The price of gold became the protagonist of the media, including the generalists, at the end of last July and beginning of August, when it exceeded its previous historical record and, a few days later, it crossed the historical barrier of 2,000 dollars an ounce. However, it must be borne in mind that there are at least three different prices for the precious metal. In this post we are going to explain why there are different prices and what their differences are based on.
When gold exceeded $1,940 an ounce at its maximum record, on July 27, we were referring to the so-called spot price . It took a few more days, until August 4, for the so-called fixing price to also exceed its all-time high, which was $1,895 an ounce in September 2011.
Why are there different prices and have different levels, although similar? To explain it, we are going to resort to the Mises Institute , an American ‘think tank’ based on the Austrian school of economics and on libertarian theory.
The Three Gold Markets
In the blog of this institution, Keith Weiner explains that “when someone asks about the price of gold, the answer depends on which gold market they are referring to” .
Indeed, there are different gold markets, in which the metal reaches different prices, although close enough so that the differences are almost insignificant.
These three markets are the spot (also called LOCO London); the futures market or COMEX; and the physical market, which is governed by the London Bullion Market Association (LBMA) fixing price .
These are three different markets, in which there are different buyers and sellers, different supply and demand balances, and different prices. These prices are usually very similar, although they are not exactly the same.
The spot price is formed by two magnitudes in constant movement: the purchase price or ‘bid’ and the sale price or ‘ask’, which is usually slightly higher.
These two prices are formed from the average of the prices of physical gold in the banks that trade with it, and which are compiled by specialized agencies such as Bloomberg or Reuters .
The most important thing is that it is not a single price, but rather the average of the prices handled by all the banks that are operating with gold at the same time throughout the world.
The COMEX price refers to that of the so-called gold futures contracts. These contracts are agreements between two parties for the purchase and sale of gold under certain conditions (amounts and prices) that are decided at the time of the agreement, but that will be executed at a future date (hence their name).
On that date is when the exchange will take place: when the buyer pays and the seller delivers the gold. The most common is that these agreements are made three months ahead. Therefore, when referring to contracts, reference is made to the expiration date.
The COMEX name is short for Commodity Exchange Inc , which is the world’s largest market for metal futures, primarily gold, silver, copper, and aluminum.
Founded in 1933, during its first four decades of existence it was dedicated to trading silver, copper and aluminum futures contracts, since gold could not be in private hands since Executive Order 6102 issued by Franklin D. Roosevelt in 1933. , which prohibited private possession of physical gold by US citizens.
This ban was maintained until 1974 , when it was repealed by then President Gerald Ford . In that year, the COMEX launched its first gold futures contract.
In 1994, the Commodity Exchange Inc. and the New York Mercantile Exchange merged, creating the world’s largest futures exchange, bringing together investors from around the world.
The price of futures contracts (and this is another notable difference from the other two) is the most susceptible and the first to react to geopolitical and economic events that are usually factors for the price of the metal to rise or fall.
The physical gold market is governed by the fixing price which, as its name suggests, has been set twice a day by the London Bullion Market Association (the London gold market), since September 12, 1919.
In another post on this blog we already explained how the London fixing originated , its history and its current operation, which is based on the agreement between the 15 main operators , based on the purchase and sale orders they have from their customers.
The differences between the highest price and each of the other two are called ‘spreads’ . The wider these are, the more chances there are for traders to trade which, in turn, causes prices to move closer again. Therefore, the business is better for traders the wider the ‘spread’.
Normally, the price of gold in futures contracts is higher than the spot , since it must include the cost of physical gold custody until the time of delivery, which, as we have seen, is usually three months.
It can also happen that the price of futures contracts falls below the spot price. This phenomenon is called ‘backwardation’ and it is very rare in the case of gold, since it means that the metal with immediate delivery (spot price) is more expensive than that with future delivery.
This situation may be logical in the case of other raw materials, since it simply means that there is a shortage due to the increase in demand. However, gold is never consumed , so this concept cannot be applied to it. In addition, the aforementioned storage costs must be taken into account.
The opposite situation, that is, the usual one (spot price cheaper than futures) is called ‘contango’ , and it is the situation that occurred in April, when the closure of refineries and the interruption of air transport caused a shortage of 100-ounce bullion on the COMEX that triggered the price of futures contracts to a ‘spread’ compared to the spot price never before seen.
In the case of spot and fixing, the ‘spread’ is even more volatile than between spot and futures. This is because it is difficult to increase the production of physical gold to respond to a sudden increase in demand.
Thus, when demand from small investors increases, what happens is that the premium paid over the spot price of the gold it contains rises. A premium that is usually 5% and that, in cases of shortages, rises to 10% or more, apart from the fact that the delivery date is delayed.
This was also the case during the past months of March and April, when retail investors flocked to buy coins and small gold bars to protect themselves from the economic crisis caused by Covid-19.…