Decades of destructive monetary policy have finally raised the curtain on the fiat money charade. With central banks worldwide going all in on indefinite quantitative easing (QE) programs, a growing crowd of investors and everyday citizens alike is seeing beyond the popular headlines and witnessing the unraveling of the paper-money scheme. The debasement of paper currencies has attracted many investors to gold, and though they may understand the driving forces behind the price of gold, few investors understand the nuances of how gold's market – or spot – price is actually set.
Like other commodities, the market for gold is best reflected in the futures market, wherein contracts trade on the basis of future delivery and payment. Sticking to its roots, the modern futures market offers miners, refiners, and manufacturers of gold the ability to lock in existing commodity prices, thereby allowing them to hedge against price gyrations. Perhaps more infamously, the futures market is also exploited by speculators who trade gold in the hopes of profiting from price fluctuations while having no intention of ever delivering and receiving the actual commodity.
Unlike the futures value, the spot price represents the explicit value of gold at a given moment with the presumption of immediate payment and delivery. Though the markets differ starkly, the futures market is still the primary benchmark for the spot gold price since most trading is facilitated through the electronic markets rather via physical exchange.
In rather archaic fashion, the gold price is established each morning in London by representatives from five international investment banks. The procedure, known as the London Fixing, traces its roots back to September 12, 1919, when the Rothchilds and four other prominent English bullion banks set the first-ever gold spot price.
Over the years, the process has changed little. The price is still determined at 10:30 GMT and 15:00 GMT each trading day by members of the London gold Market Fixing Ltd.: Barclays Capital, Deutsche Bank, Scotia-Mocatta, HSBC, and Société Générale.
The fixing commences when the chairman of the association announces an opening price – or the current market price – to the other members. The price is then relayed to the banks' customers, whose orders dictate whether each bank is a buyer or a seller and how many 400-oz. gold bars the bank will trade. If the opening price does not strike a balance between the number of buyers and sellers, the chairman will adjust the price until equilibrium is achieved, which occurs when the number of requested bars is within 50 of the counterparty's requested amount. At that point, the chairman declares the fixed price in fine troy ounces.
After the London Fixing, the spot gold price is determined next on the Commodity Exchange, Inc. (COMEX) – a division of the New York Mercantile Exchange – through a live auction in which the market price is equated by looking at the futures price of the most active nearby contract month, also known as the spot month.
The opening of the Comex market at 8:20 a.m. (ET) coincides with the London fixing, which thereby provides a starting point for gold trading on the Comex. The trading continues until 1:30 p.m. (ET). During the final two minutes of the trading day, the closing price is determined based on the average price of gold futures for the most active nearby month. Though gold futures contracts are linked to 100 troy-ounce bars, the daily Comex spot price is reported as the price per troy ounce.
The global market for gold and its interrelation with the futures market results in a highly liquid yet volatile price of gold. Although it may seem strange that the spot gold price is set in just two cities (New York and London), one must remember that gold (and silver) are traded globally around the clock. In fact, gold is traded on numerous exchanges across the planet and is increasingly becoming denominated in currencies other than the US dollar.
The gold spot price acts as the starting point for gold coins and bars. The operative phrase here is "the starting point," because bullion dealers generally mark up physical gold products to cover costs and allow for a profit. Similarly, the market price is the benchmark for the pricing of a majority of electronic, paper gold products and derivatives throughout the world. Exchange-traded funds (ETFs), like the popular GLD, incur operating expenses similar to bullion dealers. Therefore, most ETFs trade at a slight discount to the metal's spot price. Another reason for the spread between the price of physical bullion and paper gold products versus the spot price is that both the London Fix and Comex's market prices are wholesale prices, and thus a noticeable spread is to be expected.
With respect to gold's spot price, finding the lowest spread is key. This can be achieved by buying in bulk and shopping around for the best deal, but this entails being keenly aware of the current spot price. An investor in physical bullion should be sure to only do business with reputable bullion dealers. Last, it is imperative to take care of your metal since blemished or even just dirty items will likely sell at discounts relative to well-maintained products.
Doing these things along with buying and selling at the "right" price are the fundamental ways to maximize one's investment in gold.
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