Part I- The Spot Market
A spot market, is the cash market for a physical good or commodity that is available for immediate delivery. The modern spot market has evolved away from actual physical transfer of goods and relies instead on clearing firms that guarantee the transactions made by traders. Even with the backing of a clearer, it is unusual for spot traders to physically transfer goods. Instead electronic debits and credits allow ownership of valuable and/or unwieldy goods (for example gold and oil, respectively) to change from one person to another, without the danger, risk and hassle of actual transfer of the goods.
Gold is a special case and the market for bank-sized transfers of gold is wrapped in tradition and justifiably shrouded in secrecy. Because of the value of gold and its compact size, banks are understandably reluctant to disclose their procedures and security methods. However, many of the security protocols for physically transferring gold are never used. Most gold simply sits inside very secure vaults and never sees the light of day. There is simply too much risk in physically exposing gold to an insecure environment for any length of time.
While gold is traded actively in the futures market, the spot market and the London over-the-counter (OTC) market most of the gold traded only moves from one electronic account to another. A typical bar of gold weighs 400 Troy ounces (which is approximately 27.5 pounds) and at $1400/Troy ounce, costs $560,000. The gold trading organizations who trade the London fix and who participate in the OTC market are often transacting hundreds of bars of gold at a time.
This represents a very large nominal amount of dollars, but remember that many of these transactions balance out over a long-enough time frame. While the debits and credits of gold transactions change the electronic ownership of many gold bars, the trading organizations transfer mostly cash to make good on intraday profits and losses.
These large-scale gold traders are all very well known to one another. In fact, this is one of the bigger criticisms of the gold spot market. The primary gold dealers are so well known to one another, there is strong belief that they collude against the end users of gold and fix prices at unfair levels. While the idea is credible, the London gold dealers are neither the only nor primary gold dealers. The worldwide gold market is so varied, deep and liquid that it strains credulity to believe that any collusion could meaningfully distort market prices. There would be too much incentive for some member of the collusion to cheat and undercut the cabal.
Part II- The London Fix
From the late 1600s until WWI, large amounts of gold were primarily traded in London and Zurich, although the London market is preeminent. On the 12th of September 1919 at 11.00am (London time) the first Gold Fixing took place. The Fixing is a twice-daily setting of the price of gold by a five member committee of gold buyers and brokers. The original five founding members were: N M Rothschild & Sons; Mocatta & Goldsmid; Samuel Montagu & Co.; Pixley & Abell; and Sharps & Wilkins.
Prior to 1971, gold was not traded in an active and liquid market. In fact, gold was rarely traded at all. Instead it was held by central banks as a reserve for their currencies. Gold was used as the “Gold Standard” for currencies and its price was arbitrarily set at some notional value of a currency. Prior to WWI, the currency of Great Britain was the principal reserve currency of the world and gold was set in Pounds Sterling (GBP). Between WWI and WWII, the “greenback” became the world’s primary reserve currency and the price of gold was set in US Dollars (USD).
Until 1971, the price of gold was fixed or set at $35 per ounce. With the price of gold fixed at an arbitrary value, currencies would shift back and forth in relation to one another based on their relative values. For example, the GBP/USD relationship, if one needed more GBP to buy the same amount of gold, then the USD was said to be strong relative the GBP. When the US abandoned the Gold Standard, it no longer held reserves of gold to back the dollar, the price of gold was allowed to fluctuate freely and quickly rose to a high of $850/ounce. The old high of $850/ounce was reached in the London Fix on January 21, 1980.
London gold fixing became prominent after the price of gold was freed to fluctuate. The fix happened twice daily by meeting and later by conference call. This was a simplified and, no doubt very gentlemanly, method of price discovery. The five participants would conduct a sort of auction, beginning with the previous fix price, they chairman would offer the price for buyers and sellers and move the price up or down until the buyers were matched as evenly as possible with the sellers. The Fixing committee deals in 400 Troy ounce bars of gold.
Because the price Fixings often deal in large volumes of gold they have a great ability to move the price of gold, however most sellers are met with buyers and vice-versa. They do not enter the market alone and try to move 10,000 ounces of gold without warning. The Fixings do not happen in a vacuum and other gold markets help inform the committee about the price of gold. The current five members of the fixing committee are: Barclay’s Capital; Deutsche Bank; Scotia Mocatta; HSBC; and Societe Generale.
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