How the gold business works
Most of the gold in the world is produced by a small number of countries: China, South Africa, United States, Australia, Russia, Canada, Peru, Indonesia.
Gold mines produce raw gold, called a gold bar. These bars are generally made of about 80 percent pure gold. The gold is then sent to a refinery, where it is refined into gold of different shapes and purities.
Perhaps the most widely produced gold bars are London Good Delivery bars. Under rules set by the London Bullion Market Association, LBMA, these bars – the world’s gold standard for gold – must be at least 99.5% pure gold, weigh between 350 and 430 ounces (most weigh around 400 ounces) and be stamped with a unique serial number, fineness and refiner’s seal.
Who can make these bars?
Only refiners approved by the LBMA. They have to maintain excellent laboratory and production facilities, and there is proactive monitoring of those refineries on the good deliveries list. These are usually the only bars that are used for storage and warehousing purposes by investment banks.
Until this point, the gold will likely be owned by the mining company (in some cases, a gold bullion bank may also fund mine operations). Once the gold is refined, ownership is often transferred to gold bullion banks.
What happens from there?
Depending on where the gold is mined, it will usually be airlifted to a bank vault in another country: USA, UK, Dubai, India, China, Australia, wherever gold may be needed.
The role of investment banks.
Bullion banks are the intermediary of the gold world. Miners produce gold, but they might not produce it at the same time consumers want to buy the metal. Banks therefore play a sort of compensatory role: when producers want to sell, they can sell to the bank. When consumers want to buy, they can buy from the bank.
In a sense, an investment bank does a lot of things that a traditional bank does. They provide services to the entire wholesale gold industry: large miners, large consumers such as jewelry and industrial companies, central banks, and large investors like ETFs. They supply huge amounts of wholesale metal to major consumer markets: China, India, Middle East, Turkey.
They provide, for example, the financing and delivery of the physical metal. So if an Indian manufacturer makes a product, say, in Turkey or Switzerland, the gold bullion banks can advance the metal to those places for them.
Investment banks also offer many types of trading services: spot trading, futures, options, vault, etc.
Fixing the price of gold.
The price of gold is determined by supply and demand. There is not a single market for gold; there is a lot of. The most important include:
- The primary over-the-counter, OTC, where the spot or spot price of gold is determined, is in London, but there are also over-the-counter markets in New York, Dubai and even Turkey. Much of the gold trading takes place in the over-the-counter market on gold trading desks around the world. What are these offices for? They facilitate exchanges. They trade gold on behalf of their clients (miners, central banks, ETFs, jewelry makers and manufacturers, etc.) and in some cases trade on their own account. Some customers also wish to borrow or lend the physical metal.
- The gold futures market, the largest of which is in the United States;
- The London Correction, which is the main benchmark price for gold. The objective of the fixing is to provide a negotiable reference price.
How the London patch works: There are two daily âpatchesâ, a patch at 10:30 a.m. and an afternoon patch at 3 a.m. The fixing is actually a company, called London Gold Fixing Limited, and the 5 fixing members are HSBC, Deutsche Bank, Barclay’s, SociÃ©tÃ© GÃ©nÃ©rale and ScotiaMocatta. There is a president and each of the fixer members has a line with the other dealers. Think of it as a pyramid structure: the president nominates an award, and the five members pass that information on to their clients, who pass it on to other interested parties.
So, for example, a customer might say to one of the fixer members, âI would like to buy 10 bars at this price, but I will not buy 10 bars at this price; or I would like to sell 10 bars or 20 bars at that price. “So at every step of the fixing process, until the president says the price is fixed, all the customers at the bottom of that pyramid have the option to make a transaction.
Finally, each of the five fixer members declares their interest as buyer, seller or interest-free. When members reach a point where there is a certain balance between buyers and sellers, the chair will then ask each member to declare how many bars they wish to sell or buy based on the buying and selling interest of their customers, and the president will declare the price “fixed”.
Why have a fixation?
It provides a negotiable reference price. When gold is part of a portfolio, you need to have a way to value those assets. The fixing is a price at which buyers and sellers are matched at any given time of day, and because it is open, transparent and negotiable, it represents a very credible benchmark price.
There are many different gold prices around the world, so why isn’t gold trading at very different prices? Because arbitrageurs (often at gold trading desks) step in to buy gold in one place and sell it in another.
How does it get to the consumer?
While much of the gold supply is protected (held for investors like ETFs or central banks), about half of the world’s gold ends up in jewelry.
Take the example of India, the world’s largest consumer of gold. A wholesaler in the Indian market would usually be a bank. They will have a relationship with a bullion bank and say, for example, “I would like 2 tons of one kilo gold bars at a purity level of 99.5”. The bullion bank, if it’s that size and that gold purity, can pass it on to the Indian bank. If they do not have this type of gold immediately available, but in another form (different sized bars or different level of purity), they can send the gold they have to a refinery that is capable of refining. gold according to the specifications required by the bank. , then ship it from the refinery to the bank in India. The bank then typically passes the gold (often on consignment) to a large jewelry maker.
Much of the gold used for jewelry is leased. Users borrow gold to avoid the risk of gold prices moving against them. They pay a fee to borrow the gold and the title stays in the bank. Ownership transfers when a final product is produced.