The Future of Precious Metals: In conversation with Ed Blight
Many experts are claiming that we are on the verge of a second digital revolution. The rise of virtual reality, crypto-assets and other emergent technologies is means that society, and the global economy, are potentially poised for a gargantuan shift in their structure. With the burst of the Bitcoin bubble last year and the uncertain nature of the global markets in the wake of Brexit and Trump’s protectionist trade policies, our Editor Max Glynn sat down with Ed Blight, Chief Finance Officer of the London Bullion Market Association (known as LBMA), to discuss the potential impacts.
How do you think Brexit will affect the British financial services and in particular commodities?
Brexit is a difficult question to answer in any industry sector. Whether a deal is struck or not there could potentially be positive and negative impacts for the whole business community, not just the financial services sector. Businesses will be making plans for all possible outcomes, and they’ll be looking at how to exploit business opportunity from within the UK as well as how they might grow their business elsewhere, should their strategy require.
What I do know is that in the wholesale Bullion Market in London, and for wider commodities as well, there is something called the terminal markets order. This is a taxation treatment approach which supports the trading of commodities, including gold and silver, on the London Markets. It allows day to day trading on London Exchanges and Over the Counter (OTC) Markets to happen tax free. VAT is only applied at the point of delivery of goods to a specific individual or organisation. This is a valuable tool in the financial services market and one that, at this moment in time, is likely to remain post-BREXIT. As such, it will likely provide a favourable environment for financial services business, including those involved in precious metals trading, to operate from and within the UK.
The other thing that you have to remember about precious metals is that London has been a centre for over 300 years. To give you some context around the importance of London in the Global Bullion Market: If a Chinese bank in Beijing trades in gold with an Australian bank in Sydney then that gold trade will be settled over accounts in London. There’s about 7000 tonnes of gold stored in vaults in London. If you laid every bar end to end it would stretch from the centre of London to Birmingham or enough to give every resident of Paris an exact copy of the FIFA World Cup. To move this metal elsewhere would take a monumental logistic effort as well as being a very expensive operation. Further, the facilities would need to be constructed, tested and proven at any intended new location to the standards required to receive the level of insurance indemnification necessary to set against an overall value of over $300 billion required to operate such a facility. As such, the physical practicalities of moving the precious metals market away from London alone are significant, expensive and fraught with challenges that will likely be difficult to make business sense. What I can say for the precious metals market is that the combination of the physical issues coupled with the trading taxation instruments in place across the London markets suggest that, no matter what the outcome of BREXIT negotiations, the precious metals market will likely mean that the global wholesale market on bullion will continue to clear over accounts in London and hence maintain its status as the centre of the global market for precious metals.
What are the advantages of crypto-currencies compared with tangible goods?
Crypto-currencies are not my specific field, but I do know a lot of people who explore the opportunity presented by them. The real advantage with crypto-currencies is how they’re traded. All crypto-currencies, that I’m aware of, operate across a distributed leger or block chain technology system. The beauty of block chain is that once a block of trading data is resolved and the chain of blocks are complete, the deal is done, it is locked in place and can’t be tampered with in any shape or form.
Whilst the concept of blockchain technologies is relatively robust and resilient, there are some examples, for example Bitcoin, where virtual wallets have been hacked and therefore people have lost money. What should be understood is that the distributed leger approach requires trading data (the ledger) to sit within multiple nodes simultaneously and that these nodes may reside in many different countries. Theoretically, therefore, crypto-currencies are not constrained by country specific regulations. This, in turn, brings a unique combination of opportunity and risk. Trading on traditional markets in commodities, e.g. precious metals, is governed and regulated by bodies such as the Financial Conduct Authority in the UK and the Federal Reserve in the US dependent on where the exchange or market resides. Trading directly on to a block chain environment means that it is difficult to determine regulatory jurisdiction and whilst that may make the process of trading quicker and realise greater potential for margin, it also significantly reduces the investment protection offered within a regulated market. In the Global Wholesale Market for precious metals that settle in London, trades take place and in each instance a “principal” is identified who is responsible for ensuring the integrity of the trade and accountable should issues arise. In the case of the OTC Market for gold in London the risks are between the two counterparts and this includes credit which is not a risk in the crypto environment. Some exchanges around the world now offer crypto currency trading platforms that go some way to alleviate the risks, but it is still very much an emerging market.
Overall the benefits are that crypto-currencies offer more flexibility, trades can be done on a one to one basis, and the trade can be executed much more quickly on block chain environments. Exchange traded crypto currency offerings are subject to improved regulation and governance, similar to those that apply to other commodities and assets. As such, trading in such currencies and the method you choose to adopt really depends upon the individual or organisational appetite for risk.
What are the issues of crypto-currencies?
With any technology solution there are potential weak points and risks. You’ve had cases in the press recently where people’s Bitcoin wallets have been hacked and they’ve lost large sums of money that exposes the weakness of operating in some blockchain environments. Exchange traded crypto currencies have been the subject of “flash crashes” such as that which happened to Etherium some years ago that resulted in millions being wiped from the value of the currency in a matter of seconds. Sure, all markets can be volatile, but whilst there have been stock market crashes in the past, tangible commodities and goods will always retain an element of security, particularly gold which is widely considered the “safe haven” of choice when times are hard.
Crypto currencies are notoriously volatile and what happened with the Ethereum crash was, in retrospect, a classic example of this volatility. Essentially a very large volume of the currency was placed on the market for quick sale, I believe at a level below the market price at that time. This triggered a number of threshold settings for algorithms both on the exchange in question and also within traders own digital platforms. With algorithmic decision making measured in milliseconds and no human intervention measures in place, the price plummeted losing investors millions before they could blink their eyes.
Whilst the lessons of the Etherium crash may have been addressed to a point, there is still nervousness surrounding crypto currencies. Where new technologies exist, new risks can also evolve and sometimes the corrective measures themselves can cause issues. For instance, the flash crash crisis introduced the concept of limiting the volume within transactions and amount of transactions that can be placed at any one time. The recent Bitcoin bubble, another example of the volatility in crypto currencies, saw the price of Bitcoin spiral from a 12 month low of circa £2000 per XBT to new high of £14,588 per XBT, and yet the trading constraints made it difficult for investors to cash in. As the inevitable volatility of the Bitcoin market kicked in the virtual wealth investors had sat alongside a virtual loss as the value dipped to the current level of circa £6000 per XBT. The lesson here is that, whilst significant gain has been realised through the value now against that of 12 months ago, most would not have realised the benefit available for a brief time at its height. Thus in the case of the Bitcoin bubble, it was difficult to unlock the full potential of the virtual wealth driven by the volatility, that took it to its peak, in to tangible wealth. So the key issue is volatility! On the one hand spiralling highs that cannot be fully converted in to tangible benefit, and flash crashes that realise huge losses that cannot be recovered.
Is the future of exchanges crypto currencies or tangible goods?
The first thing that must be understood is that the markets are very fickle. They are influenced by so many different things: Politics, natural disasters, crisis situations, and even rumour. This drives people and business towards the perceived opportunity where the optimum margin or benefit can be realised.
Nine times out of ten when there is a crisis people will go to certain ‘safe havens’. Precious metals are considered to be one of these safe havens. Central banks will often invest in gold as part of their strategic wealth preservation plans (an insurance policy if you want) for their respective national economies. Crypto-assets would be treated very similarly to stocks and shares in this regard. Fine whilst the going is good but not when times are hard. The common analogy is as a lobster pot - a lot easier to get in than out! In fact their volatility will likely make them the first investment from which to move away.
However, some crypto currencies are now introducing new ideas such as cryptos underpinned by gold, enabling speedy transactions on blockchain platforms, but having a safety guarantee of the gold that underpins it. Some companies are also introducing banking capability that allows currency accounts alongside a gold account. The cards issued with the accounts allow you to switch between your accounts and, if necessary, to transact in gold to potentially avoid foreign exchange currency charges.
The reality is that the markets will adopt a balance of investment dependent on the situation at the time. How can you modernise what is effectively a traditional market? How can you improve the way in which you get your return? Markets will do what is necessary to deliver margin and benefit to their investors. This is what drives the direction of the all markets. The dollar being strong against the pound benefits British exports, but at some time the costs of doing business will go up which will drive the cost of those exports up and make them less attractive. When currencies stabilise, investors will move into stocks and shares and then other options where benefit can be derived. Should another conflict occur resulting in global political tension, investors will become nervous and seek out the safe havens such as gold. In the end, tangible assets will always be more reliable but people will exploit intangible assets, such as crypto-currencies, while they have the opportunity and are nimble enough to exploit the opportunity. Conversely gold is not necessarily about being nimble, more a component part of a much longer term strategy.
The markets will inevitably look to where the margin is and to where the opportunity exists, and they will go where they want to go. The reality therefore, is that tangible and intangible are likely to sit alongside each other for ever and a day. It will be the economic, political and global environment which will determine the way that the market goes and where they prioritise their efforts.