Tag: Trading Interest Rates

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Understanding Platinum Gold Spread Trades

Spread trading is a widely-used trading strategy in futures markets and offers some key advantages over outright futures trading (i.e., going long or short a single futures contract), including capital efficiencies with lower margin outlay and potentially superior risk-adjusted returns. This is particularly true for precious metals markets, where the underlying commodities demonstrate strong correlations with each other due to close economic links, but also distinct fundamental drivers that can create profitable spreading opportunities using the associated futures contracts.

Creating a Futures Spread

A spread trade using futures is created by buying a futures contract and simultaneously selling another futures contract against it. The spread acts as a hedging transaction, altering your exposure from an outright price fluctuation to the price differential between the individual legs of the spread trade. The profitability of a futures spread trade depends on the price direction, or differences in price movement, for the legs of the strategy.

Spread trades may be executed across many markets, but traders often look at similar contracts, or related markets, for spread trading opportunities. A closer relationship between the spread markets means the individual legs are more likely to move in tandem, enabling relatively stable price changes governed primarily by the pace of price moves between the legs (i.e., the relative performance of the legs), thereby reducing the level of risk for the trader. These strategies are referred to as relative value strategies.

Types of Spreads

Spreads may be broadly classified as intra-market spreads and inter-market spreads.

Intra-market spreads, also known as calendar spreads, are where a trader opens a long or short position in one contract month and then opens an opposite position in another contract month for the same futures market. Given the popularity of these spread trades, as well as their contribution to futures rollover activity, dedicated calendar spread markets are available on the CME Direct platform, which allows spread execution with no legging risk.

Inter-market spreads involve two separate, but related, futures markets with legs of the same maturity time frames. Inter-market spread strategies may have legging risk, but can be mitigated by using dedicated inter-market spread contracts or by selecting liquid underlying contracts for each leg in conjunction with using the auto-spreading functionality offered by some software vendor trading screens.

Benefits of Spread Trading

The main advantages of spread trading are reduced volatility and lower margin requirements, as the legs are generally in related markets at the same exchange.

Compared to outright futures, which can exhibit significant price swings, spreads can demonstrate extended trending price moves, making it easier for you to visualize patterns and take a directional view or implement a technical trading strategy.

Spread Trading with Precious Metals

The precious metals complex includes gold, silver, platinum and palladium contracts and offers trading opportunities to a global market through a wide variety of instruments. These markets not only provide highly correlated commodities, but also with unique price drivers that can create many attractive spread trading opportunities.

While you can choose from the range of instruments available for trade execution once you have identified your preferred strategies, the Precious Metals futures markets at CME Group offers highly liquid and deep markets that enable the fast, efficient execution of spread strategies, with the additional benefits of considerable margin savings (as all trades are centrally cleared through CME Clearing) and much alleviated legging risk.

More importantly, these futures contracts are predominantly electronically traded (over 90%) on CME Globex, which allows easy access for participants across the world and high-quality trade executions virtually 24 hours a day.

Gold-Platinum Spread Trade

Platinum is both a precious and industrial metal, widely used in catalytic converters in the automotive industry but also in jewelry and as an investment asset.

The price relationship and the price spread between gold and platinum may be useful as an indicator of shifts in the macro environment. Historically, platinum has been more expensive than gold since the white metal is about 15 times rarer than gold and has many industrial uses compared to the yellow metal. However, gold can become pricier during times of economic distress and political uncertainty when the yellow metal sees increased demand as a safe-haven asset. Conversely, during a positive economic cycle with increasing automobile sales, platinum’s premium over gold prices can rise even further as the metal will see increased industrial use. Since 2015 Gold has been trading at a premium to Platinum and the spread has been widening.

Platinum-Gold Price Spread (in U.S. dollars per troy ounce) Chart based on NYMEX Platinum and COMEX Gold Futures Prices

Current chart

CME Group offers one of the most liquid Platinum futures, making it a convenient instrument to manage risk and instantly capture trading opportunities, such as the platinum-gold price spread strategy.

Platinum-Gold Spread Profit and Loss Example

On March 2, a trader expects platinum demand to increase in the short term due to higher car sales and the platinum-gold spread to narrow. The trader buys two April Platinum futures contracts at $988.40/oz and simultaneously sells one April Gold futures contract at $1,231.90/oz (the Platinum contract is half the size, 50 oz, of the 100-oz Gold contract).

The resulting notional amounts for the legs are $98,840 and $123,190, respectively. The trader has thus entered the spread trade at -$243.50 and is long the spread.

The tables below show the trader’s realized profit and loss (P&L) as negative spread, narrowed as both Gold and Platinum increased, but at different rates.

• Platinum-Gold (negative) spread narrows when position is closed by selling two Platinum April contracts and buying one Gold April contract simultaneously on March 30.

	Platinum April	Notional Amt	Gold April	Notional Amt	Spread
Trade Enter Prices	Buy $988.40	$98,840	Sell $1,231.90	$123,190	($243.50)
Trade Exit Prices	Sell $1,056.40	$105,640	Buy $1244.20	$124,420	($187.80)
Strategy Leg P&L		$6,800		-$1,230
Total P&L			$5,570

Margin Offsets

One of the benefits of spread trading with futures is the reduced cost of margin, otherwise known as margin offset. Margin discounts can occur when CME Clearing scans the trader’s portfolio of futures positions looking for offsets.

In our example, we had a long Platinum position and a short Gold position. This spread position would have been identified as an offset and therefore would require less margin than the two outright positions.

Platinum-Palladium Spread Trade

Palladium, like platinum, is also a precious metal widely used in the automobile industry as an auto catalyst. The difference being palladium is predominantly used in petrol-engine vehicles, whilst platinum is used in diesel-engine vehicles. In the recent past, platinum has traded at a premium to palladium, but as the chart below illustrates, the premium has narrowed. The spread may cross, but the last time this happened was approximately 20 years ago. Traders can express a view on the platinum-palladium spread through trading individual outright futures contracts in a spread strategy like the ones demonstrated above.

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Discover the Gold-Silver Ratio Spread

Spread trading is a widely used trading strategy in futures markets that offers key advantages over outright futures trading (i.e., going long or short a single futures contract). These advantages include, capital efficiencies with lower margin outlay and potentially superior risk-adjusted returns, which is particularly true for the precious metals markets, where the underlying commodities demonstrate strong correlations with each other due to close economic links but also distinct fundamental drivers that can create profitable spreading opportunities using the associated futures contracts.

A spread trade using futures is created by buying a futures contract and simultaneously selling another futures contract against it. The futures spread trade acts as a hedging transaction, altering the trader’s exposure from an outright price fluctuation, to the price differential between the individual legs of the spread trade. The profitability of a futures spread trade will depend of the price direction, or differences, in price movement for the legs of the strategy. Spread trades may be executed across many markets but traders often look at similar contracts, or related markets, for spread trading opportunities. A closer relationship between the spread markets means the individual legs are more likely to move in tandem, enabling relatively stable price changes governed primarily by the pace of price moves between the legs (i.e., the relative performance of the legs), thereby reducing the level of risk for the trader. These strategies are referred to as relative value strategies.

Types of Spread Trades

Spreads may be broadly classified as intramarket spreads and intermarket spreads.

Intramarket spreads, also known as calendar spreads, are where a trader opens a long or short position in one contract month and then opens an opposite position in another contract month in the same futures market. Given the popularity of these spread trades as well as their contribution to futures rollover activity, dedicated calendar spread markets are available on the CME Direct platform, which allows spread execution with no legging risk.

Intermarket spreads, involve two separate, but related, futures markets with the legs having the same maturity time frames. Intermarket spread strategies may have legging risk, but it can be mitigated by using dedicated intermarket spread contracts, where available, or by selecting liquid underlying contracts for each leg in conjunction using auto-spreading functionality offered by some software vendor trading screens.

Benefits of Spread Trading

The main advantages of spread trading are reduced volatility and lower margin requirements as the legs are generally in related markets at the same exchange.

Compared to outright futures which can exhibit significant price swings, spreads can demonstrate extended trending price moves making it easier for traders to visualize patterns and thereby take a directional view or implement a technical trading strategy.

Spread Trading with Precious Metals

The precious metals complex includes gold, silver, platinum and palladium and offers trading opportunities to a global market through a wide variety of instruments available in the market such as the futures. These markets not only provide highly correlated commodities, but also with unique price drivers that can create many attractive spread trading opportunities.

While market participants can choose from the range of instruments available for trade execution once they have identified their preferred strategies, the precious metals futures markets at CME Group offers highly liquid and deep markets that enable the fast, efficient execution of spread strategies with the additional benefits of considerable margin savings (as all trades are centrally cleared through CME Clearing) and much alleviated legging risk. More importantly, these futures contracts are predominantly electronically traded (over 90%) on CME Globex allowing easy access for participants across the world and high-quality trade executions nearly 24 hours a day.

Gold-Silver Ratio Trade

The Gold-Silver Ratio, or GSR, indicates the price of gold relative to silver and is calculated as the price of gold divided by the price of silver on a per-troy-ounce basis. It reflects how many ounces of silver a single ounce of gold is worth. Since 2013, the ratio has widened out from 55 to 75, reaching a high of 83.5 in March 2016. In the last two years, the GSR traded within the range 65.5 and 83.5.

Whilst both metals are considered precious and may trend together, gold is viewed as a global currency and is often used as an inflation hedge and safe-haven asset in times of market uncertainty. Silver has more industrial applications, with 50-60% consumed in industrial end-use compared with 10% of gold. Silver prices are sensitive to the economic cycle. The gold-silver ratio widens if gold prices experience a larger percentage gain relative to silver prices in times of economic or geopolitical uncertainty. Silver prices outperform gold in times of economic recovery as industrial demand picks up and puts the ratio under pressure. The ratio may be viewed an indicator of the health of the global macro economy.

Gold-Silver Ratio Chart based on COMEX Gold and Silver Futures Prices

Current chart

Silver prices are generally more volatile compared to gold prices (at time of writing, 20d historical volatility for gold and silver were around 9% and 19% respectively). When gold prices fall, silver prices are likely fall more and vice-versa. Consequently, the Gold-Silver Ratio tends to be driven on numerous occasions principally by moves in the price of silver.

Trading the Gold-Silver Ratio, a technical trader would look to determine a preferred point to enter and exit the spread. Fundamental traders, would assess the supply-demand imbalances and the macro conditions for each metal to take a directional view on the ratio before initiating a trade. Irrespective of the trading approach or a mix of both, Gold and Silver futures contracts at COMEX offer cost-effective and highly liquid instruments for the GSR trade.

The following screenshot for the most active COMEX Gold and Silver futures contracts on CME Globex shows extremely tight and liquid markets for the metals. The top of the order book is generally about one tick wide and there is abundant depth in the book beyond the top level for both the contracts.

Gold-Silver Ratio Profit and Loss Example

On March 1, a trader believes that gold prices will outperform silver prices in the short term. The trader decides to go long the Gold-Silver Ratio by buying one April Gold futures contract at $1,248.90/oz and simultaneously selling one May Silver futures contract at $18.445/oz, keeping the notional amounts for the legs nearly similar ($124,890 and $92,225 respectively). The trader has thus initiated the GSR trade at 67.71. The following tables show the trader’s realized profit and loss should the GSR move in their favor (i.e., firms up).

• GSR edges higher by 1% when position is closed by selling one April Gold futures contract and buying one May Silver contract simultaneously on March 30.

Margin Offset

One of the benefits of spread trading with futures is the reduced cost of margin, otherwise known as margin offset. Margin discounts can occur when CME Clearing scans the trader’s portfolio of futures positions looking for offsets.

In our example, we had a long Gold position and a short Silver position. This spread position would have been identified as an offset and therefore would require less margin than the two outright positions.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Understanding the Precious Metals Spot Spreads

CME Group’s new Precious Metals Spot Spread allows traders to seamlessly and transparently transfer risk between the COMEX futures market and the London OTC market in one simple and cost-effective transaction.

 How Does It Work?

The Spot Spread is constructed of two legs. One leg is the active Gold or Silver COMEX futures contract and the other is a London deliverable unallocated future. This spread enables both the COMEX and London spot legs to be executed on CME Globex and cleared through CME Clearing, which provides greater security and guaranteed counterparty credit.

Example

A trader is long London OTC gold and short COMEX Gold futures and wants to offset the risks of both positions. By buying the spot spread, this trader would be able to cover the short COMEX position and liquidate the long London spot position simultaneously.

Electronic Trading and Reporting

CME Globex trading platform allows you to trade electronically and removes the worry of searching for counterparties to trade with. Spot Spread trades are automatically fed into CME Clearing to help you meet 5-minute reporting windows in busy markets.

Summary Overall

This contract melds the ease of COMEX futures and the flexibility of the OTC market. For traders who routinely transfer risk between the futures and OTC spot markets, the COMEX Precious Metals Spot Spread offers an around-the-clock transparent price for trading and a secure and efficient way of executing those trades.

If you have questions send us a message or schedule an online review .

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Peter Knight Advisor

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There are numerous examples of how future and options can be used to manage economic risks inherent in commercial operations and in investment portfolios. This module discusses risk management using COMEX and NYMEX Precious Metals futures.

Market prices respond to changing circumstances. We all know that prices will be different in the future to how they are today, but we do not know how different they will be. At a more basic level, while some people make predictions, no one knows with certainty whether prices will be higher or lower in the future.

One of the most well-known risk management uses of futures contracts is to hedge against uncertain outcomes in the future.

Example

Consider an auto parts manufacturer who has won an order to deliver catalytic converters. Platinum is a significant constituent in the production of these items and the production run will require 32 kg, approximately 995 ounces. of platinum. The firm will take delivery of platinum in two months at the prevailing spot price.

The current spot price is around $867 per ounce and NYMEX April futures are priced at $870 per ounce. To hedge the future payment, the manufacturer needs to buy futures. His requirement is for 995 ounces. Each NYMEX futures contract is for 50 ounces. Buying 20 contracts would provide exposure to 1,000 ounces of metal.

Two months later, the spot price has risen by $90 to $957 per ounce. The firm will take delivery of the metal it needs from a local supplier and does not wish to take delivery through the futures contract. It closes out the futures position in the market at a price of $954 per ounce. The gain made on the futures transaction is $84,000.

 

	Spot			Futures
	Price	Position	Value	Price	Position	Value
Start	$867	995 oz required	$862,665	$870	long 20 contracts@50oz per contract	$870,000
End	$957		$952,215	$954		$954,000
Result			$89,550 additional cost			$84,000 hedging gain

This gain offsets the rise in the price of platinum in the physical market, which has resulted in the manufacturer paying $89,550, or over 10%, more for their supply compared to the spot market price at the time they knew they had the exposure. The futures trade therefore provides an effective hedge against the rise in price of the physical supply.

Adding Precious Metals to your Portfolio

Precious metals are widely used in investment portfolios. Futures contracts can be the means of making an investment in precious metals but can also be used as a hedging tool for portfolios consisting of other precious metal assets.

Example

Consider a fund that has an investment in gold. Most of this is held through a holding of gold bars, but around 1% of the fund is held in cash to cover short term cash flow requirements. At the end of May, the spot price of gold is $1,212.1 per ounce. The fund has 20,000 ounces in gold bars and $250,000 in cash, and therefore has an end of month valuation of $24,492,000.

At the end of June, the spot price has risen to $1320.7 per ounce, an increase of 8.96%. Because of the cash balance, the value of the fund has risen to $26,665,000, which is an increase of 8.87%, which is an underperformance versus the benchmark spot price.

This underperformance could be managed with futures. COMEX Gold futures has a 100-ounce contract size. A two lot position therefore represent 200 ounces, or 1% of the physical holding. At the end of May, the August futures settlement price was $1217.5 per ounce, and at the end of June was $1320.6 per ounce. The two lot position has therefore netted a gain of $20,620 over the month. When added to the gain in value of the physical holding, the performance of the fund including the futures position is 8.96%, in line with the benchmark.

Managing Economic Exposure

Futures contracts can be used to overlay physical positions to adjust the economic exposure.

Example

An investor has a holding of 1200 ounces of gold. The current spot price is $1236.5 per ounce, and therefore the value of the holding is $1.48 million. The investor expects that over the next few weeks silver will outperform gold; however she does not wish to close her long term physical position.

The investor modifies her market exposure by selling COMEX Gold futures and buying COMEX Silver futures. The COMEX Gold June futures contract is currently priced at $1231.5 per ounce. The contract size is 100 ounces; therefore the investor needs to sell 12 contracts in order to neutralize her exposure to gold. At the prevailing futures price this transaction has a notional value of $1.477 million. The COMEX Silver May futures contract has a price of $14.756 per ounce, and a contract size of 5,000 ounces. In order to most closely replicate the notional value of the gold futures trade, 20 Silver futures contracts should be purchased.

Over the next few weeks, the prices for both gold and silver increase, but silver has outperformed gold, with the silver spot price rising 16.7% compared the gold spot price rise of 4.7%.

The investor’s physical holding of gold has increased in value by $69,000. However, as planned, this is neutralized by the return on her short position in gold futures. The COMEX Gold June futures price is now $1291.8 per ounce, and this leg of the trade has lost $72,360 in value. The silver futures transaction increased in value to $17.474 per ounce, therefore her silver futures transaction has made a gain of $271,800.

Overall the combined position has made a net gain of $268,440. The investor can close out her futures positions with her physical gold holding being unaffected.

	Spot			Gold Futures			Silver Futures
	Price	Position	Value	Price	Position	Value	Price	Position	Value
Start	$1236.5	1200 oz Holding	$1,483,800	$1231.5	Short 12 contracts@100oz per contract	$1,477,800	$14.756	Long 20 contracts@5000oz per contract	$1,475,600
End	$1294.0		$1,552,800	$1291.8		$1,552,800	$$17.474		$1,747,400
Result		$69,000 gain				$72,360 loss			$271,800 gain

Summary

COMEX and NYMEX Precious Metals futures contracts can be used to manage risk exposures to precious metals.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Precious Metals Delivery

CME Group offers a range of precious metals futures contracts that result in physical delivery on maturity. The most significant of these are COMEX gold and silver futures and NYMEX platinum and palladium futures.

Physical delivery helps to ensure that there is a convergence in pricing between the physical market and the futures market at the futures’ expiry. To be able to assess the price of a futures contract with confidence, an investor needs to understand the process for delivery and the nature of the metal that can be delivered.

Precious Metals Brands

Precious metals are minerals, found in rock deposits around the world. These natural deposits are mined and transported to refiners who turn them into a standardized product, typically in the form of a bar or ingot, suitable for use by industry or investors. Each refiner has its own production processes, and imprints its name or logo on the bar. In the industry, the refinery name is referred to as the brand. Other information is also imprinted on the bar, such as a serial number and the weight and purity, or fineness, of the metal.

CME Group only allows certain brands of metal to be delivered against its futures contracts and brands must meet pre-set minimum standards. The exchange also specifies the minimum fineness of the metal in each bar that is acceptable. For example, the minimum fineness of COMEX gold futures is 995, or 995 parts per thousand, i.e. 99.5%. For platinum, the minimum fineness is 99.95%.

Designated Depositories

To be delivered against a futures contract, a precious metal must be deposited in one of the exchange’s designated depositories. A depository provides secure storage of metal and provides inventory management to the exchange and its members.

To become designated, a depository must meet the requirements of the exchange, including providing the necessary level of security.

Additional Delivery Requirements

The exchange has additional requirements in order for precious metal to be suitable for delivery. Gold and silver bars must be of a certain size: 1,000 ounces for silver, and either 100 ounces or 1 kilogram for gold. Gold refiners must adhere to international standards relating to responsible sourcing. Gold, platinum and palladium must be accompanied by a certification of assay and must be delivered to the depository by an exchange-approved carrier in order to maintain the chain of integrity.

Warrant

Once metal that meets the exchange’s specifications has been delivered to an exchange-approved depository, the owner of the metal can choose to register the metal with the exchange, a process often referred to as placing the metal on warrant.

A warrant is a legal document of title. At CME Group, warrants are created and stored electronically. The warrant contains all relevant information related to the metal and is created by the depository to be held in the exchange’s systems by the owner’s clearing member firm.

For precious metal’s futures, the warrant is used as the means of delivery.

Delivery Month

Futures contracts typically reference a calendar month for assessing a price reference or for effecting delivery. Gold, silver, platinum and palladium delivery can be made on any business day during the contract month.

The Delivery Process

The seller of the futures contract starts the delivery process by providing a formal notice of intention to deliver to the clearinghouse. The seller must identify the warrant they intend to deliver. In turn, the clearinghouse assigns the obligation to take delivery to a holder of a long futures contract.

Delivery occurs by the transfer of ownership of the metal warrant two business days after the seller provides the notice of intent. The transfer takes place at the settlement price set by the exchange on the day the seller provided the notice of intent.

The amount of metal in a bar can vary. While a futures contract is for a standardized amount of metal (e.g. 100 oz. for gold futures), the exact weight of metal is taken into account when the payment amount is calculated.

When futures buyers take delivery of metal warrant, they can choose what to do with it.  For example, they can choose to leave it on warrant in the depository, take it off warrant and sell the metal privately or ask for its removal from the depository for use or storage elsewhere, a process known as load out.

The process described above covers gold, silver, platinum and palladium futures contracts at CME Group. Alternative delivery processes are used for other contracts, including delivery via loco London unallocated accounts.

Information about the amount of metal held on warrant at the exchange’s depositories and the volume of deliveries taking place in precious metals contract is available on cmegroup.com.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Contango and backwardation are terms used to define the structure of the forward curve. When a market is in contango, the forward price of a futures contract is higher than the spot price. Conversely, when a market is in backwardation, the forward price of the futures contract is lower than the spot price.

Contango

In the chart below, the spot price is lower than the futures price which has generated an upward sloping forward curve. This market is in contango – the futures contracts are trading at a premium to the spot price. Physically delivered futures contracts may be in a contango because of fundamental factors like storage, financing (cost to carry) and insurance costs. The futures prices can change over time as market participants change their views of the future expected spot price; so the forward curve changes and may move from contango to backwardation.

Backwardation

In the chart below, the spot price is higher than future prices and has generated a downward sloping forward, or inverted, curve which is in backwardation. The futures forward curve may become backwardated in physically-delivered contracts because there may be a benefit to owning the physical material, such as keeping a production process running. This is known as the convenience yield, which is an implied return on warehouse inventory. The convenience yield is inversely related to inventory levels. When warehouse stocks are high, the convenience yield is low and when stocks are low, the yield is high.

Convergence

Over time, as the futures contract approaches maturity, the futures price will converge with the spot price, otherwise an arbitrage opportunity would exist.

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How and Where Precious Metals Are Traded

Review the marketplaces where precious metals are traded around the world.

Precious metals have always been used as means of exchange between traders and as a store of wealth, with gold being the metal most commonly used for this purpose. Today there are many ways to invest and trade in gold and other precious metals.

Precious Metals Bars

Investing directly in gold bars is a popular way to access these markets. Bars come in many sizes to suit the needs of the investor. One of the largest markets for gold bars is organized in London. Here the standard size of bar is 400 troy ounces, which is referred to in the market as a large bar. Other bar sizes frequently used around the world include 100 troy ounces, 1 kilogram and 5 tael. The standard size for silver bars in the London market is 1,000 troy ounces. For platinum and palladium, the acceptable size in the London market is between 1 and 6 kilograms.

Taking Ownership

Taking direct ownership of precious metals often involves the use of specialist vaulting and custody arrangements, secure transportation and insurance coverage. In addition to direct investment, the London market has also developed a system of indirect investment.

Precious metals can be bought on an unallocated basis through a bank or intermediary. The bank retains control of the metal whilst the buyer holds the metal on account. Owning metal on an unallocated basis introduces an element of counterparty risk, but provides for a more straight-forward mechanism for completing transactions: trades are completed by the banks moving balances between account.

The London markets for precious metals are organized on a private, over-the-counter basis, without a central exchange coordinating trading. In a number of other locations around the world, exchanges have developed to provide trading facilities in metal. One of the most active of these is the Shanghai Gold Exchange, which provides a centralized spot market for gold and silver bars.

Buying Coins

In addition to bars, investors looking for a direct investment in physical gold and silver can also buy coins. Many countries mint coins from gold and silver, and there are many private markets and agencies that support this form of investment.

Indirect Investment

Another popular way to invest in precious metal is through a mutual fund or an exchange traded fund. This is an indirect form of investment, where investors place their assets into a fund and in turn the fund invests in metal. The fund charges a management fee to cover its costs. With an exchange-traded fund, equity in the fund is traded on a stock exchange, with the most active of these funds being listed in New York and London.

Technology is widely used in the trading arrangements for all these products. A new development that is emerging is the is use of blockchain technology to support the ownership and the efficient transfer of precious metal.

Trading Precious Metals

It is difficult to make an accurate assessment of the amount of precious metal that is traded in these markets, as many trades are in private markets that do not report transaction information.

Data for the London market shows that on average over 19 million ounces of gold and 170 million ounces of silver are transferred every day, with the amount traded likely to be a multiple of this. Volumes on the Shanghai Gold Exchange show an average daily trading volume of over 6 million ounces of gold and 140 million ounces of silver. Trading in the shares of the largest exchange-traded fund for gold can be equated to approximately 1 million ounces of gold per day. It is clear that the amount of precious metal traded on the world’s markets is many times the amount produced from mining and recycling activities.

In the middle part of the twentieth century, the U.S. dollar was convertible into gold at a fixed official fixed rate of $35 per ounce, as part of the Bretton Woods system. This convertibility ended in 1971, and the price of gold became subject to the forces of supply and demand. As a consequence, the need for risk management tools developed. Coinciding with a change in U.S. law that had previously barred private ownership of gold, COMEX launched its Gold futures contract in 1974. The COMEX Silver futures contract had been available since 1933.  Platinum futures were launched on NYMEX in 1956, and Palladium futures launched in 1968. Precious metals futures are also available on a number of other exchanges, most notably in Asia, such as the Shanghai Futures Exchange and the Tokyo Commodity Exchange.

Futures contracts provide a mechanism to manage exposure to the underlying market. In the precious metal markets, the futures contracts offered by COMEX, NYMEX and others are a part of the wider global market for precious metals. They provide transparency and price discovery to the market. Options contracts on precious metal and precious metal futures are also offered by exchanges. Options contracts add to the range of trading and hedging strategies that can be employed by an investor.

Volume (2016) in COMEX Gold futures contracts averages the equivalent of 22 million ounces per day. Each contract is for 100 ounces of gold, and is for delivery at specified time in the future. Each COMEX Silver futures contract is for 5,000 ounces of silver. Its traded volume is equivalent to over 350 million ounces per day on average. The NYMEX Platinum contract is for 50 ounces of platinum, and the NYMEX Palladium contract is for 100 ounces of palladium. Together these two contracts trade in excess of 1.25 million ounces of metal per day.

In conclusion, the world’s precious metals markets consist of a wide range of products to invest in, and tools to assist in managing the risks associated with these investments, and the financial risks of dealing in the physical supply chain.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Precious Metals Supply and Demand

Understanding the forces and drivers of supply and demand in the physical market is essential for understanding the derivatives markets.

Supply

For all four of the main precious metals, gold, silver, platinum and palladium, new supply comes to the market from mining production and recycling of scrap and obsolete material.

Mining product accounts for between 70-85% of the total new supply, depending on the metal, with recycled material accounting for the remainder. The proportion fluctuates with time, reflecting the changing cost of production, reclamation values and the economic outlook, amongst other factors.

Gold

For gold, supply from these two sources amounts to around 120 million troy ounces per year, equivalent to around 3,700 metric tons. This production has a value in the order of $150 billion, which represents the highest value of production in the precious metals space.

Gold mine production comes from countries throughout the world. Chinese mine production has risen considerably in recent years, and now China is the world’s largest producer, accounting for around 16% of global output. In contrast, South Africa, which used to be largest producer has seen declining output in recent years, and now accounts for around 5% of production. Australia, Russia, the U.S., Canada, Mexico, Peru and Ghana also produce significant quantities.

Silver

Silver has the largest supply volume of the four metals at an excess of 30,000 metric tons per annum. This has a value in the order of $17 billion. As with gold, Chinese mine production of silver has increased substantially in recent years, although Mexico remains the largest source of silver mine supply. Australia, Russia and Peru are also significant suppliers of mine production. Silver is often a co-product of the mine production of other minerals, such as gold or copper.

Platinum and Palladium

Platinum and palladium have lower production volumes; 230 metric tons for platinum and 290 metric tons for palladium. South Africa and Russia are the most significant producers of mined metal. For platinum, South African production dominates the market, representing around 2/3 of global mining output.

The mined ore, and recycled metal is refined and normally formed into bars for transportation and storage. Platinum and palladium are also formed into a powder, known as sponge, for use in various industrial applications.

Production from mines and recycling is not the only source of supply to the market. Once manufactured, bars are stored in vaults. The stock of stored metal in these vaults that has accumulated over many years is also available as supply to the market.

There are no reliable estimates of the amount of precious metal stored in vaults. Some is owned by central banks, some is owned by investment funds and some is owned by individual and corporate investors and intermediaries.

Demand

Investment demand is a significant element in the market for precious metals and has an important role to play in establishing market prices for metals. However, investment transactions usually represent the transfer of ownership of stored material. This brings valuable liquidity to the market, but will have little impact on the overall supply and demand. Taken as a whole, investment behavior can be seen as either a net buyer of metal, and therefore a source of demand, or a net seller of metal, and therefore a source of supply. The overall impact of investment will reflect investor sentiment of how ownership of metal will compare to other investment opportunities over their investment horizon.

Gold is the most widely held investment commodity. As well as private investments in gold, central banks hold a significant amount of their reserves in gold. The IMF and the World Gold Council estimate that the world’s central banks hold around 33,000 metric tons of gold, worth over $1 trillion. Changes in this amount will affect the net supply or demand in the market.

Silver is widely used in the production of coins. The U.S. and Canada are the largest producers of silver coins. The U.S. Mint produces in excess of 40 million American eagle silver dollars each year. It is estimated that the global use of silver for coinage accounts for around 14% of annual silver production.

Industrial Use

Also, on the demand side, all four metals have a wide range of industrial uses, reflecting their physical properties.

Gold is used in electronics and in medical and dental applications, amongst other industrial uses.

Silver also has extensive demand from the electronics sector, and has seen increased use in photovoltaic cells. Silver used to be used extensively in photographic production, but this has decreased sharply with the advent of digital photography.

A major use of platinum and palladium is in the creation of vehicle emission control devices. They also have applications in the electronics sector.

Jewelry

Precious metals are also widely used in the manufacture of jewelry. Jewelry use is the primary physical use of gold, with the amount used equating to over 2/3 of annual production, i.e. over 2,500 metric tons each year. The use of silver and platinum for jewelry is relatively lower, at just under 1/3 of annual production. Palladium is used in jewelry, but the amount is much less significant.

Conclusion

In conclusion, thousands of tons of precious metal are produced each year from mining operations, adding to the stock of metal available. These metals are used in industry and in jewelry, from where they can be recycled back into the market.  Precious metal is also held in store as an investment and as part of countries’ official reserves. The combination of all these factors creates an active global market for precious metal.

Further Reading:

1) CPM Group precious metals yearbooks
2) Thomson Reuters GFMS
3) World Gold Council
4) The Silver Institute
5) International Monetary Fund
6) US Geological Survey

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Regards,
Peter Knight Advisor

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