How the gold price is really set has been picked over by different analysts for many years, with vigorous debate about gold price discovery and the difference between paper and physical gold.
For investors new to the gold investment market, understanding price discovery is crucial and made more tricky by the nature of the opaque and unusual gold market.
How is the price of gold really established?
Gold price discovery mainly occurs in two major Western markets: COMEX in New York and the huge and secretive London market.
The COMEX is the world’s central gold trading exchange, where 80% of the world’s futures contracts are traded. COMEX market participants are typically institutions, funds and professional traders with limited activity from retail clients who find the contract size a little restrictive.
However, with concerns that there is not enough bullion in the vaults to allow all COMEX contracts for paper gold to be delivered upon, the integrity of this exchange has been put in the spotlight. Some investors now question whether COMEX is a good mechanism for buying gold, preferring to buy bullion in physical form instead from a different market.
What’s behind the smoke and mirrors of the London gold market?
Gold investing analysts also look at the London gold market as the next key liquidity hub for setting the international gold price. Whilst the London market is five to twelve times larger than COMEX, it’s secretive nature, opacity and lack of transparency, mean its less trusted for setting global prices. The price of gold is set in London behind closed doors, twice each day, in trading sessions that result in the ‘AM fix’ and ‘PM fix’. The fixings occur when the largest bullion banks match up their respective client books and agree what is supply and demand for the market that day. These fixing sessions have been going on for many decades.
Due to the lack of publicly available data, the London gold market is often criticised for for its poor transparency compared to other markets and investment mechanisms. This pressure has yet to change the way the gold market works though.
Nonetheless, the London market shares almost equal influence with COMEX in setting prices around the world, with influence and price setting moving like a swinging pendulum between the two markets.
New Asian demand means a new future for gold price discovery
Whilst these two gold markets have dominance today in how the price of gold is established, new, growing demand from Asia is affecting the market in interesting new ways. New markets and solutions are therefore emerging to better serve this Asian demand that finds the Western status quo in the market less than favourable.
New Asian investors in gold are concerned that Western markets set prices too much based on paper gold trading, without enough connection to physical bullion, meaning that they feel their market participation is not being accurately reflected enough in pricing gold.
We now face a fascinating future where Asian buyers, who prefer buying physical gold, are battling with Western speculators and traders to set prices. In the next few years we might see wholesale changes to how gold price discovery occurs around the world.