Price discovery is crucial for any market, and the gold market is no exception, although in the gold supply chain is limited at best. The London Bullion Market Association (LBMA) gold price is an important global benchmark. Traders primarily use two pricing models to estimate the potential investment value of gold: gold futures price and gold spot price. To understand these two pricing models first is necessary to understand the LBMA Gold Price.
Intercontinental Exchange (ICE) a company which owns and operates a myriad of exchanges, trading venues and sets pricing around the globe operates the ICE Benchmark Association (IBA) which provides the price platform, methodology as well as the overall administration and governance for the LBMA Gold Price. The IBA's platform provides an electronic, auction-based, tradable, auditable and fully IOSCO-compliant for trading LBMA Gold.
The IBA hosts an auction in London twice daily where fifteen direct accredited participants bid for physical LBMA Gold.These include banks like Bank of China and Bank of Communications, who purchase gold on behalf of governments and other financial intuitions as part of their reserve policies. Others like Goldman Sachs, HSBC Bank,INTL FCStone, purchase it for their own and their clients’ trading strategies. Based on the supply and demand in these auctions the price of LBMA gold is set.
Only LBMA refined certified bullion is traded in these auctions as the IBA only accepts source, quality and purity certified by the LBMA. Only refineries associated to the LBMA are able to supply this gold bullion.
Gold is sourced from largely two sources: unwrought gold and recycled gold. The former extracted from the ground by producers as ore, somewhat processed but unrefined. The latter primarily sourced from industrial recycling such as discarded computer parts that use gold in its components.
Refineries take the gold from those sources and refine it. Because of the high standards required for certification of gold bullion as LBMA certified, LBMA refineries incur higher costs and thus demand a higher price. Other refineries which certify under different standards from LBMA may have lower costs and demand lower prices. This is important as the price of gold is typically related to LBMA refined gold sold at the IBA auctions.
Spot and Futures Prices
The price of gold that is to be delivered immediately after purchase is called the spot price. If you were to average the net value of all currently traded gold futures contracts for the nearest month, you would get the gold spot price. In a normal market, gold futures prices are much higher than the spot price of gold. However, in times of extraordinary demand for physical gold, the spot price can be higher than the futures price. Gold spot prices is then determined by the gold futures contracts with the most volume across commodities exchanges in New York, Chicago, London, Zurich, China and Hong Kong in correlation to the LBMA gold price.
Gold Futures Price
Gold futures prices are very much linked to LBMA Gold Price. These are contracts for the physical delivery of a specified amount of gold on a set date in the future, the delivery of the gold traded with these contracts is LBMA gold hence the link. Multiple factors determine the price of a gold futures contract: the spot price of gold; the predicted changes in supply of and demand; the estimated cost of transporting and storing the physical gold; and the risk-free rate of return for the holder of the gold.Since the physical gold is not immediately delivered upon purchase, these trades are primarily electronic. They’re also highly risky because of the unpredictable nature of supply and demand factors.
Physical Gold and Paper Gold
Physical gold refers to actual gold that you have in your possession or stored for you.It is a commodity that may come in the form of bullion, coins, bars, jewellery, and the like. The owner holds a tangible object that stores value.
Paper gold, on the other hand, is a piece of paper that is a derivative of physical gold. Some examples include gold certificates issued by banks and mints, unallocated or pooled accounts, gold mining shares, exchange traded funds(ETFs), gold futures, gold options, and contracts for difference. Lately, this category can also include digital tokens that represent gold. Note that with this type of gold, you don’t actually own gold but rather a promise to receive physical gold.
The underlying issue with investing in paper gold is that it is exposed to several risks such as:
– Counter party risk. In this form, gold is held by a trustee and you must rely on them to make good on your investment.
–There isn’t always enough gold supply to support the sale and trading of paper gold. Paper gold traded is somewhere between200 to 250 to 1 of physical gold held.
–Mining stocks are often directly affected by movements in the stock market rather than the gold market. This means your investment is more at risk in times of economic duress.
Physical gold does not carry the same risks as paper gold. It is also very liquid and can be converted to cash easily.Moreover, physical gold is a store of value and is an excellent hedge for financial or political crisis.
Trading Physical Gold
Paper gold is traded more heavily because its high turnover, easy and cheaper to trade. Physical gold has expenses (transportation, taxes, storage, insurance etc.) and if its LBMA gold then it adds to the cost because LMBA gold is more expensive than gold from other refineries which may be equally relied upon for similar purity.
Trading LMBA gold would result in a higher base cost, which means that the seller would have to wait until the spot price is a point that would cover all of its costs incurred plus a profit in order to make it feasible to sell and for someone to buy has to be at the lowest cost because of the expenses to incurred. This is why physical gold strategies either are short and have thin margins or are long strategies to benefit from the price appreciation.
Liquid Hedge Fund Physical Gold Strategy
Hedge funds that invest in physical gold, do so buying LBMA gold and as a hedge to other investments to balance a particular portfolio meaning they would be holding long. Rarely as short strategies due to the thin margins.
However, Prism Capital has devised a strategy whereby it takes advantage of its relationship refineries and purchases unwrought gold at discounts, refines it and sell it close to spot price. This guarantees not only the quality and purity of the product, fixes the price of the refinement but also providing full price discovery to Prism Capital in the gold supply chain.
Knowing spot prices plus supply chain price discovery allows Prism Capital to sell at a healthy margin and quick turnover predominantly to other refineries supplying a high-quality product at often a discount to spot price which they can in turn procure into any of the myriad of certifications available included in LBMA and sell in the traditional markets.
Prism Capital stands as the first trader in the supply chain, standardizing and professionalizing the trading of unwrought gold, reaping the benefits of its trade secret gold supply price discovery in relation to spot prices.
Capacity for such a strategy is very large. On the purchase side it is tied to the production availability in particular markets; whereas on the sell side is endless with refineries and ultimate purchasers plenty as they look to fill reserves, futures orders, and supply industry.