A Guide to the Loco London Precious Metals Market
13. Futures Markets and Exchange Traded Products
While this Guide is concerned with the operation of the global Over The Counter trading of precious metals markets, it would be remiss to ignore other methods by which investors look to gain exposure to precious metals and how they relate to the OTC market.
Precious metals trade on a large number of futures exchanges around the world. As mentioned earlier in this Guide, in an exchange-traded environment, transactions will be for standard quantities (or their multiples), purities and for delivery on set dates. However, in the OTC market, a dealer will provide a tailor-made service – offering quotes for variable quantities, qualities and types of precious metal, as well as for various value dates and delivery locations. Thus, OTC markets offer far greater flexibility for clients compared to a futures exchange that operates within standardised parameters.
While there are different delivery locations and dates, and contract specifications (potentially including metal purity and bar size) between the OTC market and the various futures exchanges, it is often possible to switch positions between the two relatively simply. However, this comes with the important proviso that it will depend on applicable laws and the requirements of the various exchanges themselves.
The mechanism for switching a position in gold from/to a futures exchange (CMEs Globex, for example) to/from Loco London OTC gold would be an Exchange For Physical trade – less commonly called an Exchange Futures for Physical trade. However, in both cases, the acronym is simply EFP.
The calculation of the EFP – differential between an OTC spot transaction and a longer-dated futures contract – will vary depending on a number of factors:
- The number of days between spot delivery and futures delivery
- The level of currency and metal interest rates
- The ease, cost and time taken to transport metals between London and the requisite futures location
- The cost of exchanging 995 London Good Delivery Gold to the requisite futures exchange purity and bar size.
- Having bars created by refiners that are on the Good Delivery Lists of the LBMA (or LPPM) or the relevant futures exchange
- Complying with relevant laws and any taxes
Of course, not all futures exchanges quote the precious metals in terms of US dollars. Therefore, there may also be currency exchange rates to take into account.
Looking down from the podium onto the NYSE trading floor as the LBMA Executive and guests prepare to ring the closing bell
Exchange Traded Products
More commonly referred to simply as Exchange Traded Funds (ETFs); however, Exchange Traded Products (ETPs) is the wider nomenclature.
These were launched into the precious metal investor community in 2004 and rapidly rose to become one of the largest vehicles for gold ownership, in particular addressing a need for investors who were only allowed to invest in equities but who wanted exposure to gold directly rather than having to invest via mining shares. Thus, the ETFs have given them a vehicle to take a view on precious metal prices without having to analyse the geology of a particular mine, the state of labour relations, the particular political circumstances of where the metal is mined, the expertise of senior management at a mining company and so on.
Following the rapid success of the gold ETFs, the market has launched ETFs in silver, platinum and palladium. The success of these initial funds spawned a large number of variations from the original allocated Loco London. However, those that have achieved some sort of momentum are almost exclusively backed by allocated metal in London or Zurich.
As in the EFPs and the futures market, it is possible to swap positions between an OTC Loco London position and an ETP. Once again, this will depend on the various laws, taxes and the requirements of the various stock exchanges regarding purity, location, bar size and so on. However, there is an added issue. In general, the majority of commercial banks will trade OTC and metal futures via the same legal entity. However, for a significant number of institutions transacting the equivalent of EFPs between the OTC and equity markets (where the ETFs are generally traded) is not possible – primarily because they trade equities and metals under different legal entities and the cost of regulatory capital in trying to hold an equity position in a commodities trading unit (or vice versa) might either be extremely expensive or forbidden under the regulations.
However, there are still sufficient institutions that can arbitrage any market anomalies to ensure that both the main traded ETFs and futures exchanges do not get out of line for any extended period with the global OTC market.
12. Bank of England
The Bank of England has been the focal point of gold trading in London for much of the last three hundred years and traces its involvement back to the earliest days of the London market