Hatton Garden Refinery Reports How the Unwinding of the Chinese Commodity Complex will Send the Price of Gold Tumbling

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Highly elaborate financing deals using commodities as a tool to avoid regulatory control are unwinding, with the prospect of heavy price falls for commodities – according to research from Goldman Sachs Group Inc. As these financial deals unwind, we explain how these events will send the price of gold tumbling.

Following record breaking imports of gold bullion in 2013 China finally surpassed India as the largest importer of bullion in the world. Since 2011 China has been ravenous and has imported a staggering 2614 tons of gold. This massive volume of gold imports has been caused by the introduction of complex financing transactions aimed at avoiding central bank control.

Introducing CCFD's or Chinese Commodity Financing Deals

CCFD's are highly elaborate financial transactions with the sole aim of avoiding central bank controls, in effect bypassing official channels which currently compromise China's all important current account allocation. They are a response to capital controls from the PBOC imposed after the credit crunch. In simplistic terms traders borrow short term FX loans from onshore banks using LC’s or “letters of credit” to import commodities. Then documents issued by logistic companies representing the ownership of the underlying commodities or warrant’s are then sold offshore thus bringing in “hot money” and avoiding central bank controls in the process. It is important to understand that this process is repeated ad nauseam. Creating massive distortions in commodity markets, pricing and money flows.

Impact on Gold prices how the trade works.

The example above shows in very simplistic terms a CCFD trade. Although all CCFD's are different and reflect the specific trading characteristics of the underlying commodity. In particular gold, is traded slightly differently to most. Instead of warrants being sold offshore, gold is exported and sold offshore in the form of semi-fabricated products. As the trade is “off the books” it does not show up in official PBOC figures. Raising the possibility that the gold CCFD trade is massively larger than first imagined. An additional consideration is the fact that throughout this process the participants are hedging their gold price exposure using “paper” products such as futures and options

Chinese hot money outflows

Recently there has been an unwinding of the CCFD structures due to increased oversight from the PBOC and Yuan volatility - according to analysts at Goldman Sachs, led by Jeffrey Currie. This has resulted in copper dropping 2.4% from a 20 year high of 6040.6 USD per tonne. Downward pressure within the commodity trading block can be seen across the board.

Impact on gold prices.

Unwinding of CCFD trades leads to an increase in physical availability on the market. This would be bearish for the yellow metal due to “relatively limited physical liquidity to absorb the shock” according to Jeffrey Currie at Goldman Sachs.

Goldman further notes that unwinding long physical positions in gold will also result in futures buying ( buying back the hedge ) reducing the overall price curve, and sending the overall price of the gold lower.

Chris Brown - Head of Research at Hatton Garden Refinery. A London Based Precious Metals Refinery reports that "Given this evidence selling when the price is at these current levels, although around 25% down from the top, is a prudent financial decision to make."

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Dr M Mansoor Siddique
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