U.S. Banks Precious Metals Derivative Exposure Surged In The Beginning Of 2017

by Steve St. Angelo, SRSrocco:

According to the most recent report on the U.S. Financial Institutions Derivatives trading activity, the U.S. banks held a record amount of precious metals contracts in the first quarter of 2017. Not only did the U.S. banks report a record amount of precious metals contracts, but they also held an unprecedented quantity in notional value of commodity and equity derivative contracts.

There just seems to be a lot of paper floating around in our highly inflated stock, bond, and Forex markets. And… there needs to be. Without an ever increasing amount of leverage via their derivative bets and hedging, these markets would be in serious trouble. Furthermore, the practice of using contracts to hedge bets upon on other derivative bets has put the financial market in a highly fragile state.

The Office of the Comptroller of the Currency (OCC) put out its First Quarter 2017 Quarterly Report on Bank Trading and Derivative Activities. In that report, they published the following chart on the U.S. Banks’ notional value in precious metals contracts:


As we can see in the chart, the overall trend has continued higher since 2000. What is interesting is that the notional value of precious metals contracts held by the U.S. banks was even greater in the first quarter of 2017 versus Q4 2012 when the prices of the precious metals were much higher.

In looking at previous data, some quarters reported a larger amount of precious metals contracts, which was due to the banks adding short contracts as the price of precious metals increased. However, Q1 2017 of $43.6 billion was up considerably versus the $28.3 billion in Q1 2016.

For example, in Q3 2016, U.S. banks also held $43.6 billion in precious metals contracts. Again, this was due to a lot of short contracts held by the U.S. banks when the gold price surged to a high of $1,366 in the third quarter of 2016. As the gold price sold off over the next several months, the precious metals contracts declined in the fourth quarter of 2016:


We can see this in the last bar on the chart on the right. But what is interesting is the significant increase in U.S. banks’ precious metals exposure in the first quarter of 2017, shown in the first chart above, when the number of short gold contracts the large U.S. banks held declined significantly in the graph below:


Now, this is only showing the U.S. banks’ gold contracts. These contracts do not include other precious metals, such as silver, platinum, and palladium. However, gold is by far the largest market. If we include the FX contracts (forward exchange contracts), the total notional amount is enormous:


The total notional amount of U.S. banks’ FX & Gold Contracts was a stunning $34.5 trillion in the first quarter of 2017, up from $30.7 trillion at the end of 2016.  Here is the definition of a Forward Exchange Contract by Investopedia:

Forward Exchange Contract: A forward exchange contract is a special type of foreign currency transaction. Forward contracts are agreements between two parties.

Forward contracts are not traded on exchanges, and standard amounts of currency are not traded in these agreements. They cannot be canceled except by the mutual agreement of both parties involved. The parties involved in the contract are generally interested in hedging a foreign exchange position or taking a speculative position.

The nature of forward exchange contracts protects both parties from unexpected or adverse movements in the currencies’ future spot rates.

So, these FX Contracts are hedges on the movements of different fiat currencies spot prices. We don’t know the percentage breakdown of the Gold or FX contracts. However, I would imagine the majority being in the FX Contracts that are hedging the different fiat currencies.

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