Gold Trading: Primary supply over the counter

December 16, 2021

The two primary forms of gold trading in the wholesale market are over-the-counter (OTC) and on exchange. Most of the OTC market that most are aware of has historically been structured around London whereas exchanges offering both gold spot and futures trading can be found in various market centres most prominently NewYork.

As in most asset classes, there is a symbiotic relationship between OTC and on-exchange gold trading.

OTC markets are characterised by market participants trading directly with each other. The two counter parties to a trade bilaterally agree a price and have obligations to settle the transaction (exchange of cash for gold) with each other. This form of principal-to-principal gold trading is typically less regulated than trading on an exchange and is how most of the market has functioned historically. Often cited advantages for the OTC model are that it provides market participants with a high degree of flexibility(i.e. to customise transactions).

London became the primary center for the OTC model of gold trading and over time theOTC gold trading model required to become more regulated and transparent. Hence the formation of the London Bullion Market Association (LBMA) creating a closed, by-invitation-only private group marketplace for the trading of gold OTC under particular rules and regulations which every participant must adhere to.Fifteen selected traders participate on a twice daily gold trading exercise between one another under specific rules in relation to product, price, delivery and other variables.

There is however many other OTC gold trading markets around the world which also are very important to the gold trading industry as a whole.

Virtually every gold producing country has brokers and/or refineries, and every region where these gold producing countries are located have at least one or even multipleOTC gold trading markets. Just like the LBMA, these markets are not open to just anyone; participants must be gold producers, brokers or refineries in the region and meet certain requirements and procedures, albeit informal or customary. These OTC marketplaces is where the gold supply chain begins, and one may argue to define them as Primary OTC Gold Trading Marketplaces making the LBMA a Secondary OTC Gold Trading Marketplace.

All of these ‘Primary OTC Gold Trading Marketplaces’ have different customs, rules or requirements as to who may participate, and like the LBMA about product and delivery more often informal. Some impose selling quotas to brokers or refineries, effectively forcing smaller producers to sell to intermediaries(often other brokers or even informal intermediaries) who amalgamate the gold to meet such quotas. Other requirements could be in relation to the type of product traded, quality, form, etc.

These‘Primary OTC Gold Trading Marketplaces’ feed into brokers and refineries that are part of the LMBA or supply the jewelry industry or other industries that consume gold such as the semiconductor industry.

As these marketplaces are informal it is very difficult to penetrate them and become a significant participant, especially for highly regulated financial traders like hedge funds which would entail having to formalize these marketplaces to bring the necessary transparency required to meet regulatory compliance. Moreover, these OTC markets may be so inefficient that significant slippage or costs in the supply chain may make it un enticing to these financial traders who then have no option but to trade on exchanges having no access to more regulated marketplaces like the LBMA. The gold trading industry outside of the LBMA and similar OTC trading marketplaces is very technological backwards and has substantial legacy procedures that also makes them inefficient.

This also makes these marketplaces ripe for opportunity. From disrupting the process to formalize it to applying technology to make it more efficient, reduce cost and maximize profit. This is what Coinful Capital’s PIERCE 50 has done in theSub-Sharan Africa region, particularly focusing or small and medium sized producers and formalizing the supply chain process to reduce cost. This has enabled PIERCE 50 to become a significant player in the regional Sub-SaharanOTC gold trading marketplaces and being able to provide investor access to a market they wouldn’t otherwise have access to.

Providing exceptional lifetime total net return of over 46% and an average monthly net return of over 3% since inception just 15 months ago, with over 8% net yield in the first quarter of 2021 alone; PIERCE 50 gives investors exposure to physical gold as an underlying asset while providing a relative high degree of liquidity in an actively managed, risk adverse strategy into a niche opportunity with restricted access and a high barrier to entry.

On exchange gold trading products such as ETFs or derivatives do not necessarily give direct exposure to the underlying physical asset and these trading products could also display a high degree of volatility. Trading what we call a ‘Primary OTC Gold Trading Marketplace’ allow for a true hedge to traditional assets given not only the safe haven gold provides but also the OTC price (particularly at this level) is totally uncorrelated to on-exchange products.