COVID-19 and Gold: What Happened & How Did the Market React?

The coronavirus pandemic has put a squeeze on gold liquidity and caused huge spreads.

The coronavirus pandemic has created a number of challenges for many industries across the world. For the financial markets, the virus has brought a significant increase in volatility. As Finance Magnates previously analyzed, this has been largely beneficial for brokers, as client activity has increased, but at the same time, it has also caused challenges surrounding gold.

Gold is a prominent safe-haven asset. So during times of uncertainty, as is the case now, traders tend to flock to assets such as the commodity. This then leads to an uptick in demand.

However, as countries are going into lockdown, this raises questions regarding supply, as metal mines, refineries, and transportation companies are also going into lockdown. Because gold is a physically-settled asset, concerns have grown that global reserves are inadequate to meet the current demand.

This has then led to liquidity providers, market makers, and exchanges struggling to be able to price the commodity. Earlier this week, some exchanges stopped pricing gold altogether. At the same time, spreads widened considerably, and although things have returned closer to normal, the liquidity issues still remain.

What happened with gold?

Andy Biggs of CFH Clearing
Andy Biggs, Head of Liquidity at CFH

Andy Biggs, Head of Liquidity at CFH, explained to Finance Magnates what happened earlier in the week: “‘The EFP has blown out’ is the short answer you are likely to get from your liquidity provider, but what does this mean and why has it happened? Exchange For Physical (EFP) is not often spoken about by CFD and rolling spot providers; it allows traders to switch Gold futures positions to and from physical. Quoted as dollar basis, relative the current futures prices, EFP is a key component in pricing OTC spot gold…”

“Over the course of Tuesday, the EFP market effectively shut down as EFP market makers stopped quoting. Anecdotally lots of these market makers were short EFP/basis; this could normally be covered by delivering Gold to New York where Comex Futures take delivery. However, the measures implemented to tackle COVID-19 have halted much of the movement of physical gold.” 

“As an example of this, as Switzerland went into lockdown, all precious metal refineries were closed. Around 80% of the world supply goes through the country, 70% of refineries are in the region they decided to close.”

“All of this led to spot Gold market makers struggling with models not designed for this sort of market dislocation/breakdown. Most went extremely wide as a defense, and then some stopped quoting at all.”

How did this impact brokers?

So how did this impact brokers? Chris Nelson-Smith – Head of Risk at Vantage FX said: “As a broker, the main impact is the actual bid/ask clients are seeing is much wider. We utilize many top tier liquidity providers, so continued pricing is not an issue for us as it has been at other brokers.”

“However, pricing differs between liquidity providers, too, as they manage this phenomenon, and this leads to spreads changing rapidly. Our job is to clearly communicate to clients the reasons behind the changed trading conditions, advise them to exercise caution when they trade, and to maintain adequate account balances during this time of instability in the market.”

How long will liquidity issues remain?

Although the situation was considerably worse at the beginning of the week, we are not yet out of the woods yet, especially with COVID-19, likely to still be a threat for months to come. So how long can we expect liquidity issues to remain?

“Futures were in backwardation over the past two days (a sign of very strong demand), meaning that the front month, April, was more expensive than the June and December contracts. This is the opposite of what normally occurs, but this has since corrected with the back contracts being priced higher again,” Nelson-Smith told Finance Magnates.

“With some gold refiners being shut down indefinitely, we expect to see volatility and wide spreads between cash and futures until physical gold delivery can be assured or guaranteed again.”

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Biggs from CFH said that at the moment, it’s very difficult to say how long the liquidity issues will remain: “… I’ve seen predictions of 24 hours to a couple of months. I expect we will not be “back to normal” until Europe and the US are past the worst of the lockdowns.

“CME is doing its best to help fix the situation by creating a new futures contract with more flexible delivery. It will accept the easier-to-deliver London standard bars and should be up and running for April, pending regulatory approval.”

“However, it is not entirely clear how this will resolve the physical tightness affecting the existing main contract, whose specifications have not changed for April delivery.”

Liquidity issues are a normal reaction

Whilst the liquidity issues for gold did pose problems for traders, Dmitriy Gurkovskiy, Chief Analyst at RoboForex, pointed out that this is a normal market reaction.

Dmitriy_Gurkovskiy of RoboForex
Dmitriy Gurkovskiy, Chief Analyst at RoboForex

“Liquidity issues on capital markets will disappear together with panic and fears. Everything will calm down and go back to normal as soon as global stimulus programs show some effects, and the coronavirus pandemic slows down,” commented Gurkovskiy.

“From time to time, there appear some problems with liquidity in oil contracts, but it’s also rather okay. The fact that the market quickly responds to changes in the environment is positive. It would have been much worse if financial markets had been frozen to the spot while global economies were suffering. In this case, there would be much more questions to both processes and reactions.”

Are other assets in danger of a liquidity squeeze?

While gold is currently in the danger zone, the longer coronavirus remains a threat to economies, the more likely further assets will encounter liquidity issues if the markets continue to remain volatile

Speaking on this, Nelson-Smith highlighted: “These issues create further uncertainty in all markets, at a time when uncertainty itself has become the norm. I think these logistical and supply issues will continue to occur. I also expect to see this difficulty stretch to other precious metal markets and potentially, other commodities. Until we see supply chains reinstated, anything that is a physically-settled asset may experience liquidity drying up somewhat.”

How did market participants respond?

In light of the current liquidity squeeze, how have market participants reacted? Vantage FX has adjusted its spread filters and maximum spread settings to ensure that pricing is available for all of its markets and customers, Nelson-Smith said.

Alpari, another forex broker, sent out an email to its clients this week, alerting them to the unforeseen shortage and, therefore, switched all XAU and XAG symbols to “Close-Only” mode until further notice.

“Here at CFH, we monitored the situation extremely closely, keeping a constant dialogue with our LPs to get up to date information for the liquidity team to make decisions,” outlined Biggs. “We were able to make the judgment to keep pricing throughout and, more importantly, also able to source that pricing.”

“Our view is that it’s important to our clients that we maintain a price, so they are able to either exit existing positions or express their positional views at times of stress.”

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