How Are Spot Prices Determined?

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 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 �€œnetwork�€ of over-the-counter traders. Good luck!