Gold squeeze continues.
Pressure on the OTC market in London from demand for physical metal in New York is beginning to show signs of spilling over into gold option pricing.
Increased economic uncertainty and uncertainty around the potential for disruption owing to President Trump’s tariff policy is leading to a significant dislocation in the COMEX futures and London gold markets.
Gold is flowing to New York in large size to meet this demand.
The Loco London market is facing a squeeze with lending rates rising and concerns about liquidity.
This is beginning to make its presence felt in the gold options market, but option pricing suggests little sign of stress, yet.
Focus within the gold market remains squarely on developments in the COMEX futures market and its repercussions elsewhere, notably in the Loco London market (which encompasses gold bullion meeting LBMA Good Delivery standards, held in LBMA approved storage vaults inside the M25).
Concerns about the potential for gold to be captured within President Trump’s tariff net, coupled with increasing economic uncertainty, has prompted a steady increase in net open positions in the 100oz futures contract trading on COMEX. Additionally, there has been a surge in January of gold delivery notices to COMEX demanding physical settlement. This demand for physical gold has pushed the price of gold trading on COMEX into significant premium relative to the LBMA spot price and appears to have been exacerbated by traders closing out short exposures. In January, the spread between the front-month futures price on COMEX and the LBMA spot price averaged USD 12.33/oz, up from just USD 1.90/oz in December, with a high recorded at USD 37.57/oz on the 20th of January.
As futures clients are requesting physical delivery, it’s leading to a scramble by bullion banks to obtain the gold necessary to settle contracts, leading to a surge in inventory held in COMEX approved vaults.
The rise in the price of gold on COMEX is squeezing short positions on the exchange and encouraging bullion banks to transfer gold from elsewhere – primarily London – to New York, to meet this demand. The surge in demand from New York for physical metal has pushed up one-month lease costs to 3.25% last week, from just 0.08% on the 2nd of January.
The surge in demand is also placing pressure on the Bank of England, who are struggling to keep pace with demand to withdraw gold to fill lease contracts. Anecdotal reports suggest customers are experiencing up to four weeks, or longer, delays to withdraw the metal and it appears physical demand has also tightened gold availability in other gold centers, notably Switzerland, Dubai, Hong Kong, and Singapore.
While COMEX provides a great deal of transparency about customer flows, positioning, and inventory, the London market is somewhat opaque owing to the nature of Central Bank holdings and over-the-counter market activity. While Central Banks have a reporting requirement as part of the IMF’s Articles of Association, they don’t need to disclose in real time, nor their investment location. Meanwhile, over-the-counter exposures are often complex and constantly evolving although this is at least partially captured by LBMA reported transactions.
The LBMA report total gold held in the Loco London market was 8,686.1t as of 31 December 2024. However, 5,365.4 tonnes of this are held by the Bank of England, almost all of which is likely to be on custody for other Central Banks. Consequently, there were 3,320.7t of gold held in private vaults, although again it is likely that much of this is allocated (e.g. earmarked to an owner) with a significant portion of this likely held against gold-backed ETFs. Given the size of the over-the-counter gold market, it is likely that there is in fact very little unallocated gold in London at present, and there is considerable concern about the possibility of re-hypothecation, which could be simply described as a bank selling the same rock twice (or more); essentially like banks holding a float.
So, while US investors continue to demand physical gold in large size, it’s likely that pressure will remain on the market with potential for further significant dislocation.
If the experience of the silver market in 2021 is anything to go by, it’s entirely plausible we see physical gold trading at a premium to paper, with both under significant upward price pressure.
At this point, I’m also keeping a close eye on gold option implied volatility and gold option skew. In the past few days, we’ve seen a lift in implied volatility, and a lift in option skew, suggesting investors are beginning to turn to the options market to hedge risk exposures.
Gold option volatility has lifted across all tenors out to one year, although they remain well below their past twelve month peak.
Gold option skew has tilted further in favor of gold call options, with one-month 25-delta risk reversal skew moving up from around -0.20% prior to Christmas to around 1% on Friday, suggesting increased demand for gold call options across all tenors out to twelve months. Although, again, option skew remains low relative to its past twelve month peak.
The lift in implied volatility and skew has raised the price of buying a one month 25-delta call option, but it remains well below peaks observed in the past two years, suggesting ample scope for pressure in the COMEX and Loco London markets to spill-over into demand for gold call options.
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