How Is The Market Price Of Gold Discovered and Determined?

The price of gold is a source of grand curiosity. Everyday millions of people actively check and follow the gold price and their interest can be understood – after all, gold’s main function and purpose IS the value that it holds. Yet despite all this attention, few know or understand where it is that one magical number they see on their favorite gold price source actually comes from. The gold price discovery process revolves around demand and supply like most other commodities and assets but there are several distinctions that exist and need to be understood. We analyze here the two most often mentioned market gold prices which is the fixed gold price and the spot gold price.

Gold Fixed Price

Fixed gold prices (often referred to as the London fix or the Gold fix) are set daily at 10:30 GMT (London Gold AM Fix) and also at 15:00 GMT (London Gold PM Fix) in London where the majority of world gold trading occurs. These fixed gold prices are determined by the London Buillion Market Association (LBMA), which is a trade association encompassing over 100 of the world’s largest banks, financial institutions, and precious metals stakeholders with the task of defining gold & silver standards, good trading practices, standard documentation and the important role of price discovery.

Several of these companies serve as market makers, and have two daily conference calls at fixed times to come to an agreed price. These five companies represent not only themselves but also other members and clients, and the general task is to come to a price which will allow the greatest number of buy and sell orders to be fulfilled. This process can take anywhere from a few minutes up to an hour or more in extreme situations. An initial price is suggested and based on how the 5 market makers react to this price and the orders they have on hand, a price can be reached and agreed upon. Market makers can consult with their clients before accepting the gold price proposed, and different tricks can be employed to shift the price to where not only what their clients want but also themselves. Regardless of the limited room for jockeying around and negotiation tactics between the market makers, a fair fixed gold price is reached (in US Dollar, Euro, and British Pound) providing both liquidity to the over-the-counter (OTC) sales of gold and serving as guidance to the spot price. Fixed gold prices in New York, Dubai and other regions exist but are less frequently quoted anywhere outside the local market.

Gold Spot Price

The most widely used price of gold is the spot price, which is the price of gold at the present moment. This is most likely the price you see quoted on your favorite gold price website or the price that’s used as a base for determining prices at your local gold shop. While fixed gold prices serve as a guideline for spot prices, especially at 10:30 AM and 3PM GMT after having just been set, a myriad of new factors and developments then come into play for the rest of the day which the general market reacts to and which causes the price of gold to fluctuate throughout the day.

Remember how at the beginning we said the gold price is determined by demand and supply, well that can be misleading if we look at the gold demand and gold supply numbers that are officially quoted. Yearly gold demand and supply is around 4,000 metric tons. Yet this is only a minuscule fraction of the gold volume that is traded in a year. Recent findings show that more than 4,300 tons are being traded EVERYDAY in the gold markets around the world in London, New York, Shanghai, India, Japan, Dubai. Almost 80% of this volume occurs in London OTC markets, but these private deals are not where the majority of price discovery happens (remember that these, if anything, primarily affect the London fixed price). Instead gold futures markets around the world are where most often the gold price is actively being discovered and consequently quoted to you when you want to make an immediate purchase.

gold trading by country

The reason why gold futures prices generally lead and determine the spot prices, instead of the other way around as you would expect is because of several factors. The gold futures market, while much smaller than the OTC market, is still much much larger than the spot market. Besides the size and scope of the futures market, it also benefits from being a much better environment to capitalize on gold price movements due to immediate liquidity, speed of transactions, ability to use leverage (which speculators especially love), and the option to delay delivery. Very little gold actually trades hands in the futures markets, it’s more of a tool used by hedgers and speculators. So traders on the gold futures markets around the world are the first to react to the latest developments, this shows in the bid-ask price (the price at which a person wishes to buy or sell) movements and the price of the most recent transactions. The spot price is therefore derived from these futures transactions and when you look at the current immediate price, it’s generally quoted as the latest price at which the last exchange was made on the world futures markets. To ensure integrity, the most recent active futures month is used because some futures months have low liquidity and possibly don’t reflect the true sentiment of the general market.

Gold price discovery

Trades in the NY COMEX engage in open outcry to quickly match buy and sell orders from various clients, which then get recorded and transmitted electronically to the rest of the world.

So which futures market ends up having the most impact on the price of gold? This is a tough question to answer and the topic of many academic papers. The general feeling seems to be that there is no dominant place where gold price originates, although a general flow does happen with London fixed prices setting the price when they are set, followed by the New York COMEX taking over, with Asian exchanges like the Shanghai Futures Exchange closing out the day. With the different operating hours of these global markets, and tech trading platforms like Globex, gold is traded practically 24 hours a day on week days.

Other Gold Price Specifications

It’s important to remember that these fix and spot prices that you see being quotes on websites or newspapers will in the most part not be available to you, the small time retail investor. The futures contracts generally follow a specific set of guidelines to make things easy for all traders – such as a set weight and purity and conditions. 100 troy ounce bars are often traded in Western markets with minimum purity of .995 (~24 Karat). Access to trade on these markets requires a specific account and plenty of money, so it’s not very convenient for an average investor especially when you consider that delivery and storage costs are not included and need to be self-arranged through a strenuous process. So when you buy from your local shop, don’t be surprised to being paying a premium over these quoted spot prices because the smaller bullion size, lower trading efficiency, overhead costs all need to be added which your local retailer will naturally pass on to you. There is no set way to measure the gold price premium as each seller will have their own set of costs and margins.

Having said, the premium is not that much if you shop in the right places and the spot price should give you a good idea on how much you should be paying depending on the purity and weight in question.

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