The London Gold Market – Ripe For Take-Over By China?

Will The London Gold Market Self Destruct?

• London Gold Market has been unchallenged for nearly 100 years
• So opaque that quotes of its $5 trillion size are estimates
• Five new offerings are set to appear in the market in the next six months
• Increased fragmentation set to reduce liquidity
• A share of gold price discovery is ripe to be taken by China
• Disruption in the London Gold Market gives opportunity to the East to take more control of the market.

As markets go the London Gold Market has to be one of the oldest and most unchallenged markets there is. With its roots in the 17th century it has been through a series of makeovers but for much of the last century the OTC market has hardly changed.

But now it is having an identity crisis. In the last year we have seen a barrage of news about changes that are coming, and the last few weeks seem to have been busier than ever.

For some the $5 trillion London Gold Market is under serious threat and there are a number of reasons as to why including regulation, gold price discovery and a lack of transparency all items that have haunted players in the London gold market.

Now, the threats that face it are driving many to address these problems and attempt to disrupt the market. We take a quick look at the new offerings set to arrive in the coming months, and ask if they will weaken, rather than strengthen, the London Gold Market and thereby open up an opportunity for China.

The LBMA, A fintech Start-Up And Transparency

Right now there is no data on how much gold is traded each day. The LBMA who currently runs the joint have accepted that this lack of transparency has long been a major criticism, by both market participants and the regulators.

With this in mind it has seen the light that ‘fintech’ offers and has opened itself up to disruption before it is disrupted. Earlier this year it announced Boat Services Ltd. and Autilla Inc. had been chosen to create transparency in the market by building a trading platform.

The 149 LBMA members will report their trades to the new platform.

When the LBMA announced the initiative with Boat Services, it was made clear that the new arrangement would “go beyond UK and global regulators’ demands for data on derivatives trading [and showed] a commitment to transparency.”

London Metals Exchange, World Gold Council, ICE, CME And Block-Chain All Want In

• The LME along with the World Gold Council has launched ‘LME Precious’ as their route to the highly attractive London Gold Market. For this group it is about clearing for spot and managing risk.

‘The new contracts are designed to complement London’s over-the-counter gold and silver market’ reports Bloomberg.

In the first-half of 2017 centrally cleared gold and silver contracts are set to be introduced. The new contracts will “include contracts for spot, daily and monthly futures, options and calendar spread contracts.”

• The Intercontinental Exchange took over the London gold auction in 2015, replacing the gold-fixing by phone ritual with an electronic platform. Now it wants to play a further role and announced last month that as of February it would start a new loco London futures contract use this to clear its daily auction.
• Earlier this week CME Group announced that as of January it will start to offer gold and silver contracts listed on COMEX, “to offer a spread between spot prices and benchmark U.S. futures.”

As you can see from the graph, COMEX and London offer the largest pools of liquidity. The 100 ounces of gold and 5,000 ounces of silver contracts have “the potential to create an even stronger link between the world’s two largest pools of precious metals liquidity,” Miguel Vias, CME’s head of precious metals, stated upon the announcement.

Using Transparency To Disrupt The Gold Market

Much of the regulation brought in since the financial crisis has called for increased transparency. The move by many of the players looking at changing things up, has this in mind.

However for all of the projects mentioned above, there are none that are truly disrupting how gold markets currently work. Costs, efficiencies and current practices are not changing that dramatically.  Instead layers are being added either around the sides or on top.

In a financial world that is finding itself upended by disruption and fintech startups one would think there is an opportunity here. And we’re not the only ones who think so.

In the first real attempt at disruption in the gold market, blockchain is coming to the fore. Paxos (formerly itBit) is working with both EY and Euroclear on a projects that will bring “brings instant settlement and true delivery versus payment (DvP) to the gold market for the first time.”

The project between Paxos and Euroclear will  take “Its innovative tokenization process turns physical gold into digital gold tokens, reducing capital charges and opening new opportunities for market participants.” reports the EconoTimes.

With All This Fragmentation Will London Remain A Centre Of Price Discovery?

In recent years both London and COMEX’s monopoly of the gold market has come under pressure from the East. And, with all this fragmentation revealing itself in the London Gold Market, one wonders if it can keep its crown.

To us, it seems the role of price maker is becoming increasingly up for grabs. In April the SGE announced a new benchmark price for gold bullion, modelled on the same process currently used in the London gold market. The “base price will fully reflect supply and demand…representing the whole Chinese gold market.”

As we reported at the time, David Marsh as quoted by the official China Daily, Managing Director and Co-Founder of OMFIM, said the yuan-denominated gold benchmark offered by SGE was a necessary addition to the international gold market and should make the pricing of physical gold more open to the play of actual market forces.

Will The London Gold Market Self-Destruct?

As Mark O’Byrne told Bloomberg earlier this year, “It’s a pretty big moment for London, and it’s time to choose. Everybody wants to bring more players to the table, but there is a risk that through the failure to work together, liquidity is diluted and the market weakened.”

Every industry and marketplace faces challenges from time-to-time, more often than not these things shake-themselves out as the market decides what it does and doesn’t want. No one wishes to see countless liquidity pools and so it is highly likely the majority of users will focus on one exchange.

The question is, in the time it takes for the London gold market to come through its disruptive phase, will the Chinese have taken a bigger piece of the pie for themselves? Without doubt China’s pricing influence will take time, but it seems the timing is right given the fragmented and disjointed efforts of various parties to take advantage of London’s weak moment.