Your Offshore Guide
Offshore Guide
Gold Trading HK
THE LOCO LONDON GOLD MARKET
The trading of gold in the London market has a long history of three centuries but Gold Fixing was only formalized after the first World War in 1919. The system of Fixing originated from the London silver market and the concept is to provide market users throughout the world with the opportunity to buy and sell gold at a single quoted price. The Fixings take place twice daily at 10:30 and 15:00 hours in the City of London with the participation of the following five Fixing Members:
Deutsche Bank Sharps Pixley
Midland Bank PLC(HSBC)
N. M. Rothschild & Sons Limited
Republic National Bank of New York
Standard Chartered Bank, Mocatta Group
The procedure of the Fixing is described by the London Bullion Market Association (LBMA) as follows:
"Each member of the Fixing sends a representative who maintains telephone contact with his dealing room. The Chairman of the Fixing, traditionally the representative of N. M. Rothschild & Sons Limited, announces an opening price which is reported back to the dealing rooms. They in turn relay this price to their customers, and, on the basis of orders received, instruct their representative to declare as a buyer or seller. Provided both buying and selling interests are declared, members are then asked to state the number of bars in which they wish to trade.
"If at the opening price there is either no buying or no selling, or if the size for the buying and selling does not balance, the same procedure is followed again at higher or lower prices until a balance is achieved. At this moment the Chairman announces that the price is `Fixed'. Exceptionally a pro-rata settlement may be necessary.
"A feature of the London Fixing is that customers may be kept advised of price changes throughout a Fixing meeting, and may alter their instructions at any time until the price is Fixed. To ensure that a member can communicate such alteration, his representative has a small flag which he raises and, as long as any flag is raised, the Chairman may not declare the price fixed."
Before and after each of the Fixings, there is an active principal trading market in loco London gold. Two-way buy-sell prices are quoted by market-makers in London and in major markets outside London. This system enables the continual trading of loco London gold round-the-clock on a worldwide basis. In view of this market development, the LBMA was incorporated in 1987 under the supervision of the Bank of England.
The unit of loco London gold trading is a bar weighing approximately 400 ounces troy conforming to Good Delivery Specifications. The gold content of each bar must be within 350 to 430 fine ounces and the weight must be expressed in ounces troy in multiples of 0.025 of an ounce. Each bar must be marked with a serial number, the fineness and the stamp of an acceptable melter and assayer (about 50 in the world).
The minimum fineness is 995 parts per 1000 fine gold and gold said to be 1000 fine is marked down to 999.9 fine. The following fine gold contents of other bar weights are accepted by the LBMA. These bars are available at the spot loco London price plus a premium which varies dependent on prevailing market conditions in different locations.
The loco London gold trading system was introduced to Hong Kong immediately after the gold market was liberalized in 1974. It is a spot market with the clearing of metal in London and payment of US dollars in New York two business days after the conclusion of a deal. Notwithstanding that the loco London gold market is a spot market, settlement can be deferred by making special credit facilities available to clients. These facilities normally involve the lending of gold and dollars, initial margins and variation margins, similar to the practice for gold futures trading. The development of this mechanism led to the formation of a secondary deferred settlement market, as distinct from an inter-bank spot market, in which traders, manufacturers and producers in the world take part.
Should the price of gold advance to US$400 an ounce, for instance, the profit margin for some of the mining companies would be higher than the normal level. Under these circumstances, producers would be inclined to lock in the profit for a portion of their future mine production by selling a fixed amount of gold at the spot price.
A producer can, for example, sell 50,000 ounces of gold in the loco London gold deferred settlement market at US$400 an ounce to hedge against 20% of his production for the next 12 months. After the required facilities and documentation have been established with a bullion bank, the structure of the deal is that 50,000 ounces of gold would be leased to the producer and debited to his Metal Account. Gold interest at prevailing market rate would be debited to his Metal Account effective from the value date of the deal. Simultaneously, 50,000 ounces of gold would be sold on behalf of the producer at US$400 an ounce and the proceeds of US$20,000,000 and the interest at libid minus charges would be credited to his Dollar Account.
The producer can carry forward the deal until the quantity of gold is produced and delivered to the bank to unwind the deal. Alternatively, should the market price decline to a lower level, say US$370 an ounce, after conclusion of the deal and before delivery of the metal is effected, the producer can buy back from the bank 50,000 ounces of gold sold previously at US$400 an ounce to realise a profit of US$1,500,000 (SO,OOG x 30).
Under the market practice and depending on the credit standing of the producer, a fixed amount of initial margin has to be deposited with the bank to cover the deferred settlement facility. Furthermore, should the market price move against the open position, the producer will be asked to make an extra deposit (variation margin) to maintain the original level of the initial margin. Similar types of deals can be undertaken by professional traders and individual speculators who are keen to take a view of the market.
When the price of gold dropped to US$372 an ounce on 3rd January 1995, a number of Asian traders and speculators bought the metal as they anticipated that the market would turn at this price level. The strong physical offtake in Asia at around US$370 an ounce experienced on previous occasions provided them with confidence. A trader could have bought, for example, 10,000 ounces loco London gold on 3rd January 1995 on deferred settlement basis and sold the same quantity when the price rose to US$388 an ounce on 10th March 1995. The accounting procedures would be as follows:
1. On 5th January 1995 (the value date of the buy order) the total value of the deal of US$3,720,000 (372 x 10,000) was debited to his Dollar Account.
2. Effective 5th January 1995, interest at Libor plus charges was debited to his Dollar Account daily.
3. On 14th March 1995 (the value date of the sell order), the total value of the deal of US$3,880,000 (388 x 10,000) was credited to his Dollar Account.
Assuming that the total interest covering the deferred settlement period amounted to US$40,000, the realized profit for the deal would be US$120,000 being the dealing profit of US$160,000 (3,880,000 - 3,720,000) minus the interest charge incurred.
On the other hand, the trader would lose money if the price of gold declined after 3rd January 1995. Furthermore, should the initial margin drop below the original level due to adverse price movements, variation margin would be called. If the respective amount was not deposited, the outstanding position would be closed and any loss incurred would be carried by the trader. These conditions are stipulated in the agreement which the customer would be asked to sign before any trading would commence.
The loco London gold market runs in parallel to the Exchange and in view of the different trading unit, price denomination, fineness of tael gold bars and interest payment system, arbitrage opportunities are available at times. The position can be set up by buying loco London gold and selling simultaneously an equivalent amount of tael gold in the Exchange (bear arbitrage) or vice versa (bull arbitrage). Given below is the formula to calculate the premium of tael gold over the level of loco London gold price:
Assumption :
Tael Gold Price : HK$3,495 per tael
Loco London Gold Price : US$378 per troy oz
US$/HK$ TT : US$1 = HK$7.7250
Tael Premium = (3,495 ÷ 1.20337÷0.99 ÷ 7.7250) - 378
= 379.80 - 378.00
= US$1.80 per troy ounce
The normal practice is to undertake deals for 1,700 taels against 2,000 troy ounces each. Under the above assumptions, the unrealized book profit for setting up the bear arbitrage by selling tael gold (1,700 taels @HK$3,495) and buying loco London gold (2,000 ounces @US$378) is US$3,600(2,000 x 1.80). At this point, there is an open foreign exchange position which should be covered. The total value of US$756,000 (2,000 x 378) covering the deal should be bought for payment to the gold seller. The HK$ equivalent value of HK$5,840,100 (756,000 x 7.7250) can be borrowed from the Bank.
Having concluded the first part of the arbitrage deal as described above, the remaining variables are spot tael gold prices (at premium or discount to loco London gold), carried over charges (contango or backwardation) and money cost (HK$ overnight lending or borrowing rates). The following are the factors which determine the actual profit or loss.
Firstly, tael gold should normally be traded at a premium above loco London gold and the amount should be equivalent to the freight, insurance and manufacturing charges (CIF premium) for delivering tael bars to the Exchange. However, the premium fluctuates largely in accordance with the open interest of the Exchange and prevailing sentiment of the investors. On certain occasions, tael gold is traded at discount to loco London gold.
In the case of the example given earlier, should the premium of US$1.80 decline to US$0.50 an ounce, for instance, thearbitrageur can take advantage of the situation and reverse the deal. This means that he would buy back 1,700 taels of tael gold and sell 2,000 ounces of loco London gold to realize a total profit of US$2,600 (2,000 x 1.80 - 2,000 x 0.5) plus or minus interest charges.
Should the premium continue to advance and exceed US$1.80 per ounce, the arbitrageur can take delivery of the 2,000 ounces of loco London gold purchased and make arrangement for the large standard bars to be transformed into tael bars. The transformation charge fluctuates normally between US$1.00 to US$1.50 per ounce dependent on the prevailing supply and demand. The tael bars can then be delivered to the Exchange to unwind the arbitrage with a profit of US$0.30 to US$0.80 per ounce. The essence of the operation is to avoid building up a bear arbitrage position when the tael premium is below the transformation charge.
On the other hand, bull arbitrage deals can be undertaken on the same principle when tael gold is available at discount to loco London gold. Should the discount exceed the CIF premium substantially, tael bars can be bought and converted into Good Delivery standard large bars for delivery to the London Gold Market to unwind the deal.
Secondly, the Carried Over Charge (COC) rate should normally be negative (i.e. sellers receive COC from thosebuyers who do not have sufficient funds to pay for the purchase) and should be equivalent to the overnight cost of HK$. However, the contango and backwardation rates exceed the normal limit sometimes and adversely affect the profit of the arbitrage. Should this be the case, delivery of the tael bars sold should be effected to unwind the deal.Thirdly, when there is a shortage of tael bars, positive COC rate (contango) would apply. This means that the bull arbitrageur receives interest on the HK$ deposit plus the COC covering the long position in the Exchange. On the other hand, the bear arbitrageur has to pay both the interest for the borrowing of HK$ and the COC for the short position of tael gold. Under these circumstances, the bear arbitrageur should arrange for the delivery of tael bars to the Exchange to unwind the deal.
Another type of facility available in the loco London market is the gold loan. The tenor of the loan varies depending on individual requirements of the borrowers. Interest charge is based on the spot gold market value and the prevailing gold interest rate on the drawdown date. This facility is widely utilized by local jewellery manufacturers in Hong Kong as a hedging and financing instrument.
For example, a manufacturer is required to keep constantly 1,000 ounces of finished articles in stocks for sale to his customers. Subject to satisfactory negotiation, he can make an arrangement with a bullion bank to borrow 1,000 ounces of gold monthly for this purpose. Assuming that the spot gold price is US$385 an ounce and the gold interest rate is 3.50% per annum, the interest calculation is illustrated below:
Tenor : 1 month (30 days)
Quantity : 1,000 troy ounces
Spot Gold Interest : 3.5% per annum
Spot Gold Price : US$385 per troy ounce
Loan Interest (1,000 x 385 x 0.035 x 30 )÷360
= US$1,122.90
The total interest charge of US$1,122.90 is payable on the maturity date of the loan when the full quantity of the gold is returned to the lender. The loan can also be rolled over for another period subject to the negotiation between the lender and borrower.
Credit terms governing gold borrowing facilities are comparable with those covering bank loans. Normally, securities in various acceptable forms are pledged to the lender if cash payment of the initial margin is not made by the borrower.
The worldwide contraction of the bullion industry in the past 10 years has greatly reduced the number of participants in the market. Currently, the active foreign institutions engaged in loco London gold trading in Hong Kong include AIG, Barclays Bank, Credit Suisse, Deutsche Bank, Republic National Bank of New York, Smith Barney, Standard Chartered Bank - The Mocatta Group, Standard Bank of London, Rothschild, Swiss Bank Corporation and Union Bank of Switzerland. The volume of business has also declined and existing turnover is in the region of 1,000,000 ounces daily.
The trading of gold in the London market has a long history of three centuries but Gold Fixing was only formalized after the first World War in 1919. The system of Fixing originated from the London silver market and the concept is to provide market users throughout the world with the opportunity to buy and sell gold at a single quoted price. The Fixings take place twice daily at 10:30 and 15:00 hours in the City of London with the participation of the following five Fixing Members:
Deutsche Bank Sharps Pixley
Midland Bank PLC(HSBC)
N. M. Rothschild & Sons Limited
Republic National Bank of New York
Standard Chartered Bank, Mocatta Group
The procedure of the Fixing is described by the London Bullion Market Association (LBMA) as follows:
"Each member of the Fixing sends a representative who maintains telephone contact with his dealing room. The Chairman of the Fixing, traditionally the representative of N. M. Rothschild & Sons Limited, announces an opening price which is reported back to the dealing rooms. They in turn relay this price to their customers, and, on the basis of orders received, instruct their representative to declare as a buyer or seller. Provided both buying and selling interests are declared, members are then asked to state the number of bars in which they wish to trade.
"If at the opening price there is either no buying or no selling, or if the size for the buying and selling does not balance, the same procedure is followed again at higher or lower prices until a balance is achieved. At this moment the Chairman announces that the price is `Fixed'. Exceptionally a pro-rata settlement may be necessary.
"A feature of the London Fixing is that customers may be kept advised of price changes throughout a Fixing meeting, and may alter their instructions at any time until the price is Fixed. To ensure that a member can communicate such alteration, his representative has a small flag which he raises and, as long as any flag is raised, the Chairman may not declare the price fixed."
Before and after each of the Fixings, there is an active principal trading market in loco London gold. Two-way buy-sell prices are quoted by market-makers in London and in major markets outside London. This system enables the continual trading of loco London gold round-the-clock on a worldwide basis. In view of this market development, the LBMA was incorporated in 1987 under the supervision of the Bank of England.
The unit of loco London gold trading is a bar weighing approximately 400 ounces troy conforming to Good Delivery Specifications. The gold content of each bar must be within 350 to 430 fine ounces and the weight must be expressed in ounces troy in multiples of 0.025 of an ounce. Each bar must be marked with a serial number, the fineness and the stamp of an acceptable melter and assayer (about 50 in the world).
The minimum fineness is 995 parts per 1000 fine gold and gold said to be 1000 fine is marked down to 999.9 fine. The following fine gold contents of other bar weights are accepted by the LBMA. These bars are available at the spot loco London price plus a premium which varies dependent on prevailing market conditions in different locations.
The loco London gold trading system was introduced to Hong Kong immediately after the gold market was liberalized in 1974. It is a spot market with the clearing of metal in London and payment of US dollars in New York two business days after the conclusion of a deal. Notwithstanding that the loco London gold market is a spot market, settlement can be deferred by making special credit facilities available to clients. These facilities normally involve the lending of gold and dollars, initial margins and variation margins, similar to the practice for gold futures trading. The development of this mechanism led to the formation of a secondary deferred settlement market, as distinct from an inter-bank spot market, in which traders, manufacturers and producers in the world take part.
Should the price of gold advance to US$400 an ounce, for instance, the profit margin for some of the mining companies would be higher than the normal level. Under these circumstances, producers would be inclined to lock in the profit for a portion of their future mine production by selling a fixed amount of gold at the spot price.
A producer can, for example, sell 50,000 ounces of gold in the loco London gold deferred settlement market at US$400 an ounce to hedge against 20% of his production for the next 12 months. After the required facilities and documentation have been established with a bullion bank, the structure of the deal is that 50,000 ounces of gold would be leased to the producer and debited to his Metal Account. Gold interest at prevailing market rate would be debited to his Metal Account effective from the value date of the deal. Simultaneously, 50,000 ounces of gold would be sold on behalf of the producer at US$400 an ounce and the proceeds of US$20,000,000 and the interest at libid minus charges would be credited to his Dollar Account.
The producer can carry forward the deal until the quantity of gold is produced and delivered to the bank to unwind the deal. Alternatively, should the market price decline to a lower level, say US$370 an ounce, after conclusion of the deal and before delivery of the metal is effected, the producer can buy back from the bank 50,000 ounces of gold sold previously at US$400 an ounce to realise a profit of US$1,500,000 (SO,OOG x 30).
Under the market practice and depending on the credit standing of the producer, a fixed amount of initial margin has to be deposited with the bank to cover the deferred settlement facility. Furthermore, should the market price move against the open position, the producer will be asked to make an extra deposit (variation margin) to maintain the original level of the initial margin. Similar types of deals can be undertaken by professional traders and individual speculators who are keen to take a view of the market.
When the price of gold dropped to US$372 an ounce on 3rd January 1995, a number of Asian traders and speculators bought the metal as they anticipated that the market would turn at this price level. The strong physical offtake in Asia at around US$370 an ounce experienced on previous occasions provided them with confidence. A trader could have bought, for example, 10,000 ounces loco London gold on 3rd January 1995 on deferred settlement basis and sold the same quantity when the price rose to US$388 an ounce on 10th March 1995. The accounting procedures would be as follows:
1. On 5th January 1995 (the value date of the buy order) the total value of the deal of US$3,720,000 (372 x 10,000) was debited to his Dollar Account.
2. Effective 5th January 1995, interest at Libor plus charges was debited to his Dollar Account daily.
3. On 14th March 1995 (the value date of the sell order), the total value of the deal of US$3,880,000 (388 x 10,000) was credited to his Dollar Account.
Assuming that the total interest covering the deferred settlement period amounted to US$40,000, the realized profit for the deal would be US$120,000 being the dealing profit of US$160,000 (3,880,000 - 3,720,000) minus the interest charge incurred.
On the other hand, the trader would lose money if the price of gold declined after 3rd January 1995. Furthermore, should the initial margin drop below the original level due to adverse price movements, variation margin would be called. If the respective amount was not deposited, the outstanding position would be closed and any loss incurred would be carried by the trader. These conditions are stipulated in the agreement which the customer would be asked to sign before any trading would commence.
The loco London gold market runs in parallel to the Exchange and in view of the different trading unit, price denomination, fineness of tael gold bars and interest payment system, arbitrage opportunities are available at times. The position can be set up by buying loco London gold and selling simultaneously an equivalent amount of tael gold in the Exchange (bear arbitrage) or vice versa (bull arbitrage). Given below is the formula to calculate the premium of tael gold over the level of loco London gold price:
Assumption :
Tael Gold Price : HK$3,495 per tael
Loco London Gold Price : US$378 per troy oz
US$/HK$ TT : US$1 = HK$7.7250
Tael Premium = (3,495 ÷ 1.20337÷0.99 ÷ 7.7250) - 378
= 379.80 - 378.00
= US$1.80 per troy ounce
The normal practice is to undertake deals for 1,700 taels against 2,000 troy ounces each. Under the above assumptions, the unrealized book profit for setting up the bear arbitrage by selling tael gold (1,700 taels @HK$3,495) and buying loco London gold (2,000 ounces @US$378) is US$3,600(2,000 x 1.80). At this point, there is an open foreign exchange position which should be covered. The total value of US$756,000 (2,000 x 378) covering the deal should be bought for payment to the gold seller. The HK$ equivalent value of HK$5,840,100 (756,000 x 7.7250) can be borrowed from the Bank.
Having concluded the first part of the arbitrage deal as described above, the remaining variables are spot tael gold prices (at premium or discount to loco London gold), carried over charges (contango or backwardation) and money cost (HK$ overnight lending or borrowing rates). The following are the factors which determine the actual profit or loss.
Firstly, tael gold should normally be traded at a premium above loco London gold and the amount should be equivalent to the freight, insurance and manufacturing charges (CIF premium) for delivering tael bars to the Exchange. However, the premium fluctuates largely in accordance with the open interest of the Exchange and prevailing sentiment of the investors. On certain occasions, tael gold is traded at discount to loco London gold.
In the case of the example given earlier, should the premium of US$1.80 decline to US$0.50 an ounce, for instance, thearbitrageur can take advantage of the situation and reverse the deal. This means that he would buy back 1,700 taels of tael gold and sell 2,000 ounces of loco London gold to realize a total profit of US$2,600 (2,000 x 1.80 - 2,000 x 0.5) plus or minus interest charges.
Should the premium continue to advance and exceed US$1.80 per ounce, the arbitrageur can take delivery of the 2,000 ounces of loco London gold purchased and make arrangement for the large standard bars to be transformed into tael bars. The transformation charge fluctuates normally between US$1.00 to US$1.50 per ounce dependent on the prevailing supply and demand. The tael bars can then be delivered to the Exchange to unwind the arbitrage with a profit of US$0.30 to US$0.80 per ounce. The essence of the operation is to avoid building up a bear arbitrage position when the tael premium is below the transformation charge.
On the other hand, bull arbitrage deals can be undertaken on the same principle when tael gold is available at discount to loco London gold. Should the discount exceed the CIF premium substantially, tael bars can be bought and converted into Good Delivery standard large bars for delivery to the London Gold Market to unwind the deal.
Secondly, the Carried Over Charge (COC) rate should normally be negative (i.e. sellers receive COC from thosebuyers who do not have sufficient funds to pay for the purchase) and should be equivalent to the overnight cost of HK$. However, the contango and backwardation rates exceed the normal limit sometimes and adversely affect the profit of the arbitrage. Should this be the case, delivery of the tael bars sold should be effected to unwind the deal.Thirdly, when there is a shortage of tael bars, positive COC rate (contango) would apply. This means that the bull arbitrageur receives interest on the HK$ deposit plus the COC covering the long position in the Exchange. On the other hand, the bear arbitrageur has to pay both the interest for the borrowing of HK$ and the COC for the short position of tael gold. Under these circumstances, the bear arbitrageur should arrange for the delivery of tael bars to the Exchange to unwind the deal.
Another type of facility available in the loco London market is the gold loan. The tenor of the loan varies depending on individual requirements of the borrowers. Interest charge is based on the spot gold market value and the prevailing gold interest rate on the drawdown date. This facility is widely utilized by local jewellery manufacturers in Hong Kong as a hedging and financing instrument.
For example, a manufacturer is required to keep constantly 1,000 ounces of finished articles in stocks for sale to his customers. Subject to satisfactory negotiation, he can make an arrangement with a bullion bank to borrow 1,000 ounces of gold monthly for this purpose. Assuming that the spot gold price is US$385 an ounce and the gold interest rate is 3.50% per annum, the interest calculation is illustrated below:
Tenor : 1 month (30 days)
Quantity : 1,000 troy ounces
Spot Gold Interest : 3.5% per annum
Spot Gold Price : US$385 per troy ounce
Loan Interest (1,000 x 385 x 0.035 x 30 )÷360
= US$1,122.90
The total interest charge of US$1,122.90 is payable on the maturity date of the loan when the full quantity of the gold is returned to the lender. The loan can also be rolled over for another period subject to the negotiation between the lender and borrower.
Credit terms governing gold borrowing facilities are comparable with those covering bank loans. Normally, securities in various acceptable forms are pledged to the lender if cash payment of the initial margin is not made by the borrower.
The worldwide contraction of the bullion industry in the past 10 years has greatly reduced the number of participants in the market. Currently, the active foreign institutions engaged in loco London gold trading in Hong Kong include AIG, Barclays Bank, Credit Suisse, Deutsche Bank, Republic National Bank of New York, Smith Barney, Standard Chartered Bank - The Mocatta Group, Standard Bank of London, Rothschild, Swiss Bank Corporation and Union Bank of Switzerland. The volume of business has also declined and existing turnover is in the region of 1,000,000 ounces daily.
Related websites
- Related websites
- Exchange traded_fund
- Getting Gold 1898 book
- The Royal Exchange London
- Diamonds are big in the North