Gold bugs’ bankers take a step back in time

NOTHING says gold is hot quite like a story that big US banks are considering getting back into the business of holding other people’s bullion.

I did a double take as my first instinct was that I’d picked up a story from the 1970s. But having spoken with several sources it’s a real thing. Citigroup is eager to get back into an activity it probably should never have left, and several other major institutions are leaning the same way. It costs a lot to store gold. The logistics, let alone the security, are mind-bogglingly expensive.

Here’s the sceptic’s take, courtesy of Warren Buffett: “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility.” But not everyone shares his view that “it won’t do anything between now and the end of time except look at you”. Clients increasingly want to hold gold as a portfolio hedge, so banks are responding with old-fashioned customer service and commensurate fat fees. 

This isn’t about digging new vaults but leasing or repurposing existing facilities. Storage fees are on a sliding scale based on a percentage of the bullion’s value. With gold having doubled since 2023, it’s properly profitable again to offer full service, as it captures the whole value chain; very profitable, in fact, for JP Morgan Chase, as it dominates the sector acting like the quasi-central clearer for bullion. According to Bloomberg News, HSBC Holdings comes a distant second, though it’s strong in Asia. UBS focuses on its private wealth franchise and, though ICBC Standard Bank has made big investments, it’s yet to crack the international market in a major way.

Still this is a decades-long commitment. That tells you the major players think high gold prices are here to stay. The quarterly World Gold Council Demand Trends report was released last Thursday (Oct 30) showing gold buying rose 3 per cent to a record of 1,313 tonnes for the third quarter, matching the increase in mining supply. Bar and coin investment was up 17 per cent on the year, a trend that was even highlighted in the UK’s September retail sales release. Central bank demand apparently was 28 per cent higher on the quarter but only narrowly above the five-year average. The only notable faller was jewellery sales facing sticker shock with the gold value up by nearly half. 

Precious metals trading is quite a profitable business again. Partly that’s because it’s one of the last old-fashioned markets left, outside of an active gold exchange-traded fund (ETF) business. Physical gold is still an over-the-counter market with no central counterparty. There’s no published forward curve, or rates for deposits or loans, and only monthly data on inventories. Liquidity is highest in London trading hours, which explains why storage interest is growing predominately in the UK, as well as the Bank of England’s vaults holding many other central bank’s reserves. The infrastructure required means only the biggest banks have the balance sheets and regulatory bandwidth to segregate client holdings efficiently.

New York has suddenly become a more attractive location because of Trump tariff fears. There was a delivery short squeeze on New York’s Comex futures exchange gold contract earlier this year triggering a sudden panic to get different-sized bars into the US but this has largely dissipated. 

Gold storage including clearing, transfer and settlement services is a banking business line that’s been hollowed out since the global financial crisis. Banks have eschewed trading businesses as regulators have been notably rigorous over monitoring commodities. Gold even became subject to Basel 3 rules. It hasn’t helped that on the retail side it often involves dealing with unregulated, smaller entities or individuals.

The majority of trade is interbank – which means it’s all about funding and the ability to use client holdings as collateral elsewhere – a practice known as rehypothecation. JP Morgan will likely have hundreds of billions of dollars of gold on its balance sheet. The key clients are central banks, which care a lot about dealing with a counterparty with very high credit quality. 

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For others looking hard at this business, such as Morgan Stanley, it’s about synergy with wealth management; there are lots of clients who want to hold gold, so why not hold it in their own vaults and accrue the fee income? Private wealth revenue is valued at a higher multiple than trading businesses. Other banks with big wealth management operations will be watching closely.

Although the great debasement trade hype over US dollar usage has probably been overstated, it has transformed the pet rock back into a viable asset class. This holds true despite a recent slide of almost 10 per cent. Banks, as their proprietary trading activities have been heavily curtailed, are less reliant on ever higher prices but just want to capture lots of margin in trading activity. Gold storage is back, baby. Time to wheel out the denim flares and Neil Diamond albums.