Investor’s Guide to the Gold Market and Gold ETFs | The World Gold Market (Part 1/5) | RMAU
Few metals have captured the imagination of humanity like gold – it is a currency, an object of obsession, a sign of royalty and wealth, and the star of innumerable legends and fables worldwide. Gold’s appeal transcends age, culture, politics and time.
Gold is virtually indestructible, is used for many purposes and is relatively scarce. Gold has always been viewed as a way to store wealth and in recent years, golds role as an investment asset has become increasingly significant is now a cornerstone asset for any multi-asset portfolio.
How much Gold?
The best estimates currently available suggest that around 193,472 tonnes of gold (1) have been mined throughout history, of which around two-thirds has been mined since 1950. And since gold is virtually indestructible, this means that almost all of this metal is still around in one form or another.
But there’s not much of it: if every single ounce of this gold were placed next to each other, the resulting cube of pure gold would only measure around 21 metres on each side. (2)
Supply & Demand: Drivers of Gold Prices
Gold is often used as a safe-haven asset since gold price performance often stays stable, or rallies in times of market uncertainty. Gold is both pro-cyclical and counter-cyclical. Investment drivers tend to influence heavily short- and medium-term gold price performance.
But long-term price dynamics respond to consumer demand, long-term savings, central bank demand and supply dynamics.
The Over-The-Counter Gold Market
Gold is traded in spot, forwards, options and other derivatives in the Over-The-Counter (OTC) market on a continuous basis. Gold futures, options and ETCs are also traded on exchanges. The OTC gold market is among the largest and most liquid of all asset classes and accounts for most of the world’s gold trading. The OTC gold market is relatively flexible, with bullion dealers often customising price, size, quotes and delivery destination for their customer transactions.
12 Market Makers in LBMA
There are 12 market makers in the LBMA (4): BNP Paribas, Citibank,Goldman Sachs, HSBC, ICBC, JP Morgan, Merrill Lynch,Morgan Stanley, Standard Chartered, Bank of Nova Scotia,Toronto Dominion and UBS.
The majority of OTC gold trading occurs in London, Zurich and New York with substantial amounts of business also transacted in the Middle East and Asia. Gold is a truly global business and while many bullion dealers have offices throughout the world, the majority are members of the London Bullion Metals Association (LBMA). As of December 2019, the LBMA has 86 Full Members and 53 Associate Members located all around the world.
Loco London and Loco Zurich
‘Loco London’ and ‘Loco Zurich’ refers to gold bullion that is physically stored in vaults in London or Zurich. To be accepted,the gold must meet rigorous standards of purity, weight and identifiability. Bars that meet these specifications are known as LBMA ‘London Good Delivery’ bars. The high standard of ‘London Good Delivery’ bars means they are a de facto international standard and are accepted for delivery in Zurich, New York and other gold trading centres.
As the Loco Zurich and Loco London specifications are very similar, LBMA Good Delivery Bars physically stored in Zurich can be quoted ‘Loco London’. If there is not enough physical gold in London to meet demand, gold can be flown in from Switzerland or vice versa.
Who Sets the Price of Gold?
The global gold market operates 24 hours a day across Europe, North America and Asia, but the primary pricing data source is known as the ‘London fix’. During the London trading session there are two ‘fixes’ that provide the market with a benchmark price for portfolio valuations and derivative contracts – one in the morning and one in the afternoon. Most asset managers will use either the morning or afternoon fix as the basis for their valuations, risk management and research.
Up until March 2015, the gold price was set by the consensus of LBMA members over telephone. This system was replaced by the LBMA and the gold price is now calculated electronically by ICE Benchmark Administration. In March 2015 the previous consensus-based system was updated and replaced by the LBMA and the gold price is now set electronically, administered by ICE Benchmark Administration (IBA), the leading provider of regulated benchmarks for numerous international financial and commodity exchanges.
Security & Standardisation
LBMA members may store gold in their own vaults, or use those of another company. Clearing services are offered by some LBMA members who use a daily clearing system whereby unallocated gold is used to settle trades and third-party gold transfers. This system helps reduce the cost and security risk involved in physically transferring gold from one location to another.
The Difference Between Allocated and Unallocated Gold Accounts:
An allocated account is an account held by a gold dealer on behalf of a customer. Gold held in an allocated account will be identifiable via a unique serial number so the investor knows exactly which bars they own. These accounts are segregated from other clients and are held separately from other metals stored in the dealer’s vaults. The customer has full ownership of the physical gold, with the dealer acting as custodian. In contrast, an unallocated account does not entitle the customer to specific gold bars. Instead, the customer is entitled to a set amount (weight) of gold. Most gold traded in London and Zurich is held on an unallocated basis.
‘London Good Delivery’ Bars
The ‘London Good Delivery’ bar is the de facto international standard for quality. A bar of gold must meet stringent standards of purity/fineness, weight, dimensions and shape to be considered ‘London Good Delivery’. Only bars that meet these standards can be used in the settlement of a gold trade in the OTC London gold market.
‘Good Delivery’ bars are often called ‘400 oz bars’ and contain between 350-430 fine troy ounces of gold and will also have a minimum ‘fineness’ or purity of 99.5%. Each bar has a unique serial number and year and bears the stamp of an LBMA approved smelter. Every gold bar that enters the clearing system is controlled by the clearing inspector for conformity to the‘Good Delivery’ standards. The gold spot price refers to a ‘Good Delivery’ bar unless otherwise stated.
A London ‘Good Delivery’ bar will, by definition, comply with the LBMA’s Responsible Gold Guidelines (5). This ensures the gold used in bars, and the gold supply chain is sourced post 2012 and complies with anti- money laundering and anti-terror financing legislation and is not sourced from mines and companies located in high risk areas in terms of human rights, environmental impact or conflict. LBMA members are required to have an auditable process to ensure the guidelines are met.
View part two of the Investor’s Guide to the Gold Market and Gold ETCs and find out about 'Buying Gold'.
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Download the full whitepaper "Investors Guide to the Gold Market and Gold ETCs" here.