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Spread in gold market continues to baffle investors as futures prices eye higher levels

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(Kitco News) The spread between spot gold and futures prices continue to puzzle investors despite some improvement on the logistical side of the issue. 

Analysts highlighted major gold refineries and mining shutdowns as well as transportation limitations as some of the main reasons behind the unusual price spread. 

“COMEX gold futures surged to an unprecedented $80+ above the London spot price some two weeks ago and the basis remains at elevated levels, as air travel restrictions and precious metal refinery closures limit the availability of 100oz bars to meet settlement requirements,” TD Securities commodity strategist said on Monday. “Other restrictions also place limits on arbitrage for those able to secure the specified metal.”

The futures-spot price differential points to a perceived higher cost of transporting gold from London to deliver against COMEX futures contracts in the U.S. due to all the COVID-19 disruptions, the strategists explained. 

At the time of writing, spot gold was trading at $1,725.50 an ounce, up 0.74% on the day, while June Comex gold futures were at $1,759.70, down 0.10% on the day, after nearing $1,800 earlier in the session. 

Tuesday’s $34 spread is not as wide as a couple of weeks ago, but the price difference is still significant considering that futures and spot usually trade around the same levels.

“A differential … is quite unusual. The futures basis typically trades within a few dollars of physical — a function of financing, shipping, insurance and storage costs — as plentiful physical metal in London could always be brought to smooth any significant disequilibrium conditions. Financing, shipping and modest recasting costs also traditionally acted as constraints on basis expansion,” explained the strategists at TD. 

However, the whole system was broken as COVID-19 logistical limitations disrupted everything from production to air travel. 

To deal with the physical squeeze, COMEX introduced a new gold futures contract with expanded delivery options that include 100-troy ounce, 400-troy ounce and 1-kilo gold bars. 

In the meantime, gold prices have been gaining ground and futures are benefiting as investors seek exposure to the yellow metal in the face of the looming economic uncertainty. 

Gold-backed ETFs have also been seeing impressive demand. “Gold’s rally continues, with the price back above $1,700 an ounce on the back of sixteen consecutive days of net inflows to physically-backed gold ETFs. Total YTD increases in ETF holdings are over 10Moz,” said BMO Capital Markets head of commodities research Colin Hamilton. 

Important to keep in mind that the issue is not about the shortage of gold as there is plenty of physical metal out there. The problem is that oftentimes it is at the wrong location, according to analysts.

“Total above-ground gold bullion stocks were some 197,576 tonnes at the end of 2019. This includes roughly 121,037 tonnes of jewelry and other products (excluding coins), private sector investment of 42,619 tonnes and about 33,919 tonnes of official holdings. There is plenty of gold in the market, but it’s not in the right places and not in the correct bar specification,” TD Securities added. 

And even as the logistical bottlenecks begin to ease, it will take some time to equalize the spot versus futures price spread, according to the bank. 

“The resumption of commercial flights, the restart of Swiss refining capacity, lower market volatility which should ultimately see liquidity return, along with the CME Group's launch of a new gold futures contract with expanded flexible delivery in 100-ounce, 400-ounce or 1-kilo bars will eventually bring the COMEX gold futures-London spot differentials towards average levels,” the strategists wrote. 

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