The Gold Market, Futures, and COVID Contango

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What Is Going On With The Gold Market?

The coronavirus pandemic effectively crippled the global economy. Oil suffers, economists are uncertain of the strength of the US dollar, and the gold market sees high demand and short supply in most places. The future of the US dollar and economic fallout from COVID-19 has led many investors to buy gold to hedge their assets. Let’s take a look at the current state of the gold market internationally.

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Gold And The World Market

Sunday, April 3rd, 2020 was the Indian holiday of Akshaya Tritiya, a festival celebrating wealth and prosperity. What is important about this holiday for the gold market is that people tend to celebrate by purchasing gold as gifts. In comparison to last year’s holiday, gold prices are about 43% higher than they were in 2019 in rupees. The India Bullion and Jewellers Association (IBJA) concluded that about 23 tons of gold were sold last year around Akshaya Tritiya.

Despite the holiday, India’s demand remains subdued. This is important because if China and India have low demand, the dollar will strengthen. Thus, the market can decrease in volatility and the gold price lessens. However, in the rest of the world, gold demand is high. Therefore, the price of gold remains high.

Furthermore, Venezuela apparently is paying Iran hundreds of millions of dollars in gold bars to help its crippled gasoline refineries. Oil is Venezuela’s main source of revenue, and because of the sharp decline of oil demand, its economy is suffering. This deal provides both Iran with more revenue, and it also means Venezuela’s oil supply doesn’t run out.

U.S. Gold Market

Given current circumstances globally with the COVID-19 pandemic, quarantines created a worldwide limitation on the economy. This includes limiting the transportation of gold resources and temporary shutdowns of precious metals refiners and mints. Therefore, as a result, there's a shortage of gold in the physical marketplace, creating what is known as contango.

Contango means that the price for commodities for future delivery contracts is much higher than the spot gold market price. Normally gold is transported for trade through passenger planes. Now that travel has been limited or altogether stopped, London’s spot prices and NY Comex gold futures have a large price difference. Despite shortages, COMEX demands for futures contracts remain high as investors fear for the strength of the dollar.

In the past, the COMEX only accepted 100 oz gold bars to be considered good for delivery. Since the high demand and shortage of supply from not being able to get bars from Swiss refiners, COMEX had to change its rules. Now, COMEX uses 400 oz and 1-kilo bars to meet contracts. This way, they can tap into the London Bullion Market Association (LMBA) to have supply and fulfil deliveries. The Perth Mint, one of the largest mints in the world, can also now contribute to this shortage as well and is currently producing 1-kilo bars for NY Comex.

Why Is There A Gap Between Futures And The Gold Spot Price Today?

So, how did contango happen? When bullion banks feared not being able to deliver gold to Comex on short contracts, they had to buy long futures. This helped protect themselves from not being able to deliver the physical supply. Also, sourcing small bars to meet deliveries is difficult with COVID-19 quarantines. COMEX, in response to the low supply, wanted to close short positions by buying up longs. This led to the NY price to spike, thus establishing the spread between spot and futures: contango.

There is usually a difference between Comex Futures and the London spot market, but that spread is historically around $1.50. In March, the spread reached a $60 difference, meaning premiums were much higher. The usual way to close the spread is for bullion banks to buy up London spot and sell NY futures. This time, it is too risky for the banks because they are not sure if they can deliver on futures since transportation of physical supply is limited.

We anticipate demand to continue to be strong given the macroeconomic stances of global economies. This is especially true if there is a second wave of COVID-19, resulting in longer shutdowns. Refiners and mints are still working in a limited capacity, which strains the current supply. Therefore this still creates a divergence between spot and physical gold markets that will probably continue for the next few months.

Even though refineries reopened, the gap persists. So, COMEX changed its rules about only using 100 oz and 1-kilo bars to meet deliveries. Larger refiners in the world, such as the Perth Mint, stepped in to help produce kilo and gold delivery bars to meet COMEX's shortage.

What Is Going To Happen To The Us Economy?

ETFs saw a record-breaking volume in the first quarter, mostly with the GLD ETF. We anticipate the 2nd Quarter to break records again due to coronavirus fears and countries continuing to print money to subdue global slowdowns and recessions.

Historically, gold does well as the US dollar depreciates. So, gold and the dollar have what is called an inverse relationship. In 2019, this relationship did not appear inverse. Both the US Dollar and gold increased in strength. With the virus in 2020, this relationship may change again. There are multiple concerns for how the US dollar will fare, and where gold will go.

Inflation And Deflation

Because the US is pumping the economy full of money, there are simultaneous fears about inflation and deflation. Inflation occurs when there is too much money in circulation, and deflation occurs when there isn’t enough money in circulation. For the past four decades, the US dealt with falling rates of inflation, pushing bond yields to record lows.

Now that the Federal Reserve is printing more money in federal aid to combat deflation, economists are uncertain of the long term effects of inflation. The last time deflation happened to this extent was during the Great Depression. If there is a second wave of COVID-19, economists are uncertain of the full extent of the economic ramifications to occur six months or even a year down the line.

Gold Price

Investors now place their faith in gold as a result. Bank of America also boosted its 18-month gold price target to $3,000/oz, which is more than 50% above the gold price right now. This leads economists to analyze the future weakness of the US dollar. While that is good for gold and silver, the Federal Reserve simply cannot print gold. So, everyone flocks to precious metals before it gets too expensive to purchase.

Disclaimer. This article is not meant to serve as professional economic advice. Any action you take upon the information from this article and website is strictly at your own risk.

About Eric Gozenput

Eric Gozenput founded Bullion Exchanges at the age of 27 and has been featured in places such as Fox Business News, Forbes, Reuters, Seeking Alpha, Value Walk. Eric maintains that precious metals are vital for investment portfolios and that investing in precious metals should be convenient, transparent, and secure. Before beginning his business in 2012, he began his career at Merrill Lynch as a Financial Advisor, then transitioned into working at a Hedge Fund as an International Trader for six years. Today, Bullion Exchanges has grown to become one of the largest precious metals dealers in the world that buys and sells physical precious metals and numismatic coins online and in-person at our location in the Diamond District of NYC.