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High Premiums in Physical Gold Market: Scam or Supply Crisis?

Commodities / Gold & Silver 2020 Jul 01, 2020 - 03:18 PM GMT

By: Arkadiusz_Sieron

Commodities

During the coronavirus crisis many people couldn’t find physical gold, as there was a bullion shortage at dealerships. And these lucky individuals who managed to obtain bullion had to pay high premiums. We invite you to read our today’s article about the high premiums in physical gold market during the pandemic and find out whether they were indicated scam or supply crisis.

Gold is expected to serve as a safe-haven asset. But during the coronavirus crisis many people couldn’t find physical gold, as there was a bullion shortage at dealerships. And these lucky individuals who managed to obtain bullion had to pay high premiums. What a safe haven that people can’t find? And does not the price divergence between physical and paper gold show the price manipulation in the latter market? Let’s analyze what really happened in the bullion market during the coronavirus crisis.


First of all, gold was perceived as a safe haven – and this is why it was in such high demand. Since the dawn of civilization, people turn to gold to protect their savings when they are worried about the future. The yellow metal was demonetized in 1971 when President Nixon closed the gold window, ending the gold standard, but gold never lost its position as a store of value. It should not be surprising, as gold was used as money for thousands of years and it has no counterparty risk.

However, that high demand did not meet with sufficiently increased supply. You see, the coronavirus crisis is both the negative demand and supply shock. Many supply chains were broken. The quarantine, labor absenteeism, travel limitations and other measures undertaken to prevent the spread of the coronavirus disrupted the normal, smooth functioning of the economic engine. And it applies to the mints and refiners which simply could not work at full capacity. The bullion coin you see in the retail store is a highly sophisticated product which had to be earlier minted, refined and transported, which can be logistically challenging even in normal times, but it became really difficult during the Great Lockdown.

This is the reason behind the supply shortage and high premiums. They do not necessarily prove manipulation in the paper gold market. Rather, refineries and mints stopped operating or capped production because of the collapse in global travel and shutdowns of local economies. Remember that three important gold retailers – Valcambi, Pamp and Argor-Heraeus – are all based in the Swiss region of Ticino, near the border with Italy, that was quickly shut down at the beginning of the current pandemic.

Investors should remember two things here. First, there is always a certain premium on retail gold, as bullion dealers live on these premiums. One cannot have “spot gold”, so if somebody wants to own physical gold, he or she has to pay premium. After all, small and beautiful bullion coins or bars add some value and there are costs involved in producing them. Yes, during the coronavirus crisis these premiums soared, sometimes to 10-15 percent or even more over spot prices. But the havoc was unique: exploding demand and disrupted production and distribution chain at the same time.

Second, the markets are not homogenous, but heterogeneous – they are many segments on each market. Just as there is no single labor markets, but many labor markets (one for IT specialists, another for waiters, etc.), there is no single gold market. So, prices in these markets may differ, which is pretty normal (you don’t expect that the salary of IT specialists will be equal to waiters’ pay, do you?). After all, the LBMA Gold Price is a snapshot of gold prices quoted by traders in the London OTC spot market for wholesale transactions (and spot price might be even something else, as it is derived from the futures prices quoted in Comex), while the price offered by bullion dealers is the market price of physical bullion in retail trade.

Hence, there might be plenty of gold in a big trading hub like London, as there might be more sellers in the institutional market during the asset selloffs. And big fish typically use large bars of 400 ounces. The big ETFs and central banks do not buy gold at local bullion shops – they buy large gold bars by the truckload. This is why the size of different products is an important reason for the price discrepancy. Such large gold bars are beyond the reach of regular people, who prefer kilobars, one ounce bars and coins, or even smaller products. So they have to pay premium for the possibility to get gold products suitable for their shallow pockets.

Summing up, the bullion shortage and high premiums in the retail market do not prove manipulation in the gold market. They result from the market segmentation and supply disruption together with the explosion in demand for retail gold. But these shortages and high premiums do not have to impact the gold spot price, which is shaped in different segment of the gold market and by different factors. This is why London gold prices could go down during the stock market selloff, as the chart below shows, simultaneously with gold shortages in the retail market.

Chart 1: Gold prices (London P.M. Fix) from January 2 to June 1, 2020


To be clear, it doesn’t mean that the price of gold will not go up. We actually consider gold’s fundamentals to be bullish. But if gold prices appreciate, they will not do it because of the bullion boom in the retail market, which is a small fraction of the whole gold market, but because of stronger fundamentals and better sentiment among bigger players.

If you enjoyed the above analysis, we invite you to check out our other services. We provide detailed fundamental analyses of the gold market in our monthly Gold Market Overview reports and we provide daily Gold & Silver Trading Alerts with clear buy and sell signals. If you’re not ready to subscribe yet and are not on our gold mailing list yet, we urge you to sign up. It’s free and if you don’t like it, you can easily unsubscribe. Sign up today!

Arkadiusz Sieron

Sunshine Profits‘ Market Overview Editor

Disclaimer

All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

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