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How is the Price of Gold Determined?

In theory, the price of gold is determined - a process known as “price discovery” - by market participants who buy and sell physical gold for shorter-term profit, longer-term investment, or for use in jewelry and industrial applications. Such a gold trading market would be like any other market — the stock market, housing market, bond market, or the market for commodities such as wheat and crude oil. Like all markets, the price of gold would rise and fall based on the forces of supply and demand. If demand for gold was greater than the supply, the price of gold would rise; conversely, if the supply of gold was greater than the demand for it, the price of gold would fall.

However, in practice, the price of gold is not determined by physical supply and demand but by the trading venues that generate the highest trading volumes. These are the Over the Counter (OTC) LBMA London Gold Market where synthetic unallocated gold contracts are traded), the COMEX gold futures market (where gold futures contracts and other gold derivatives are traded). It is estimated that these two markets account for 85% of the world’s gold-related trading volume. These venues create the international price for gold (which is quoted in US dollars). Smaller local gold markets around the world use the international price of gold to set their prices. The LBMA and COMEX markets are price makers. The other smaller markets are price takers.

Note that unfortunately, the price discovery process for gold and silver has been corrupted and distorted by the explosion of “paper” or synthetic gold and silver in the form of futures, options, swaps, and exchange traded funds that are not fully backed by actual physical gold and silver. At the moment, the amount of synthetic gold and silver in existence completely dwarfs the amount of physical gold and silver in existence. Paper gold and silver supply has flooded the market, which has had the effect of suppressing precious metals prices. In a genuine and fair precious metals market, physical precious metals prices would be much higher than they currently are.

Spot Trading vs. Futures Trading

Gold trades in two primary ways: in the spot market and the futures market. The spot market refers to trading in gold that can be bought or sold in the wholesale market for immediate delivery and short-dated settlement. Gold is typically traded in unallocated form the spot market in amounts of 5,000 to 10,000 troy ounces. The spot price of gold is quoted during normal trading hours by market makers who facilitate the trading of gold. Most spot trading of gold occurs on The London Gold Market, which is not a typical exchange-based market, but an over-the-counter (OTC) gold market in which participants trade via phone, broker, or electronic platforms.

The gold futures market, on the other hand, refers to the trading of gold futures contracts that are a derivative of the price of gold. A gold futures contract specifies the delivery of a pre-defined quantity of gold at a certain date. A buyer of a gold futures contract agrees to take delivery of the gold prior to the contract’s expiration, while a seller of a gold futures contract agrees to deliver the gold to the buyer prior to the contract’s expiration. Traders can close out their futures contracts if they don’t intend to deal with the physical delivery of gold, which is what occurs most often.

Though futures may sound very complicated, their use is much simpler in reality. Gold futures prices track spot prices almost identically, so gold futures are often used as a practical way for traders and investors to gain exposure to gold prices without worrying about the shipping or storing of physical gold. Due to this fact, gold futures, like unallocated gold, are often considered to be a form of “paper gold.” The majority of gold futures trading is conducted on the COMEX exchange, where the typical futures contract represents 100 ounces of gold.

Gold Trading Hours

- The London Gold Market trades from 8:00 am to 4:30 pm, London time

- LBMA Gold Price auctions occur twice daily at 10:30 am and 3:00 pm, London time

- COMEX gold futures trade electronically all day, from 6:00 PM Sunday to 5:15 PM Friday, New York Time

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