Demystifying London’s Gold and Silver Vault Holdings

A move towards greater transparency

Last May, the LBMA and LPMCL announced plans to start publishing data on the volume of gold and silver held in London vaults this year. This is in line with efforts to increase transparency in the market and is certainly a valuable addition to the pool of available data. Vaulting statistics is the first instalment towards further transparency, which will eventually be followed by trade reporting.

The newly launched data series covers end-period data from July 2016 through to March this year, and going forward the statistics will be published monthly, with a three-month lag. This will include gold and silver in the form of large bars, kilo bars or coins, but exclude jewellery and other private holdings held in vaults that are not part of the London clearing system. The data is collated from the Bank of England and seven custodians which offer vaulting services and is reported on an aggregated basis. These seven are HSBC, ICBC Standard Bank and JP Morgan, which are also clearing members of the LBMA, as well as Brinks, G4S Cash Solutions (UK), Malca-Amit and Loomis International (UK) Ltd., which are also LBMA members. Clearing members which do not have their own vault operations in London use accounts with these custodians or the Bank of England (BoE), and therefore do not contribute to the statistics to avoid double accounting

Additional pieces in the puzzle

Given that only limited historical data is available, it is hard to fully put into perspective. For instance, we cannot compare current levels versus the amount of gold and silver held during the peak of the bull run or during the 2015 trough of the correction from 2013. Nevertheless, looking at the change in levels between July last year and the end of Q1 this year still offers some insights.

Gold

Examining the data more closely, we note some interesting observations. It is worth highlighting that the BoE has been an important contributor to this move towards greater transparency in the precious metals market. Gold holdings at the BoE account for the bulk of the metal physically held in London, representing about 68% of overall holdings at the end of March. The BoE provides custody services primarily to central bank customers, helping them get access to London gold market liquidity. To further facilitate this, the BoE also holds gold custody accounts on behalf of certain commercial banks that support central bank access to the liquidity of the London gold market. About 12 years ago, the BoE started reporting gold holdings in its annual report. This year, monthly data has been made available, with the series covering end-period data from January 2011 through to the first quarter of this year.

On the assumption that the BoE custody service primarily caters to central bank customers, it’s probably fair to say that gold held outside of the BoE should better capture investor activities. Clearly, this is a broad generalisation: the BoE also has commercial banks as customers and holds gold on their behalf, while at the same time, it is also possible for central banks to hold gold in other (non-BoE) vaults. To put some context around this, let’s say for illustration’s sake that about 80% to 90% of BoE gold holdings are accounted for by the official sector. Further, for simplicity let’s assume that the vast majority of gold held in commercial vaults is on the back of investor positions and only a negligible amount comprises official sector holdings. This suggests that over the past year, an average of about 2,945 to 3,450 tonnes ($119-$139bn) of investment-related gold was held in London. These inventories would include metal held on behalf of ETFs, which as mentioned above we estimate to be around 1,485 tonnes or about $60bn worth of gold. Taking these ETF-related holdings into account would then leave roughly around 1,460 to 1,965 tonnes or about $59bn to $79bn worth of gold in unallocated and allocated accounts as available pool of liquidity for OTC trading activities. As details on the actual breakdown of gold holdings are not available, all these figures are obviously only presented here for indication. Nevertheless, despite these limitations, the data still somehow supports the broad generalisation on how Loco London gold stocks may be split between official sector and investor holdings. For instance, gold held at the BoE appears to be more stable relative to gold held in other London vaults, such that changes in total Loco London gold over the past nine months have been driven more by changes in non-BoE gold. Arguably, investment-related gold holdings would tend to be more volatile relative to official sector holdings. Central banks hold gold as part of their official reserves, which also serve monetary purposes, and they typically have much longer time horizons.

Finally, comparing total gold holdings data with the UK’s gold trade flows confirms a strong link between the two. This is intuitive in that net inflows of gold into the UK should understandably translate into a build in holdings, while net outflows would suggest a reduction in overall levels. There is a shorter lag in trade data reporting, meaning that trade statistics should help market watchers anticipate changes in Loco- London inventories before getting confirmation a couple months later from the LBMA report.

In addition to UK trade statistics, Swiss data on gold flows from and to the UK is also a useful indicator of how much gold is leaving or entering London vaults. Given Switzerland’s key role in global gold refining, it essentially acts as an important interface between investment demand in Western markets and consumer demand in Asia which means that Swiss gold trade flows tend to hold important insights. Combining Swiss and UK trade data with London vault holdings allows for a more complete picture (see chart 1). For instance, periods of strong physical demand out of key centres such as India and China could mean that large investment bars sitting in London vaults could be shipped to Switzerland to be transformed into kilo bars and eventually sent to physical buyers in Asia to meet consumer demand for gold jewellery and investment products. Net outflows of gold from the UK should coincide with declines in vault holdings in this case. In fact, this scenario occurred back in 2013: as the Fed’s taper tantrum led to a sharp rise in US real rates, gold collapsed by 29% as investors exited gold exposures. In turn, the sharp drop in the gold price made it very attractive for physical buyers, especially in the context of a decade-long bull market. Investor gold positions held in London vaults – whether OTC or ETF-related – were being heavily liquidated. This metal then made its way to Switzerland, was converted into kilo bars, and shipped to Asia to satisfy the surge in demand in China, India as well as other parts of the region.

Interestingly, LBMA data shows that in Q3 last year, the opposite occurred – the UK was a net importer of gold and vault holdings increased. This coincided with weak physical demand for most of last year, which was more than offset by a pick-up in investment interest. Given strong demand from the investor community, gold still managed to rally 8% in 2016 (and as much as 30% from trough to peak) despite the weak fundamental backdrop. Towards the end of the year, market forces became conducive for gold to once again leave London vaults and be shipped out of the UK. Investors unwound positions in anticipation of the Fed rate hike, while at the same time, seasonal and regulatory factors in key markets boosted physical demand, allowing buyers in Asia to absorb the liquidation from Western investors. Demand out of China kicked in heading into year-end in anticipation of the Lunar New Year holidays, while the demonetisation of high-value banknotes in India led to a knee-jerk spike in demand. So far this year, physical markets have been more stable, while investment demand has been positive yet broadly more subdued. As mentioned earlier, the data tends to reflect this, with changes in Loco London gold holdings relatively limited during the first quarter of 2017.

Silver

There’s only one component in the data series that aggregates the amount of silver held in London, unlike gold data where it is possible to split out what is held at the BoE and what is held in other vaults. This is primarily because the BoE does not provide silver custodial services. More broadly, silver tends to be considered a cheaper and more volatile way to get exposure to gold price trends, attributes that are likely more attractive for investors rather than the official sector. Silver holdings increased at a higher rate of 8% or 2,485 tonnes between July 2016 and March 2017 relative to the 2% (166 tonnes) gain in gold. Changes in global ETF holdings shows that silver positions have generally been more stable against gold in recent years. However, our database suggests that silver ETF holdings backed by Loco London metal actually declined by about 3% or 375 tonnes from July 2016 to March 2017. Relative speculative positioning between gold and silver on Comex similarly shows a stronger build in investor positions in silver than gold, at least during the first half of the year (see chart 2). Given silver’s large industrial demand component, it initially attracted some attention on the back of growth and risk optimism amid the reflation theme. This translated into persistent gains in Comex investor positioning, which reached a fresh all-time high in May. Yet as reflation trades were unwound, so did the interest in silver, and Comex positioning has since given back about 81% from the highs. It would therefore be interesting to see Q2 and Q3 data on Loco London silver holdings, to find out whether OTC positions followed a similar trend. Loco London silver holdings could potentially be relatively more robust than what Comex speculative positions imply. Silver ETF holdings have generally been resilient over the past few years, despite heavy liquidations in gold ETFs, which could mean that silver OTC positions could also show a similar sense of stability.

More data, more insights

The provision of information on gold and silver vault holdings brings more transparency to the London precious metals market. It marks the first step and will soon be augmented by trade reporting, which will further enhance the ability of market participants as well as regulators to track and assess market activity. Eventually having access to data on gross turnover for the Loco London market will enable better comparisons with trading activities in other key centres such as New York and Shanghai and allow for a broader and more holistic understanding of the market.

For a keen observer of the precious metals market, these are all very positive developments. Common questions that get asked by clients and other market participants every so often revolve around the level of holdings, the availability of metal or the comparison of physical versus paper trading activities. Up until now, the market has had to rely on third-party estimates of above- ground gold holdings, such as those provided by Thomson Reuters GFMS, the World Gold Council or Metals Focus. While the LBMA has been publishing monthly clearing statistics for many years, this is not the same as trading turnover and the market has had to come up with educated estimates from the data that’s available, including the one-off survey that was done to get a sense of trading volumes in the past. The publication of London vault holdings and the provision of Loco London trade data later on will now enable us to provide more informed responses to these questions.

More broadly, the availability of these statistics should allow for much better insight and analysis of the precious metals markets, which in turn should ultimately contribute to more informed investment decisions.