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Melting gold market is a hot issue

By John Dizard

Published: March 27 2011 15:22 | Last updated: March 27 2011 15:22

There are two types of commentary on the politics of currency and central banking: the chin-stroking, keyboard-tapping opining you might get on this or other news pages, and the more definitive whirrs, buzzes, and clanks on the shop-floors of the world's gold refiners.

While the first sort tends to wash in and out with euro summits and International Monetary Fund meetings, the second is now going three shifts, 24 hours a day every day of the year.

That was not always true, as a Swiss gold refinery director of my acquaintance says. "In the old days, August was so quiet, nothing really happened."

In the 1990s, "we would consider a healthy average capacity utilisation to be maybe 70 per cent. Now, technically, we have been running at over 100 per cent of capacity."

That's good, because refining is a business with high fixed costs, but it means there is little time to do necessary maintenance. All the major refiners are expanding their plants.

What's interesting, from the chin-stroking macro commentary or investment analysis point of view is how the flows of product in and out of the refiners have been changing.

While the exchange traded gold funds now have a couple of thousands tons of the metal, the faster acceleration has been in the holding of physical metal, in the form of coins or bullion, by the investing, or hoarding, public.

The low transaction costs and ease of holding gold in the form of commodities exchanges' warehouse receipts, or shares in exchange traded funds, would suggest the rational way to invest in gold is through futures or ETF shares bought and sold electronically.

But the lack of trust in central banks' and governments' integrity now has seeped into a general distrust of institutionally managed assets.

So the rich, or middle class, are buying physical gold. Not just the Middle Easterners. The European rich and middle class.

"This to me is one of the hottest issues for the future," says my Swiss refiner.

When I say "my" Swiss refiner, I should add that I'm not a customer. Neither are you, unless an average gold purchase or sale for your account is in the 500kg range.

"In the old days," he says, "I might take an order to refine just 100 kilos," but now that might not be enough trade to get him on the phone.

After all, his problem is fitting orders into tight capacity, not getting new business.

The European refiners aren?t taking gold ore and turning it into metal ingots; that happens close to the mines.

The core business these days is taking the classic 400oz "good delivery" bars, refined to 0.9995 purity, melting them down, removing most of the remaining impurities, and producing 'four nines", or 0.9999 pure, kilo bars.

As a gold arb friend of mine in London says: 'The 400-ounce bars are over the EasyJet carry-on limit, not of real use to man nor beast.

"Kilo bars are what people want these days."

The buyers of kilo bars, stamped with fancy Swiss logos, tend to be Europeans or Asians.

The retail trade demands a higher standard of purity than the institutional buyers at the exchanges or ETFs, who are, so to speak, satisfied with bars that are close enough for government work.

For decades Europe has been a net exporter of gold, which came from the vaults of central banks, and the bags of gold Napoleons handed down from one French generation to the next. That flow slowed, and is now reversing.

I've only raised the possibility of euro-area capital controls, and discussed the possible technical issues. The kilo-bar buyers are, in effect, betting on exchange controls and higher taxes.

There are enough of them now so the refiners have a backlog for kilo-bar production, which started with the Lehman bankruptcy in September 2008.

"That was the first big wave [of kilo-bar buying]," says our refiner.

"At that time, the backlog was about six to eight weeks, and it never entirely went away."

About a month ago, the backlog was up to four weeks; last week, with a slight slackening in Chinese demand, it was back down to 10 days.

Here, of course, I am talking about the delivery times for serious customers, such as banks, oligarchs, or Middle Eastern heads of state.

"If you want five or 10, or 20 kilos, you will not be able to get this in time, because there is not enough melting capacity in the world."

Some of the refiners' classic product lines, such as the old 10-tola bar, are out of favour.

That bar size, developed for the Indian and Middle Eastern smuggling market, was just the right size to fit into a sheep's intestinal tract.

The refiners think someone should start an ETF that holds gold in kilo bars. "They could lend out the gold for a leasing fee, and be more liquid than the funds holding 400oz bars," as the London gold person says.

So Europe is again a continent of opportunity. For that, retail gold dealers thank the European leadership.


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