Market Basics » Gold
Gold is the world's most well known precious metal.
One fine troy ounce generally quoted in American dollars. The unit represents pure gold irrespective of the purity of a particular bar.
Units for delivery
The "London Good Delivery Bar" is the primary unit for international commercial and monetary transactions.
- London Good Delivery Bars must ideally contain 400 troy ounces of gold refined to a purity of 999.9 parts per 1,000.
- Assays of 999.5 and higher must test within ±0.05 parts per 1,000.
- Assays of less than 999.5 must test within ±0.15 parts per 1,000.
- The minimum acceptable gold content is 350 troy ounces.
- The maximum acceptable gold content is 430 troy ounces.
- The minimum acceptable purity is 995 parts per 1,000.
- Length, width and height are specified.
- Each bar must be uniquely identifiable with four marks - serial number, refiner stamp, fineness, and year of manufacture.
A wide variety of bars, coins and jewelry also trade based on local custom and use.
In developed economies the preferred form is a 1 troy ounce coin. In developing markets the preferred form is jewelry.
Primary Pricing mechanisms
Fixings, Spot Market, Futures Contracts, Hedging.
Dealers apply premia or discounts to spot prices based on the demand for, supply of, and form of gold product being traded.
The difference between the prices for sale (ask or offer price) and purchase (bid) is the "spread". Spreads can widen if the market:
- has an imbalance of supply and demand;
- has poor liquidity (is "thinly" traded);
- is inefficient.
Differential spreads apply to different forms.
- Global real yield.
- Real US interest rates.
- US dollar value.
- Reciprocal investments (e.g. conventional equities).
- Crisis hedging.
Sources of gold supply include both mine production and the recycling or mobilizing of existing above-ground stocks. The largest portion of gold supplied into the market annually is from gold mine production. The second largest source of annual gold supply is from old scrap, which is gold that has been recovered from jewelry and other fabricated products and converted back into marketable gold. Official sector sales have outstripped purchases since 1989, creating additional net supply of gold into the marketplace, although the pace of these net sales has slowed sharply in recent years. Net producer hedging accelerates the sale of physical gold and can therefore impact, positively or negatively, on supply in a given year.
It is a truism that nearly all the gold ever mined is available to be mobilized if the price is high enough.
Existing stocks may be broadly divided into two categories based on the primary reason for the purchase or holding of the gold:
- Gold purchased or held as a store of value or monetary asset; and
- Gold purchased or held as a raw material or commodity (e.g. jewelry).
The majority of supply comes from new mine production. Gold is mined from nearly every continent. Output is sensitive to input costs which tend to move in sympathy with the gold price.
Miners contribute approximately 80 million ounces of gold per year.
The largest gold miners by market capitalization, reserves, and production are represented in the MineFund Gold Equity Index (GEX).
Gold also comes from recycled "scrap" (e.g. pawned jewelry, dental fillings), net producer hedging and central bank sales.
Most central bank sales are regulated by the Central Bank Gold Agreement, a voluntary pact among 15 central banks to sell only 500 tonnes per year of gold. The deal expired in September 2009. Before the expiry central banks had become net buyers rather than sellers of gold.
Gold's main source of worldwide demand has traditionally been jewelry, but this has been displaced by investment demand. The metal is also used significantly in the production of consumer electronics. Other industrial uses, including dentistry, make up the remaining demand.
Avenues of trade
The global trade in gold consists of over-the-counter, or OTC, transactions in spot, forwards, and options and other derivatives, together with exchange-traded futures and options.
Most of the trading volume clears through London. This is driven primarily by the "Gold Fix" which is controlled by five members of The London Gold Market Fixing Ltd.
The Fixings are a price clearing mechanism for settling contracts between members of the London bullion Market Association (LBMA). The twice daily fixings have become the global benchmark daily price for gold.
The gold fix is denominated in United States dollars (USD), Pound sterling (GBP), and European euros (EUR). It occurs daily at 10.30am and 3pm, London time, via a dedicated telephone conference facility.
Orders are placed either with one of the five fixing members or with another bullion dealer who will then be in contact with a fixing member during the fixing. The fixing members net-off all orders when communicating their net interest at the fixing. The fix begins with the fixing chairman suggesting a "trying price," reflecting the market price prevailing at the opening of the fix. This is relayed by the fixing members to their dealing rooms which have direct communication with all interested parties. Any market participant may enter the fixing process at any time, or adjust or withdraw his order. The gold price is adjusted up or down until all the buy and sell orders are matched, at which time the price is declared fixed. All fixing orders are transacted on the basis of this fixed price, which is instantly relayed to the market through various media. The London fix is widely viewed as a full and fair representation of all market interest at the time of the fix.
The OTC market provides a relatively flexible market in terms of quotes, price, size, destinations for delivery and other factors. Bullion dealers customize transactions to meet clients' requirements.
The OTC market has no formal structure and no open-outcry meeting place. The main centers of the OTC market are London, New York and Zurich.
Mining companies, central banks, manufacturers of jewelry and industrial products, together with investors and speculators, tend to transact their business through one of these market centers. Centers such as Dubai and several cities in the Far East also transact substantial OTC market business, typically involving jewelry and small bars of 1 kilogram or less. Bullion dealers have offices around the world and most of the world's major bullion dealers are either members or associate members of the LBMA.
Gold also trades in derivative form as "futures"
The most significant gold futures exchanges are the COMEX, the Chicago Board of Trade or CBOT, and the Tokyo Commodity Exchange or TOCOM.
The COMEX and the CBOT both began to offer trading in gold futures contracts in 1974. For most of the period since that date, the COMEX has been the largest exchange in the world for trading precious metals futures and options. Trading volumes in gold futures on the CBOT have, however, sometimes exceeded those on the COMEX.
The TOCOM has been trading gold since 1982.
Trading on these exchanges is based on fixed delivery dates and transaction sizes for the futures and options contracts traded. Trading costs are negotiable. As a matter of practice, only a small percentage of the futures market turnover ever comes to physical delivery of the gold represented by the contracts traded.
Both exchanges permit trading on margin. Margin trading can add to the speculative risk involved given the potential for margin calls if the price moves against the contract holder. The COMEX operates through a central clearance system. On June 6, 2003, TOCOM adopted a similar clearance system. In each case, the exchange acts as a counterparty for each member for clearing purposes.
Gold trades heavily in a securitized form via exchange traded funds (ETFs), also known as exchange traded commodities (ETCs).
ETFs are designed to closely track either spot or futures gold prices. These securities are backed by physical gold bullion held in trust or by allocation.
The most popular gold ETCs include Central Fund of Canada (CEF); SPDR Gold Trust (GLD - formerly streetTRACKS Gold Shares), Gold Bullion Securities, and iShares COMEX Gold Trust (IAU).
Gold also functions a monetary asset used in central bank and private holdings. Market functions are generally based on supply and demand fundamentals and safe-haven investments at times of uncertainty in the U.S. dollar.
The global gold markets are overseen and regulated by both governmental and self-regulatory organizations. In addition, certain trade associations have established rules and protocols for market practices and participants. In the United Kingdom, responsibility for the regulation of the financial market participants, including the major participating members of the LBMA, falls under the authority of the Financial Services Authority, or FSA, as provided by the Financial Services and Markets Act 2000, or FSM Act. Under this act, all UK-based banks, together with other investment firms, are subject to a range of requirements, including fitness and properness, capital adequacy, liquidity, and systems and controls.
The FSA is responsible for regulating investment products, including derivatives, and those who deal in investment products. Regulation of spot, commercial forwards, and deposits of gold and silver not covered by the FSM Act is provided for by The London Code of Conduct for Non-Investment Products, which was established by market participants in conjunction with the Bank of England.
Participants in the U.S. OTC market for gold are generally regulated by the market regulators which regulate their activities in the other markets in which they operate. For example, participating banks are regulated by the banking authorities. In the United States, Congress created the CFTC in 1974 as an independent agency with the mandate to regulate commodity futures and option markets in the United States. The CFTC regulates market participants and has established rules designed to prevent market manipulation, abusive trade practices and fraud. The CFTC requires that any trader holding an open position of more than 200 lots (i.e. 20,000 ounces) in any one contract month on the COMEX division of the New York Mercantile Exchange must declare his or her identity, the nature of his or her business (hedging, speculative, etc.) and the existence and size of his or her positions.
The TOCOM has authority to perform financial and operational surveillance on its members' trading activities, scrutinize positions held by members and large-scale customers, and monitor the price movements of futures markets by comparing them with cash and other derivative markets' prices. To act as a Futures Commission Merchant Broker, a broker must obtain a license from Japan's Ministry of Economy, Trade and Industry, the regulatory authority that oversees the operations of the TOCOM.
Extraction, Processing, Refining & Supply Chain
Gold, a naturally occurring mineral element, is found in ore deposits throughout the world. Ore containing gold is first either dug from the surface or blasted from the rock face underground. Mined ore is hauled to a processing plant, where it is crushed or milled. Crushed or milled ore is then concentrated in order to separate out the coarser gold and heavy mineral particles from the remaining parts of the ore. Gold is extracted from these ore concentrates by a number of processes and, once extracted, is then smelted to a gold-rich dore (generally a mixture of gold and silver) and cast into bars. Smelting, in its simplest definition, is the melting of ores or concentrates with a reagent which results in the separation of gold from impurities.
The dore goes through a series of refining processes to upgrade it to a purity and format that is acceptable in the market place. Refining can take a number of different forms, according to the type of ore being treated. The dore is refined to a purity of 99.5% or higher. The most common international standard of purity is the standard established by the London Good Delivery Standards, described in "Operation of the Gold Bullion Market - The London Bullion Market."
The gold mining company pays the refinery a fee, and then sells the bars to a bullion dealer. In some cases, the refinery may buy the gold from the mining company, thus effectively operating as a bullion dealer. Bullion dealers in turn sell the gold to manufacturers of jewelry or industrial products containing gold. Both the sale by the mine and the purchase by the manufacturer will frequently be priced with reference to the London gold price fix, which is widely used as the price benchmark for international gold transactions.
Some gold mining companies sell forward their gold to a bullion dealer in order to lock in cash-flow for revenue management purposes. The price they receive on delivery of the gold will be that which was agreed to at the time of the initial transaction, equivalent to the spot price plus the interest accrued up until the date of delivery.
Once a manufacturer of jewelry or industrial products has taken delivery of the purchased gold, the manufacturer fabricates it and sells the fabricated product to the customer. This is the typical pattern in many parts of the developing world. In some countries, especially in the industrialized world, bullion dealers will consign gold out to a manufacturer. In these cases, the gold will be stored in a secured vault on the premises of the manufacturer, who will use these consignment stocks for fabrication into products as needed. The actual sale of the gold from the bullion dealer to the manufacturer only takes place at the time the manufacturer sells the product, either to a distributor, a retailer or the customer.
In some cases, the manufacturer may, often for cost reasons, ship the gold to another country for fabrication into products. The fabricated products may then be returned to the manufacturer's country of business for onward sale, or shipped to a third country for sale to the customer.
Gold Data & Information
- MineFund Analytics
- World Gold Council