Investors have been piling into gold this year in order to hedge against the rapid spread of coronavirus which has wreaked havoc on the global economy.
ETPs have been the vehicle of choice with gold-backed ETPs seeing record inflows of $8.1bn last month, according to the World Gold Council.
Despite the flows however, investors trading the precious metal towards the end of March would have found themselves paying far more than usual as bid-ask spreads blew out to record-wide levels.
Highlighting this, Europe’s cheapest gold ETP, the $2.5bn Amundi Physical Gold ETC (GOLD) saw its spreads widen to 1.01% on 24 March while the spreads on the $8bn WisdomTree Physical Gold ETC widened to 0.82% on the same day.
Usually, gold ETPs trade at 0.02%-0.03% spreads in line with the spot price spreads, however, a dislocation in the Exchange of Futures for Physical (EFP) market drove the ETF spreads to levels not seen before in the gold market. The EFP market allows traders to switch to and from futures and spot positions.
On 24 March, after the Federal Reserve announced its "unlimited" quantitative easing measures, spot prices traded well below the futures market as traders expressed concern about the ability to deliver the gold amid restrictions on travel due to the coronavirus.
According to Jim Goldie, head of capital markets, EMEA, at Invesco, the futures market, which is based in New York, was trading at an $80 premium to London spot prices despite prices normally trading within a few dollars of each other.
These spreads between the spot gold and futures market were “unprecedented”, he added.
For the futures contracts to be delivered, the gold needs to be melted down from the 400 ounce bars used in London and remade as 100 ounce bars for the Comex futures exchange in New York. This process was affected after three major refineries based in Switzerland closed due to the lockdown.
“As commercial airlines were not flying, the gold could not deliver into the futures contracts,” Goldie explained.
This dislocation between futures and spot prices also increased the cost for market makers to hedge their risk when trading which added to the widening spreads.
Somewhat interesting, it was only the European-domiciled gold ETCs that saw their spreads widen. For example, the spreads on the SPDR Gold Shares ETF (GLD) were on average 0.03% on 24 March.
Andrew Limberis, investment manager at Omba Advisory & Investments, said the refinery closures combined with the UK announcing lockdown measures “certainly contributed” to this.
“Unexpected demand may also make it difficult for market makers to provide the necessary liquidity if they are not carrying the necessary inventory and if there is disruption in the underlying market,” Limberis added.
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