The Gold Market: Evaluating Risks and Adapting to a New Normal

Gold nuggets on black surface
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By Greg Muecke, Head of Product Management at Tradewind Markets.

The COVID-19 pandemic has had widespread effects on economies globally, forcing businesses across all sectors to think outside the box and to reinvent themselves. As the world adapts, companies are strategizing on how to return to a new state of normal.

For the precious metals industry in particular, the entire value chain for gold, from the upstream supply chain to the wholesale market down to retail distribution, has felt the impact of economic and logistics disruptions catalyzed by COVID.

Take for example the gold supply chain. Many upstream participants, such as primary producers, refiners, banks, dealers, and wholesalers, have experienced a disruption in business as a result of COVID-19, some even halting operations altogether. In the past few months, we have seen mine closures in China, South Africa and Peruthree Swiss refineries suspend production; and the London Precious Metal Clearing Limited (LPMCL) being forced to consider additional gold storage sites due to travel restrictions.

COVID also challenged the traditionally reliable operations of two global gold hubs: the London Over The Counter (OTC) gold market and New York-based COMEX gold futures market. Together they create a deep and interconnected marketplace for gold market participants, but in the face of a global pandemic these two hubs leave the industry vulnerable due to the reliance on physical movement of gold to settle financial transactions.

All of these unprecedented events have impressed the need to change the decades-old legacy systems and market structure of the gold industry. Presented with an opportunity to transform, below are a few ways that financial market infrastructure firms, liquidity providers, trading houses, wholesalers and dealers can adapt to the changing landscape.

Tapping Into New Distribution Channels

For decades, the London OTC gold market and New York COMEX market have served as the primary distribution channel for gold mining. This has historically worked well as mining companies, through refining, trading, and storage agreements, have been able to efficiently monetize their assets in liquid markets. With one premise of this model called into question, namely the availability of physical transportation of gold, and with a slowing of global trade, mining firms are looking to diversify how they bring their products to market. By diversifying where they refine, they may not only reduce risk should a specific refining operation become inaccessible or need to temporarily pause operations, but they may also have an opportunity to sell into new markets aside from London and New York.

Now is the time to forge new relationships with counterparties that have not been traded with before, ranging from retail and wholesale bullion dealers and banks, to numismatic manufacturers and their distributors. For example, trust companies that focus on other asset classes such as digital assets are uniquely positioned to adopt the role of digital custodians, thus broadening the geographics. By tapping into new geographic segments outside of the traditional London and New York markets, such as Canada, South Korea, or Singapore, there is an opportunity to globalize relationships, diversify supply chain operations and minimize transaction and transportation costs. Increasing the value of these regional hubs allows firms to streamline steps in the supply chain and offramp into different directions should one counterparty become unavailable.

Adding More Players to LOCO London

An additional benefit of diversifying relationships in the metals market is mitigating the risk of continued concentration of the LPMCL. In March, the London Bullion Market Association (LBMA) began searching with clearing banks and market participants for additional storage and delivery locations outside of London due to travel restrictions affecting all five players of the LPMCL. Expanding operations outside of just one central region not only brings other qualifying metal market participants to the forefront, but alleviates the burden and potential shutdown of the entire industry should the one single source become an infeasible point of delivery.

The LPMCL requires metals to be stored and custodied within London, but when COVID-19 created disruptions within the precious metals supply chain, market participants were forced to look elsewhere. By creating a separation of the physical location where metals are held and where the value of that metal is being used, regional hubs outside of London may be well-suited to streamline operations. Since physical delivery is an arduous hurdle, regional hubs such as Switzerland, or even New York, may be a viable option to store metals and transfer ownership in the event that London or other gold hubs experience delays. By granting regional hubs the ability to interoperate and transfer ownership records, trades may be settled more efficiently.

Though COVID-19 is such a rare crisis to occur, it has certainly tested the structure of the metals market. As we begin to recognize the risks and opportunities presented within the mining industry, firms should be asking these kinds of questions on how to forge new relationships and brainstorming product innovation that will provide enhanced visibility, make models more cost-effective and diversify partnerships.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.