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How the Gold Market Works

January 10, 2012

What we call “the gold market” is actually a network of exchanges around the world where gold is traded as a commodity. What is traded on these markets is not actual gold but contracts, or options to buy and sell specific amounts of precious metals.

The traders don’t take possession of the bullion instead it remains safe in vaults mostly in London. The movement is done purely on an electronic network the gold is measured in troy ounces. Only 24 karat or 100% pure bullion is traded which is why the price for most gold jewelry is much lower than that published in the newspaper. Most jewelry is made from less than 24 karat gold.

The Nature of the Gold Market

In reality, the gold market is a commodities market just like those for wheat, oil and other minerals. The market treats the metal like any other commodity despite its history and high price. You should remember that the gold market is a market subject to the same forces as other markets.

Despite what many people think the gold market is subject to bulls and bears just like any other market. It can also be affected by bubbles or huge irrational increases in price that can suddenly collapse. Gold lost 16% of its value between September and December of 2011. During the 1980s the price fell by nearly half.

The difference is that gold often runs in the opposite direction of the stock market and the rest of the economy. When economic times are good optimistic, investors pull money out of precious metals and buy equities or securities. When times are bad panicky investors often put a large percentage of their money into gold.

That means the market for precious metals is just as irrational as the stock or real estate market. The safety that many people assume is that it offers largely an illusion. Funds invested in the gold market are just as vulnerable to market forces as funds invested elsewhere.

How the Price of Gold is Set

The price of a troy ounce of 24 karat gold is determined by trading on a number of key exchanges in the Over the Counter Market. These exchanges set the price used around the world and the basis of the retail prices charged for the metal. The price paid for jewelry or coins is usually a percentage of the gold price.

The main trading venues are the London Bullion Market, the New York Mercantile Exchange and the Tokyo Commodity Exchange. The most important market is London where the price of gold is set by trading among members of the London Bullion Market Association. This is a trading venue for major banks, bullion dealers and gold refiners. London sets the price because it has the highest volume of trading in the world. The standard international price is that at which gold is moving at in London or was moving at when the market closed.

There are several other gold exchanges around the world including the Chicago Mercantile Exchange. There are also national and regional exchanges in Canada, Australia, China, India and the Middle East. None of these are as important as London or New York.

Steven Hart is a freelance writer and a Financial Advisor from Cary, IL. He writes about Annuity topics like Single Premium Immediate Annuities, What is an Annuity, and Current Annuity Rates.


From → Investing

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