FT.com (Financial Times)

Demand for bullion puts strain on vaults

June 12, 2010

By Javier Blas in London,  June 12, 2010

Veteran gold traders are fascinated by the sea-change in bullion demand - and the strains it is putting on banks and security companies' network of cavernous vaults.

Neil Clift, managing director at JPMorgan, told an industry conference recently he remembered going down to the bank's vault, one of the biggest in London, more than a decade ago and seeing "literally one pallet of gold, which was all we had".

"If you go to our vault now or you go to HSBC's vault or certainly the Bank of England's vault, you will see a very, very different story," he said.

Banks estimate that at least 250m ounces of gold are stored in London, the world's most important vaulting hub, equal to $310bn - about two years of mine supply. The BofE holds a substantial chunk of that gold, much of it on behalf of other parties.

Additional, and significant, amounts are stored in other gold hubs, including New York, Zurich, Geneva, Toronto, Johannesburg, Hong-Kong and Singapore.

The boom in vaulting demand comes on the back of what industry executives say is a "new gold market", driven by investors rather than by the jewellery sector.

GFMS, the precious metals consultancy, says investors last year bought more gold than buyers of jewellery for the first time in three decades. Investment demand doubled to 1,820 tonnes, while jewellery purchases fell 23 per cent to 1,687 tonnes, a 21-year low. The change is critical for the networks of vaults because investors tend to buy and to hold their bars and coins, needing vault space for years if not decades, while fabricators of jewellery only use vaults as a short stop-over.

The surge in investor demand has fuelled prices, pushing gold this week to a nominal all-time high of $1,251.20 a troy ounce. Adjusted for inflation, gold prices are still a long way from their record above $2,300 in 1980, however.

Much of this investor demand comes from physically backed exchange traded funds. Bullion holdings of the world's largest ETF, the New York-listed SPDR Gold Trust, yesterday hit a record of 42m ounces, more than the holdings of most central banks. Its gold is stored at an enormous HSBC vault in London.

The rapid growth of gold ETFs, together with investors buying bars and coins, is straining the logistics to store and move physical gold worldwide. "Demand has been strong this year as there has been increased interest from different segments of the client community," a Swiss-based banker says.

Vault space is at a premium in a business dominated by few names. Among them are banks such as HSBC, JPMorgan, The Bank of Nova Scotia, UBS or Credit Suisse, security companies Brink's and Via Mat International and refiner Johnson Matthey.

Some central banks, including the Bank of England and the Federal Reserve Bank of New York, also provide vault space to banks, countries and international institutions, such as the International Monetary Fund. But central banks tend to keep their vaults for themselves, even if space is ample nowadays due to large disposals of gold during the last 20 years, particularly in Europe.

Yet while some bankers say space is available - particularly in Zurich - others still acknowledge problems at times of peak demand, such as now.

The size of vaults is not the main bottleneck. More important is staff - some of which retired years ago and were never replaced as vaulting services languished during the 1990s - and the fleet of armoured trucks to move the gold. "Vault staff are doing overtime, working six days a week," says a senior dealer. Another industry executive says: "[The vaults are] absolutely up to the ceiling. Space is really short."

Frank Ziegler, head of precious metals at BayernLB, says to get enough staff inside the vault is a challenge. "You have to pick and pack the gold - if you have orders which are 300 per cent higher than usual you have not got the manpower," he says. "We have put 20 per cent more people on the vault."

Executives add that the supply of armoured tracks can also form bottlenecks.

Last month alone, banks in London made transfers of 24.7m ounces of gold, a 54.9 per cent monthly rise, the biggest month-on-month jump since these statistics were first produced in 1996, according to the London Bullion Market Association.

Limits imposed by insurers, as prices have risen 85 per cent during the last three years, constrain the amount of gold shipped in planes.

Tight vault space, lack of staff and transportation bottlenecks strain the logistics of moving and storing gold. But the industry is not complaining. Banks and security companies are cashing in on the boom, reaping record fees for storing the precious metal.

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