Some questions for bullion dealers
AboutAg
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I have a couple of questions aimed at bullion dealers.
First, what exactly is a "repo" account in the bullion world, and how would it typically work (e.g. why would someone use it)?
Second, why would bullion dealer to pay a fee for an option to buy metal at market price? e.g. you pay a company a fee, they buy gold and have it in their possession, and you have "the right to purchase it at market price."
Thanks in advance for any help here.
First, what exactly is a "repo" account in the bullion world, and how would it typically work (e.g. why would someone use it)?
Second, why would bullion dealer to pay a fee for an option to buy metal at market price? e.g. you pay a company a fee, they buy gold and have it in their possession, and you have "the right to purchase it at market price."
Thanks in advance for any help here.
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Comments
<< <i>Second, why would bullion dealer to pay a fee for an option to buy metal at market price? >>
Options are often used to offset the risk of a dealer trade. Say a dealer makes are large gold purchase and does not want to risk a fall in the market before he can sell off the bullion. By purchasing a put option at the current metal price his exposure is minimized.
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<< <i>Second, why would bullion dealer to pay a fee for an option to buy metal at market price? >>
Options are often used to offset the risk of a dealer trade. Say a dealer makes are large gold purchase and does not want to risk a fall in the market before he can sell off the bullion. By purchasing a put option at the current metal price his exposure is minimized. >>
Sorry, I should have clarified. In your scenario, if spot is $1,200 today, you would later refer to it as having the option to buy at $1,200. But I'm referring to a case where later you would refer to it as an option to "buy at market price." (e.g. "Last year I had the option to buy 100oz of gold at market price"). My interpretation is that the dealer would have the option to buy it at the market price the day he buys it (but I cannot see why anyone would pay to enter such a transaction).
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<< <i>Second, why would bullion dealer to pay a fee for an option to buy metal at market price? >>
Options are often used to offset the risk of a dealer trade. Say a dealer makes are large gold purchase and does not want to risk a fall in the market before he can sell off the bullion. By purchasing a put option at the current metal price his exposure is minimized. >>
Sorry, I should have clarified. In your scenario, if spot is $1,200 today, you would later refer to it as having the option to buy at $1,200. But I'm referring to a case where later you would refer to it as an option to "buy at market price." (e.g. "Last year I had the option to buy 100oz of gold at market price"). My interpretation is that the dealer would have the option to buy it at the market price the day he buys it (but I cannot see why anyone would pay to enter such a transaction). >>
I am not familiar with that type of option and agree, why would any one pay for it?
I think it is safe to say that the person who gave me this information was intentionally trying to be deceptive and "clever" (while at the same time claiming to be disturbed by my failure to understand what he was talking about).
"Interest rates, the price of money, are the most important market. And, perversely, they’re the market that’s most manipulated by the Fed." - Doug Casey
<< <i>Thank you both for your input.
I think it is safe to say that the person who gave me this information was intentionally trying to be deceptive and "clever" (while at the same time claiming to be disturbed by my failure to understand what he was talking about). >>
Or that person is just an ahole, and generally has social issues. We have a person in our circle of friends that despite the advice we give him can't stop being an ahole. Slowly but surely we invite him less and less to parties, poker, etc...
Successful card BST transactions with cbcnow, brogurt, gstarling, Bravesfan 007, and rajah 424.
Repos are used for short term borrowing (secured with an asset, so your borrowing cost is lower).
Perhaps, if there is a liquidity problem, you would pay to have an option to purchase at market price (depending on the definition of market price). Maybe, if you're looking to buy $10 eagles in the future but you're concerned that no one will want to sell eagles at that time, you might pay to have that option. But how do you determine the market price of something when no one is selling?
You essentially store (some of) your inventory with the wholesaler, who pays you for it, and you have the option of buying it back. This setup, while it has costs associated with it, avoids you having to pay spreads both on buying and selling, and avoids exposure to changes in the spot price.
Let's say I'm a bullion dealer. I set up shop near a bullion wholesaler. I start out with 5 monster boxes of silver eagles, and would like to always have that much in my store.
On my first day of business, I sell all 5 monster boxes of silver eagles in my store (and get $51,000 cash for them), and buy 100 1-oz gold eagles from a customer (who I promise to pay $119,000 by tomorrow).
I call up the wholesaler, and say "I'd like to buy 5 monster boxes of silver eagles to replenish my stock in the store, and here's 100 1-oz gold eagles, could you pay me for the gold eagles but set them aside for me to buy later?" I stop by, give them the 100 1-oz gold eagles, and pick up my 5 monster boxes of silver eagles. The 5 monster boxes of silver eagles cost me $50,000, the wholesaler pays me $120,000 for the gold eagles. So when I drop off the metal, they hand me a check for $70,000 ($120,000 minus the $50,000 for the silver). I pay my customer his $119,000.
At the end of the day, I have the same amount of metal, with a $2,000 profit. BUT, I also have 100 1-oz gold eagles sitting in storage, that I can buy in the future for whatever the spot price happens to be.
The advantage of this system (repo account) over strict buying/selling is that it could cut down on the spread. If I were to get an order on my second day for 100 1-oz gold eagles, rather than buy them at spot+$30 each from the wholesaler, I just say to the wholesaler "I want to pay for my inventory now." I pay them whatever spot happens to be that day. So instead of paying a $30 spread ($3,000 for 100 coins), the spread could be eliminated. And there is no market risk (unlike those monster boxes that will be worth half price tomorrow if spot goes down that much).
In exchange for this service, you would have to pay storage fees, and some other fee(s) to account for eliminating the risk (the wholesaler likely buys futures or something else to cover them against the loss).
<< <i>I think I'm starting to understand how it all works.
You essentially store (some of) your inventory with the wholesaler, who pays you for it, and you have the option of buying it back. This setup, while it has costs associated with it, avoids you having to pay spreads both on buying and selling, and avoids exposure to changes in the spot price.
Let's say I'm a bullion dealer. I set up shop near a bullion wholesaler. I start out with 5 monster boxes of silver eagles, and would like to always have that much in my store.
On my first day of business, I sell all 5 monster boxes of silver eagles in my store (and get $51,000 cash for them), and buy 100 1-oz gold eagles from a customer (who I promise to pay $119,000 by tomorrow).
I call up the wholesaler, and say "I'd like to buy 5 monster boxes of silver eagles to replenish my stock in the store, and here's 100 1-oz gold eagles, could you pay me for the gold eagles but set them aside for me to buy later?" I stop by, give them the 100 1-oz gold eagles, and pick up my 5 monster boxes of silver eagles. The 5 monster boxes of silver eagles cost me $50,000, the wholesaler pays me $120,000 for the gold eagles. So when I drop off the metal, they hand me a check for $70,000 ($120,000 minus the $50,000 for the silver). I pay my customer his $119,000.
At the end of the day, I have the same amount of metal, with a $2,000 profit. BUT, I also have 100 1-oz gold eagles sitting in storage, that I can buy in the future for whatever the spot price happens to be.
The advantage of this system (repo account) over strict buying/selling is that it could cut down on the spread. If I were to get an order on my second day for 100 1-oz gold eagles, rather than buy them at spot+$30 each from the wholesaler, I just say to the wholesaler "I want to pay for my inventory now." I pay them whatever spot happens to be that day. So instead of paying a $30 spread ($3,000 for 100 coins), the spread could be eliminated. And there is no market risk (unlike those monster boxes that will be worth half price tomorrow if spot goes down that much).
In exchange for this service, you would have to pay storage fees, and some other fee(s) to account for eliminating the risk (the wholesaler likely buys futures or something else to cover them against the loss). >>
It seems to me that you sold the 100 gold eagles outright for $120,000 so why do you think that you have any claim to ownership? If spot goes down $15 overnight why do you think that they would sell them back to you at a loss?
<< <i>It seems to me that you sold the 100 gold eagles outright for $120,000 so why do you think that you have any claim to ownership? If spot goes down $15 overnight why do you think that they would sell them back to you at a loss? >>
You sold the 100 gold eagles for $120K, yes. But per your contract, they keep them in segregated inventory, for you (at a cost to you). The wholesaler would presumably have ownership in this scenario, as they paid you for it (but not necessarily -- it could be listed as a 'loan' for example, to be paid back later).
If spot goes down $15 overnight, the value of those gold eagles goes down $1,500. But, their hedging gains $1,500. So you would pay $1,500 less to buy back the 100 gold eagles, and they would get $1,500 by closing out whatever hedging position they had.
They pay for that hedging position, but you pay them a fee for this repo account, which covers that cost of theirs.