It seems simple, but many ask ‘what is the spot price, where does it come from, who sets it?'” Most often you will hear that this is the last physical trade, or the current market price of physical bullion. Unfortunately, that is not correct.
The reason for this is that there is no centralized and efficient market for the sale of physical bullion in the US at anything resembling a ‘spot price.’
There are several large markets for physical bullion in the world, where real buying and selling occurs, with delivery given and taken. The most famous is the London Bullion Market Association (LBMA), which is a dealer association, over the counter market where the price is set twice a day as the ‘London fix’ but each counterparty stands on their own with no central clearing authority. From the perspective of bullion the LBMA is ‘where the action is’ and the Comex is a sideshow.
The reason that physical trading in bullion became so highly concentrated in London was best explained by one large bullion dealer. “This situation exists because of the gold confiscation in the US in 1933. When that happened, physical metal trading in the US came to a complete stop. When gold ownership was again made legal on December 31, 1974, the physical metal trading had become so developed outside of the US that it stayed there and never really returned.”
But once the London Fix is over, and the day moves around the world, the New York markets open and become more dominant. Where and how is that price obtained?
The fact of the matter is that the bullion market in the US is highly fragmented among many, many dealers in bullion. Yes they have their ‘wholesale’ sources, but even those sources are more fragmented than one would have imagined.
There seems to be no central market for physical gold and silver in the US, except for the largely paper futures markets. Because the fact of the matter is that the spot price of gold and silver are a type of Net Present Value (NPV) calculation based on the futures price in the nearest month, or the front month.The details are not so important, again as I say, unless you wish to start up your own quotations service, or do your own pricing as a large dealer to make sure you know what a fair price might be.
What is important is that almost all retail transactions for physical bullion in the US key off a ‘spot price’ that is derived from a paper market which is not based in the reality of physical supply, since the futures exchanges explicitly allow for the settlement in cash if physical bullion is not available. In fact, the vast majority of transactions are settled in cash, and are little more than derivatives bets it seems, and often hedges related to other things like another commodity or interest rates.
So that is the truth of the spot price of gold and silver in the US as best as I can determine it. Obviously, the system is inefficient in that it suffers from the lack of a robust physical market to ‘keep it honest.’ A more effective spot price might be an averaged ‘Ebay’ price because it is based on physical retail sales which include market premiums.
Regardless, we are stuck with the system we have.Whether it works well or not is another matter and it seems a personal opinion heavily biased on where you sit at the playing table. But from a purely economic perspective if I were going to set up a mechanism to allow price fixing and fraud to occur, I could do little better, except perhaps to set up something more like an opaque monopoly such as the Federal Reserve with the ability to create supply out of nothing. Fortunately, gold and silver cannot be printed. Nonetheless, the investors and producers are largely at the mercy of those who control the paper markets and this says nothing about the involvement of the central banks in influencing the price, which they admit that they do, if only obliquely.
Sure one can say. If you don’t like the price you can keep taking delivery, except that you can’t. The price is set on the Comex, which delivers paper dollars at will, and has a history of changing its rules at the drop of a hat to rescue trapped suppliers and speculative shorts. This is the sort of odd market that resolves itself in executive actions precipitated by breakdowns and default.
There is nothing here that could not be greatly improved by position limits and much greater transparency and accountability for counterparty risk. But as amenable as this paper based market is to the ‘easy skim’ one might imagine there is a status quo that would fight any reform vociferously.
To use a poker analogy, I don’t mind a ‘no limits’ game as long as it is table stakes where you put your ‘stash’ on the table for all to see, which again this is not, and the pot is split if you are raised beyond your bankroll, which this is also not. I would not imagine that a no limits game in which the big players are also often the dealers, and can see the cards that other cannot because of their seating, is the best sort of a mechanism with which to conduct price discovery for the average person in the market, who only wishes to play a few hands on a limited budget, or a small producer who wishes to bring their product to market.