Zero wedge: Shrinking margins and increased regulation leaves 'restrained optimism' for gold

Another year, another London Bullion Market Association conference, and this year was full of what HSBC senior analyst James Steel described as "restrained optimism." A similar description was given of the recent Denver Gold conference in Colorado Springs, where one fund manager summed the mood up as "veiled optimism." But this didn't stop an air of positivity buzzing on the sidelines of both events, with the mood jubilant, especially in Singapore this week. At least at face value.

Regulation continued to weigh heavy on an industry with ever decreasing margins. As Stuart Murray, non-exec chairman at Sylvania Platinum, bluntly put it: "regulation is killing capitalism."

There was a flurry of news out of the event, mainly linked to the ongoing reformation of the London over-the-counter market.

Things certainly seem to be heating up with the three exchanges currently managing the LBMA prices: the London Metal Exchange, ICE and CME Group.

ICE appeared pretty happy with their announcement that they will be centrally clearing the LBMA Gold Price starting in early 2017, backed by a new futures contract.

This appeared to be going in direct competition with the LME's project, LMEprecious, aimed at driving more business on to an exchange, but allowing for continuity with the OTC market.

CME stayed quiet on the announcement, although many in the know said that they expected the group, which offers the world's number one gold futures contract on COMEX, to launch some gold-related products in the near future.

"Let's not forget with all the buzz around London, CME still operate the number one gold futures contract in the world," said one senior source.

A second source backed this up saying, "COMEX is the go to for liquidity and depth."

In a bid to increase participation of the LBMA Gold Price, administrator ICE Benchmark Administration said that it will be introducing central clearing of the price discovery mechanism in March 2017, backed by a loco London futures contract.

Reaction to the news was somewhat mixed at the LBMA conference, with some seeing the move as way to skirt UK regulation.

In response, LBMA general counsel Sakhila Mirza said that wasn't the case and that the new system is a means to increase participation for users with less access to credit.

A source said that he thinks it’s more to do with the fact that ICE already operates out of the US, and is just easier to set up.

One banker was less than optimistic of any of the exchanges moving the OTC market; “I’ll take a wager they’ll all fail. There’s no incentive for the market to move to exchange, they’ve all tried it before and not been successful, what’s different this time?”

Separately, and in participation with the Singapore Bullion Market Association, IBA and the LBMA are mulling the introduction of a third price discovery mechanism designed for the Asian market.

The joint feasibility study on the development of a 1330 SGT (0530 GMT) 'Pre-AM Gold Price' is "an important first step towards establishing a US dollar price discovery mechanism for gold during Asian hours."

Still, some were cautious of how the market will receive a the new settlement.

"I think there's concern it will cannibalize the AM settlement in London, and that there may not be enough participation to gain traction," said one senior source.

On the subject of price discovery in Asia, a workshop hosted by the China Gold & Silver Exchange Society and SBMA, participants talked of how Asia should be the price maker rather than a price taker.

The region needs to develop partnerships to assume its "rightful role as the price maker in the global market," a CGSE representative said.

However, let’s not forget, this has been a theme for many years at LBMA conferences and meetings.

Then we had the mounting headache of proposed 'net stable fund requirement' regulation penciled for launch early 2018.

Speaking at a round table, Asahi Refining President Grant Angwin said the new regulation, could have a potentially devastating knock-on for the business, as money loaned from banks became increasingly expensive.

"Imagine if I have three lines of credit with three separate banks, for $200 million per bank. Then two banks step away, the third bank can't just increase the credit to $600 million," he told S&P Global Platts.

As The Barrel has previously said, the industry could be in for a wake-up call and a further liquidity squeeze, when potential new NSFR rules are passed. The requirements are being promoted by the European Commission.

"This is going to be really bad for the market and will hit hard. More should have been done earlier in regards of lobbying for change," a second refiner said on the sidelines of the conference.

"The banks certainly aren't going to bear the additional costs," the refiner said.

Speaking on a separate panel, LBMA's Mirza said that NSFR would likely mean more banks leaving the business and as such "costs will significantly increase...this will effect everyone [involved in the bullion business]."

Still, at  the round-up session, John Reade, strategist at gold fund Paulson, said that regardless of all the conversations; "I'm still no clearer on how NSFR will effect the refiners."

It's likely this confusion that is leading to an air of panic across the value chain. “And rightly so too,” said one senior bullion banker.

Sylvania Platinum’s Murray summed regulation up from one of his own conversations at the event; "you can't make a baby while wearing a condom," he said of the impact of overzealous regulation of the market.

Getting back to the more positive stuff.

Wolfgang Wrzesniok, CEO of high-end gold retailer Degussa, told Platts that he thinks the conference has changed over the years, and is now much more physical in nature.

"There are a lot less banks, more logistics and mints. I think the attendance has changed a lot over the years," he said.

He said that from a business perspective he remains bullish on the outlook for gold, as the company plans to open more shops across Germany.

Wrzesniok added that the expansion wouldn't see large shops opening, rather smaller operations in smaller cities. There are no plans for anymore international offices for the time being; with a branch in London, Madrid, Zurich, Geneva and Singapore.

And, with less banks in the fray new opportunities are opening; for certain refiners and brokers.

INTL FCStone's precious metals division is launching PMXecute+, an online trading platform connecting consumers and suppliers of physical gold globally, the US financial services group said during the conference.

PMXecute+ provides customers with free, direct and real-time access to INTL FCStone's inventory across the world, as well as all product offered through its global network of supply partners.

The broker is in a prime position to lap up the business that the banks are leaving alone; either because of compliance issues or margins being too slim, or the fact there are just less banks.

"We developed PMXecute+ to become the physical platform of choice for the global bullion market," said Barry Canham, the company's global head of precious metals

Then there was the rather unique Perth Mint, the only operation seemingly shielded from the threat of over-regulation.

CEO Richard Hayes said his company was working with small-to-medium-sized miners to create "a one stop shop" for financing. He did caution however that as refiners become more involved in the financing of the business regulators' attention would turn to them.

Moderator Courtney Lynne, vice president, investor relations and treasurer at the world's largest primary silver producer, Coeur, questioned whether refiners had the ability to fill the liquidity gap.

Hayes said that as long as there was some margin to be made then there would always be a group of banks to service those requirements.

On the sidelines bankers said Perth Mint was an exception because it is fully backed by the Western Australia state government. Hayes agreed: "[We're] a standout, owing to our credit lines. Peers may be effected by banks exiting."

The bullion world is changing. That's one certainty. And for the time being that could bring fragmentation and confusion.

Still, as one senior exchange source said, "we love fragmentation."

Let's wait and see if the struggling end-users agree.