JPMorgan And Citi are 90% of The U.S. Gold Derivative Market
JPMorgan And Citi are 90% of The U.S. Gold Derivative Market
JPMorgan had $330 billion in March 2022 vs. $28 billion in Dec. 2021– an increase of over 1,000%.
The public is treated like mushrooms: kept in the dark and fed a lot of sh*t. But every once in a while the door opens and we get to see what is really going on.
TL/DR
Gold derivative risk exposure held by FDIC banks jumped 520% in one quarter
This was due to an accounting change where Gold derivatives were previously grouped in with Exchange-Rate currency contracts
As a result, JPM’s seen exposure jumped by over 1,000% from December 2021, to March 2022
JPM and Citi have had 90% of the Gold market derivative risk with almost all of it categorized elsewhere for some time.
The Chart
About midweek last a chart reflecting changes in bank holdings of precious metals derivatives began circulating. It rightly caused much speculation as to the reason for an enormous jump in amounts of derivatives held by US FDIC insured commercial banks in 2022.
Here is our attempt to explain: what it is, what happened, what it implies, and why it exists. Nobody has a monopoly on the truth. This is our attempt to shine some light and get the conversation going and minimizing the noise.
Table of Contents
What it is.
JPMorgan And Citi are 90% of The Gold Market
Why The Change?
Where were Gold Derivatives prior to the change?
Why were they “Exchange Rate Risk” Before?
What Advantage did this Give Banks?
Why is This Wrong?
1- What it is.
The above graph is a representation of precious metals derivative contracts outstanding to which a US Bank is counterparty. The Office of the Comptroller of the Currency (OCC) releases this report (attached at bottom) quarterly listing derivatives held at Wall Street and other US Banks. It is a derivative accounting report (without risk recommendations) for our whole banking system.
Gold Derivatives Outstanding ending March 31st, 2022 ( Dec 31, 2021 inset)…
For the first quarter (90 days) of 2022, the number of Gold derivative contracts jumped by an astounding 520% from 79.28 billion to $491.86 billion. Did activity increase that much? No. Is something going on? Yes. There was an accounting change.
The prima facie reason for this, as stated by the OCC is in a footnote highlighted below.
Starting January 1st, 2022, the largest banks became required to move all gold derivative risk, not currently in the “Precious Metals” risk category pictured above into that very category. Which Banks had the biggest changes? JPM, Citibank, and Goldman1 did. But JPM and Citi really stood out.
2- JPMorgan And Citi are 90% of The Gold Market
The two banks that stand out and carry the lion’s share of changes are JPMorgan and Citi. JPMorgan Chase rose $330 billion as of March 31, 2022 and Citibank held $114 billion in precious metals derivatives.
Notional Derivative Contracts Held by Banks at end of March 2022
According to the Federal Deposit Insurance Corporation, as of March 31, 2022, there were 4,796 federally insured banks and savings associations in the U.S. Combine that figure with the latest report from the OCC and it means that just two banks, JPMorgan Chase and Citibank, control 90 percent of the precious metals derivatives of all 4,796 insured financial institutions in the U.S.- Source
Notional Derivative Contracts Held by Banks at end of 2021…
How big of a change is that from last year? In the OCC report (attached at bottom) for the previous quarter ending 2021, JPMorgan had $28.2 billion in precious metals derivatives versus the shown above $330.1 billion at end of Q1 2022 – an increase of over 1,000%.
Why such an aggressive change overnight?
3- Why The Change.
Why would a Gold option/future be classified as an “Exchange rate contract” to begin with?
Last year, more or less, the rule change under Basel 3 in Europe forced Bullion banks and their customers to restate Gold derivative risk as notional2. Simply put, using notional value deleverages a position for risk purposes. Even more simply: banks had to answer this question: “How much can you really lose if it goes all to hell?”.
This Basel 3 change necessitated banks either: set aside more risk capital, pass through that requirement to customers where possible, or close the position down entirely.3 It, in many ways turns all derivatives into spot transactions. LBMA banks needed to get a delay on the EU side as we reported in July last year
Banks Get Bullion Bypass Friday Night
1-Britain carves out exemption for gold clearing banks from Basel III rule: Banks clearing gold trades in London can apply for an exemption from tighter capital rules due in January 2022, a British regulator said on Friday, removing what some said was a threat to the functioning of the market.
That was a year ago. Now the US is getting it’s own golden ducks in a row given the new reality out of Russia and possibly China.
Russia Forced Our Hand
The OCC accounting change is, in our opinion, an attempt to bring uniformity (with Basel 3) to Western governance of Gold (remonetized) derivatives. It solidifies our position on the west’s Gold and potential back door destabilization during times of war. This action also discourages regulatory arbitrage by Banks between the EU and US markets as well.
It is very consistent with a world where a mercantile behavior is the norm as a result of diminished trust along nations. Much more on that in our write up entitled Gold: "A crisis is unfolding. A crisis of commodities"- Zoltan Pozsar:
..if you believe that the West can craft sanctions that maximize pain for Russia while minimizing financial stability risks and price stability risks in the West, you could also believe in unicorns.- Source
From that analysis, Pozsar explained in his own way that without collateral (an effect of sanctions on Russia as war retaliation), financial markets must shrink or destabilize.
Zoltan’s version of Exeter’s pyramid….
The west is now protecting what it has to in light or Russian aggression and sanctions. That means Gold must be corralled into strong hands. Since the Gold market is international with very strong ties between the LBMA and US Comex, it could be assumed that regulatory rules would at some point converge, as they almost always do.
This is all very consistent with the western world in general deleveraging, especially with the shortage of good collateral for commodity trades once the Ukraine war started. Which begs the question,Where did these positions come from if they weren’t labeled Gold before?
4- Where were Gold Derivatives prior to the change?
Gold contracts are to foreign exchange contracts what zebras are to a centipede.- Pam and Russ Martens4
That is a question easily answered with a little digging, but harder to understand “Why were they there to begin with?” follow up. We will try to answer both questions.
A section of the footnote pictured above answers the Where were they? question. It states (our emphasis):
“Beginning January 1, 2022, the largest banks are required to calculate their derivative exposure amount for regulatory capital purposes using the Standardized Approach for Counterparty Credit Risk …
…gold derivatives are [now] considered precious metals derivative contracts rather than an exchange rate derivative contract resulting in an increase in reported precious metals derivative contracts compared to prior quarters….”
The footnote states that prior to this rule change, Gold options, futures, and other derivative contracts were placed in the bucket of risk entitled Exchange Rate Derivative Risk.
Banks had, prior to June 2022 been placing most if not all of their gold position risk (net shorts we’d imagine) in a different category called “exchange rate derivative contracts” with the OCC’s blessing.