How the “Safe Heaven” Physical Gold behaves during the “Hell” Crisis?

ArticleChange of moneyMay 21, 2020 - 8:11:18 AM

In the light of the Covid-19 situation, it became really interesting to study how Gold Investment is reacting in its best element: A global crisis.

Singapore Mid-April on the Evening – Covid-19 Situation

Hi, Christophe, how are you today? Tell me, do you have gold to sell?”

This is how started the conversation with one of my business contacts based in Switzerland. Actually, I was perplexed and in shock. Why is someone based in Switzerland calling me in Singapore to buy gold? Seemed weird, above all, when you know that the Helvetica country “produces” 70% of the world physical gold and the financial price of the gold is directly linked to its well-known LBMA refineries (Metalor, Argor-Heraeus, Valcambi…).

My first reaction was about the gold itself: “How it is possible not to find gold in a key gold country?

Then about the prices: “Why didn’t we see a strong gold prices surge in the market?

And finally, for the investor: “How will he be impacted?

Usually, wise words recommend to invest in gold (10% of its assets) in order to get prepared for big economic crisis or even the coming doomNormally, gold shipment days. So, in the light of the Covid-19 situation it became really interesting to study how the “safe haven” investment is reacting in its best element: a global crisis.

Thus, here are the parameters of what many used to call “hypothetic” or “alarmist” scenario:

The world experiences a huge crisis because of a major deadly virus. All countries have closed their borders. Most businesses are shutting down to avoid the spread of the pandemic. Unemployment is on a rise. The stock market is crashing. And, even if governments try to save the economy by printing huge amounts of money, the social, monetary, and economic crisis is hitting the society with full force. So, how will safe investment concretely react when you need it? What will happen?

This text will be divided in 3 brief articles:
First article will review the access to the gold, the second one will focus on the price issues and the last one will study the impact for investors.

Will we be able to access the Gold?

The logical answer for my contact regarding the inability to find gold in Switzerland was the closure of the borders and the lockdown of the country including the refineries. But this is just a glimpse of the answer. So, let’s breakdown the supply chain process.

The supply chain is the primordial element to get access to the gold. But it is interesting to notice that under stress, this chain can hardly face the circumstances.

The Production of the Gold

Surprisingly, this part of the process was not directly affected by the lockdown. Indeed, most of the mining companies managed to quarantine the site with the miners inside to isolate them from the virus, and hence, ensured that the production continues effectively. Thus, although some adjustments were required, the production itself was not so much affected.

Instead, the way mines get funded has become a real issue cutting down the production, especially for junior mines.
This point will be developed in the second article in relation to the price.

The Collection of the Gold

Here it is more complicated.

of the gold is collected by armed security logistic companies. But during a pandemic, for “safe distancing measures”, many securities companies had to reduce the number of people working in the same place as the guards required to convey a truck with gold, for example. This meant they simply could not go and collect the metal.

Besides, a significant amount of the world’s gold production comes from notorious and dangerous zones such as South Africa or Central/South America (Mexico, Colombia..). Thus, with less working staff available, the secured logistic transports refuse to collect the physical gold in order to avoid becoming an easier target for criminals. Also, their insurance may not cover them in case of problems.

The alternative is usually to use a helicopter/private jet to go to the mine to collect the gold, but this is very expensive and the rotation cannot be as often as the automotive way. Since it’s expensive, only big major mines can afford this kind of transport unlike medium and small mines. Worst, major mines will refuse medium and small mines to share the planes.

Therefore, a significant part of the gold cannot be transported to refineries!

Hence, here is the first issue: the gold cannot be collected normally.

The Shipment to the Refinery

Then comes the shipment to the refinery (in Switzerland).

Normally, gold shipment relies on aircraft via major commercial airlines companies offering cargo service. But when these commercial airlines reduced their flights drastically, the logistic companies could no longer ship their valuable goods.

Another issue is many airlines are only operating cargo service during this time. But the safety carrier companies were relying solely on commercial flights and did not have a contract with cargo airlines. Signing up contracts with these cargo companies could take time, and hence, brokers/logistic carriers got stuck with commercial airplanes.

Without saying that in times of sanitary crisis, the cargo planes will prioritize health supply (masks, oxygen bottles…) even if the place (ratio volume/weight) taken by these goods is not so high.

This bring us to another issue : Logistic carriers rely essentially on commercial airlines and even if they managed to get a cargo airline, they might not be given priority over health supplies.

Regarding the supply chain, this was (and still is) the global situation:

  • Within American Continent: Good Logistic conditions;
  • Within European Continent: “Big Mess” (Eg:7 days to transport gold from Brussel to Paris);
  • Between Africa and Europe: Difficult Logistic conditions
  • Between Europe and USA: Difficult Logistic conditions
  • Between Europe and Asia: Extremely Difficult Logistic conditions (flight/cargo fly almost exclusively to China and not the main financial spot like Hong Kong or Singapore).
  • The Refinery

    As mentioned above, 70% of the world gold production is refined in Switzerland, so when the lockdown started in Switzerland, the world experienced a shortage of gold. This was due to the fact that the refineries were either closed or (working at 30% at their best) and the supply of gold was disrupted.

    But another element came into the picture: The fall of paper gold.

    Because of the crisis, many of the clients we used to buy paper gold (contracts where you pay gold now for a future physical delivery) wanted their physical gold. Usually at the end of the contract (maturity) investors do not take the physical delivery; instead just rollover into a new contract.

    Betting on the fact that people will not physically take the delivery of gold, financial institutions and banks generally issue more contracts than the volume of physical gold they hold, per investor. Now that the investors demanded delivery of their physical gold as per contract, the problem started. Banks failed to deliver on their obligation.

    Citing an example, the world’s biggest marketplace for paper gold, Comex, based in New York, experienced this problem. Customers wanted to collect their bars physically at the end of the contracts, but there were not enough bars for the clients!

    In order to save its marketplace, Comex came to the major player in the physical gold market: LBMA (London Bullion Market Association).

    The problem is that Comex’s delivery standards used to be 100 ounces (3kg), whereas a significant part of LBMA gold bars are in 400 ounces (12kg). In that way, refineries had to recast 400 ounces bars into 100 ounces in order to send them to Comex. It is a lot of work and takes time.

    Thus, you had a huge inflow of banks' gold bars, using the productive capacity of shortened staff refineries. But, this gold is not for the true dealer of physical gold like the bullion dealer but the ones who bought paper gold initially.

    FYI : Comex now accepts LBMA 400 ounces gold bars now… But no one wants it.

    Of course, each country, mine, logistics transport is different and deal with different issues.
    But here are some of the main reasons why the gold can be difficult to get in times of crisis. Ironically, while the production may continue normally, the different supply chain players are not fully ready to face a crisis situation. And something even more worrying is that, although investors buying physical gold try to stay away from the paper gold market, this fictitious paper gold market manages to compromise the normal process of the physical market.

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