There are two key markets in which the prices of gold and
silver are determined.
1. Over-the-Counter (OTC)
The OTC market consists of traders dealing with other
traders on a one-on-one basis. It operates much like the internet ����� it is just a network of traders
independently dealing with each other 24 hours a day. OTC is generally meant
to refer to professional/corporate entities trading 400oz gold bars (and
1000oz silver bars), usually for settlement in London. However, when you buy
a coin from a bullion dealer, you are also doing an OTC deal.
OTC trading is done on the telephone or via a dealer's
proprietary trading platform software. Just like your transaction with a coin
dealer, the amount dealt and the spot price agreed is not public.
To facilitate price discovery in what is an otherwise
opaque market, precious metal dealers often use a service like Reuters or
Bloomberg as an indicator of where the spot price is. This spot price is
updated by the bullion desks of the big banks and is, in effect, a bulletin
board or forum where these banks can publish their prices. However, unlike a
stock market, it is not a commitment to deal at those prices (but generally
one can).
It is therefore hard to "pin down" the OTC spot
price, compared to a public exchange.
2. Futures Exchanges
Futures markets are public, regulated exchanges where the price for
delivery of gold or silver at various dates into the future is traded. The
largest and most influential market is the US COMEX market.
Often the current (or nearest) future prices quoted as a spot price of
physical gold. Technically this is not correct as it is a price for gold or
silver to settle in the future whereas the "spot price" is the
price for immediate settlement. However, in countries with futures exchanges
dealers often base their price for immediate delivery of gold or silver off
their local futures market, so from a retail customer's point of view a
futures prices is effectively the spot price.
It is important to note that futures and spot prices are related to each
other and as such are kept in alignment by arbitrage traders who look at the
relative costs of borrowing cash and gold (and other factors) and will sell
futures and buy OTC spot (or vice versa) if they see too much divergence
between the prices.
There has been some debate as to whether US futures markets or the London
OTC spot markets drive the price. This
analysis concludes that it is not fixed and changes over time, even
though the London OTC market is much larger than COMEX in terms of ounces
traded.
A Bullion Dealer's Spot Price
So how do bullion dealers selling to customers set their spot price? They
do so by considering the following factors:
�� The spot/futures price may change in the time
between committing to a price with their customer and executing a deal with
their OTC counterparty or futures market broker.
�� OTC and futures markets are
wholesale markets (trading in "lots" of 1,000oz and 100oz of gold,
respectively) whereas a dealer's retail customers will be buying in much
smaller amounts. This means it may take some time before they have
accumulated enough ounces to execute a deal, during which the OTC/futures
price will change.
�� The dealer may not be quoted the Reuters or
Bloomberg screen price when trying to lock in a price in the OTC market,
especially when the market is moving quickly and bullion banks are not
updating their prices into those information services quickly enough.
�� For futures trading, the dealer will be charged
brokerage fees. For both futures and OTC trading there is also general costs
of employing dealers and settling trades.
The way bullion dealers manage the above factors is to add a margin (or
buffer) to the spot or futures price they see quoted. How much they add and
how often they will change their spot prices depends on how volatile the
wholesale price is and how much buying or selling their clients are doing.
This changes dynamically during the day and will also vary between each
bullion dealer. Note that this spot price margin is in addition to any
fabrication premium.
The result is that you will find each bullion dealer quoting different
spot prices. This can be confusing to first time investors who are used to,
for example, a single price for a company's stock on a single exchange. It
often leads to questions about whether they are being quoted a "fair"
price.
The only way to know if you are getting a fair price is to
do what bullion dealers themselves have to do, which is to shop around and
see who is offering the best price at that time and take it. In doing so, you
become part of the huge, opaque precious metal market �network� of
over-the-counter traders. Good luck!