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London's Palladium Market's Metal Shortage, Structure, and Irregular Appearance
With the spike in the London short-term palladium lease rates to 16% during the week of June 9, 2017, the market was signaled of a shortage of physical metal in London catching the attention of many market observers.
The London platinum and palladium market, as noted in the following article excerpt from 2013, is the dominant market for these metals. "... Peter Smith, head of the London Platinum and Palladium Market (LPPM), told Reuters that the majority of the market was now trading on a 'loco London' basis..." with the article also noting that large amounts of physical palladium had been moved from Zurich to London between 2009 and 2013 to make the London the dominant market for physical platinum group metals (PGM) trading and delivery of metal when desired. See CNBC: Precious Palladium Near 16-Year High, Gold Firm Ahead of Fed Meeting
The LPPM, as the second major precious metals market in the UK in addition to the gold and silver trading London Bullion Market Association (LBMA), has announced that it will merge with its sister organization the LBMA at the LPPM's next Annual General Meeting on June 29, 2017. The global reference daily reference point platinum and palladium price auctions have now been moved to the London Metals Exchange (LME) but confusingly being called the LBMA Auction - more on this further below - with the pricing data owned by the LBMA.
One of the founding members of the LPPM when it was established along with the LBMA in 1987 is Johnson Matthey PLC and it continues as one of only 5 LPPM member participants in the new daily LME price auction.
Johnson Matthey (J&M) has two of its three large PGM refineries located in the UK and it is thus well positioned to understand both the trading dynamics of the LPPM unallocated spot contract paper market as well as the physical structure of the PGM market. J&M recently states "Over the last ten years, the market has been kept adequately supplied by a very large movement of palladium out of existing stocks, as is evidenced by trade statistics suggesting net withdrawals of around 10 million oz from Swiss and UK inventories between 2007 and 2016... ...While we do not believe that above-ground stocks have been exhausted, no market can support large deficits indefinitely." The spike in palladium lease rates appear to signal to all that the market may well be at an inflection point for palladium due to long term draw-down of available above-ground palladium stockpiles as hinted by J&M. See Reuters: London overtakes Zurich as Market for Platinum Group Metals
Given the dominant role of London's LBMA/LME tag-team in establishing reference pricing for physical PGM trades, let's have a look at UK export and import data to follow UK palladium metal flow using data from the UK's HM Revenue and Customs. During the time span from 2013 to April 2017, the UK exported a net amount of 5.34M oz. of palladium from its vaults (see data table below).
Of note is that over the 4 months of January - April 2017, the rate of importation of palladium to the UK declined to total just 163k oz. for this period while UK palladium exports continued in 2017 at the roughly 2.8M oz. p.a. annual run rate of 2016. Also of note is that in 2017 both Russia and Switzerland, as prior major holders of vaulted palladium stockpiles, supplied no material amount of physical palladium to the UK resulting in the UK's increased palladium flow deficit. While Russia stepped-in with more than 500k oz of palladium supply in 2016 to compensate for a drop in 2016 Swiss palladium exports to the UK, no such increased supply of metal is visible from Russia to the UK through April of 2017.
During this period, the lease rate of palladium in London steadily increased indicating that just this relatively small decline in ounces of palladium imported to the UK was enough to increasingly stress the London physical market. This gives an indication of the availability of physical palladium metal from London stockpiles as J&M stated, no market can support large deficits indefinitely. We may now be seeing that London physical metal stockpiles have dwindled to the point that they cannot even support small palladium import deficits for a short time irrespective of the availability of large amounts of unallocated spot contracts (paper metal) in London.
These data indicate that since at least 2013, there have been persistent, large, and increasing draw-downs in UK physical palladium stockpiles.
Looking now at available data from the Swiss Federal Customs Administration, for 2016 and through February 2017, Switzerland has not been a source of material amounts of physical palladium to the global market despite stockpiles putatively held in Swiss vaults:
Creating and Trading 'Metal' with Unallocated Instruments in London
Important background reading:
- Bullion Banking Mechanics Ronan Manly - Bullionstar
- LPPM The London Platinum and Palladium Market Ronan Manly - Bullionstar
At the historic London center of precious metals trading, the LBMA and the LPPM associated company the London Platinum and Palladium Fixing Company have set the price daily for commercial precious metals transactions in gold, silver, platinum, and palladium. Both the LBMA and the LPPM were created in 1987 and with the creation of the LBMA saw a material and secular decline in the real (inflation adjusted) price of gold from historic norms thereafter despite long-term decreases in real interest rates (see slides 7 and 8 of Transition of Price Discovery in the Global Gold and Silver Market).
Reference 1) above from Ronan Manly documents the fractional reserve nature of 'physical' bullion banking in London and the use of unallocated contracts that permit the creation of spot metal contract claims for immediate ownership of metal without limit given a minimal grub stake of gold, silver, platinum, or palladium in a pooled metal account of a bullion bank. A more descriptive name for these unallocated contracts would perhaps be window dressing contracts as the pooled metal gives an appearance of substance for a spot metal contract but the capacity to create limitless additional claims beyond the amount of metal held by the bank dictates that these unallocated contracts will ultimately be valueless.
The LBMA and the LPPM confirm that 95% of London trading use unallocated spot contracts. By issuing such unallocated contracts for physical metal and substituting contractual metal indebtedness for actual ownership of specifically allocated bars of real metal, the precious metals were essentially made virtual and true demand for these metals obscured from the market thwarting effective price discovery. The associated price suppression works really well until inevitable metal shortages occur due to mispricing of the metals with some of the unallocated spot contract holders then attempting to secure real metal in an already thin market.
The new LME twice daily price fixes for PGMs have been in place since December 2014 and involve only 5 member participants from the 17 member LPPM Association with 4 of the 5 of these members being either original members or successor owners of subsidiaries that were original members of the LPPM Association in 1987 only Goldman Sachs is a new player in the daily LME platinum and palladium auctions.
Two things immediately stand out with this auction: 1) having only 5 participants in the auction is less than desirable if a full and robust bidding process for price discovery is desired and 2) the LME informed this writer through Alex Shaw, its Head of Market Development, regarding the twice daily LME platinum and palladium auctions (that it calls the LBMA auction) that "At present the LME does not have Platinum and Palladium contracts, but the LBMA auction specifies LBMA Good Delivery material, but the delivery format is Loco London unallocated bullion."(e-mail exchange follows this article). The implication is that auction participants could merely be swapping coupons in the daily LME auction to daily set a principle global PGM reference price with very little (or any) metal itself necessarily trading hands during the auction.
While the LPPM is about to disappear from sight, some aspects of this group give an irregular appearance and stand out in Manly's reference article 2) above:
1) The LPPM is an association not an incorporation (i.e. no corporate veil to give members a legal corporate shield from potential legal liability), yet the LPPM informed Manly that they have no Memorandum of Association or Articles of Association as would be considered normal to define the legal relationship of this 30 year old group of bullion banks. This group central to the London and global platinum and palladium market have established themselves on an undocumented basis merely to hang out in this market? Perhaps.
2) The daily platinum and palladium price 'fix' was determined daily until December 2014 by the London Platinum and Palladium Fixing Company Limited (LPPFC) having close connections to the LPPM. The LPPFC is made up of directors from HSBC, Goldman Sachs, ICBC Standard Bank, and BASF Metals which companies make up 4 of the current 5 LPPM participants in the new LME daily platinum and palladium auctions. Manly notes that the LBMA legal counsel in 2015 asserted that the LPPFC was dissolved despite the LPPFC later making annual return filings and director appointments in 2016. The LPPFC remains a defendant in a class action suit, accused of platinum and palladium price manipulation, filed on April 21, 2015 in the Southern District Court in New York.
The Achille's Heel of unallocated spot contracts is physical metal bar demand. The London palladium market has been recently indicating that it is having difficulty delivering real metal to market participants. As Warren Buffett has said, when the tide goes out you see who's been swimming naked. At that point, London's palladium market won't be a pretty sight.
E-mail received from LME:
Subject: RE: LME Platinum and Palladium Contracts
Date: Wed, 14 Jun 2017 08:20:05 +0000
From: Alex Shaw <Alex.Shaw@lme.com>
To: David Jensen
Apologies, I never received your email in May - it may have been caught by a spam filter.
At present, the LME does not have Platinum and Palladium contracts, but the LBMA auction specifies LBMA Good Delivery material, but the delivery format is Loco London unallocated bullion. When trading spot, settlement is on a T+2 basis and meeting delivery obligations is the responsibility of those trading.
Alex Shaw | Head of Market Development Precious Metals
Direct +44 (0)20 7113 8137 Mobile +44 (0)7867 456 878
Address 10 Finsbury Square, London EC2A 1AJ
lme.com | Twitter | LinkedIn
From: David Jensen
Sent: 13 June 2017 05:49
To: Alex Shaw
Subject: Re: LME Platinum and Palladium Contracts
Please confirm receipt of this e-mail and a date at which I will receive a response.
Thank you for your assistance.
On 17-05-03 07:48 AM, David Jensen wrote:
> Dear Alex,
> Please direct me to where I can find details of the platinum and
> palladium contracts that are traded in the LME Auction process.
> Also, does the LME ensure that the auction participants have metal for
> delivery when they participate in the Auction?
> Thank you for your assistance.
> David Jensen
> Vancouver, BC
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