The total quantity of unallocated gold is estimated to be 15,000 tonnes at the end of 2008 which supports the 2,134 tonnes on average of spot gold trade through London every day representing 14.2% of the pool. This compares to average daily turnover in UK equities of between 0.34% and 0.63% for the 12 months ending September 2009. While members of the LBMA provide no information on the backing for unallocated gold the improbably high turnover is suggestive they are operating a fractional reserve system where unallocated accounts are only partially backed by physical gold. Similarly to a bank run this makes LBMA unallocated gold accounts susceptible to loss if a sufficient number of market participants request delivery of physical bullion.
Jesse had a go at this in 2010.
Summary: There is no transparent, 3rd party referenced, gold delivery backed spot price. There is a calculation based on the front month futures price (which can be cash-settled if needs be) on a Net Present Value basis, that is what is published by Comex/Globex and picked up by subscribers and Trading Platforms (the TPs then modify the price internally) and there is the London AM & PM Fixing. The LBMA market making banks have an informal market spot price based on 25 LGD (400Oz) bars that is apparently quoted on Bloomberg and Reuters terminals. So, the Spot Gold Price (and silver) is something that you are expected to take on faith.
I haven't yet found the original version of "Comex is a sideshow" that Jesse references Adrian Douglas as saying, but in trying to find it I was inevitably led to the Comex/LBMA issue, and manipulation.
The size of the LBMA is paper based...sound familiar? Just as London has been exposed by the failure of AIG and MFGlobal in the Great Re-Hypothecation Scandals, it stands to reason the London Bullion Market is the Mother of Great Re-Hypothecation Scandals with fractional reserve gold banking of 1:100, that is one part gold to 100 parts "paper" in unallocated accounts, according to GATA's excerpted testimony of Jeffrey Christian at the CFTC's hearings http://www.gata.org/node/8478 . I understand that Christian later recanted on this testimony as to the exact level, but in other publications he has said that 40:1 leverage is practised. If you read Christian's testimony, he is the one constantly saying how truly complicated it is and that few will understand, he even confuses fellow former Goldmanite Chairman Gary Gensler, who asks him to clarify his statements.
Here is Adrian Douglas's written testimony to the CFTC hearings, which at 8 pages is quite straightforward:
It seems, at this stage of my understanding, that any efforts to bring Comex precious metals trading into line would just further side-line Comex and increase the need of the Bullion Banks and other large institutions in the precious metals markets to "get the money to London", (a la AIG and MFG), where it can be re-hypothecated to eye-watering levels.
If there is one take-away from all this, it is two words: take delivery.
Anyway, there seems to be considerable confusion as to how the spot market functions relative to the Comex. I invite all to pose additional questions in the comments of this thread and, perhaps, some Turdites with intimate knowledge of the process will continue to chime in with answers.
Have at it! TF