Singapore Bullion Market Association

The Day the EFP Broke

Singapore, 26 March 2020

Today, Comex April gold futures printed at a $50 premium to loco London, having touched $70+ last night, this compares to a more usual $1.5 premium. This dislocation between two of the largest global gold markets is unheard of.

The EFP (exchange for physical) links the two markets via financial and physical connectivity on gold pricing platforms across the world. The EFP facilitates the co-sharing of liquidity which results in an almost 100% correlation between the two markets. Many market participants typically utilise both markets to manage the price risk exposures of their underlying businesses.

Yesterday this relationship broke down.

The key to understanding the reasons for the breakdown, lies in each market’s physical delivery fundamentals.

Physical arbitrage:

Comex is a futures exchange where open interest often dwarfs available inventory. Only few positions actually go to physical delivery, as most are closed or rolled forward before settlement date. Physical delivery, if required, would be to a Comex approved vault in NY in the form of 995 fine acceptable bars, normally 100-ounce weight.

OTC loco London trading on the other hand, is usually for full settlement. Delivery is loco London, i.e. for 400 ounce (large bars) produced by an LBMA accredited refiner delivered to an approved clearing vault in London.

There is a physical arbitrage between each market, being the respective costs to deliver from London to Comex or visa versa. These costs include exchange fees, transportation and insurance, recasting, funding, vault fees etc. normally these fees amount to approximately $1.5.

If the differential between each market widened past this cost, the arbitrageurs would enter by buying or selling the EFP. Under recent market conditions, arbitrageurs would typically be running short Comex and long London.

Financial arbitrage:

The EFP is usually a very liquid and active market traded by market participants via brokers. This market enables traders to hedge respective positions offsetting their cross-market risk. The EFP market also facilitates streaming gold prices across many market makers platforms.

The EFP is, theoretically, limited by the physical arbitrage costs. However, in practice, the EFP could move above or below its fair value for a short period of time. This might be due to regulatory risk position limits, lack of access to funding liquidity, futures position and delivery limits, or mark to market pressures.

What happened yesterday?

In short, there are two main contributory factors behind yesterday’s breakdown.

The impact of COVID-19 firstly,on refining capacity – notably recent announcements from Switzerland regarding refinery closures, and secondly reduced airline capacity (n.b. gold is usually shipped on passenger flights).

This restricted the ability of the market to make physical delivery onto Comex, resulting in a dislocation between the markets. Comex started to price in a shortage of supply. Short EFP positions were forced to cover in thin conditions pushing the April futures up dramatically against spot.

Overnight the LBMA has been working with the CME, who announced the” Launch New Gold Futures Contract with Expanded, Flexible Delivery in 100-ounce, 400-ounce or 1-kilo Bars”

Although, this does not cover existing positioning in near dated futures, it will allow the delivery of 400-ounce bars into the new futures contracts. The movement of gold into Comex either from London or from good delivery refiners globally should result in the narrowing of the market differentials towards more normal trading conditions, in the coming months.

Watch the backwardation of the Comex futures curve as the market prices in future supply.

Jeremy East

Chief Executive Officer
EastWind Capital