London Gold Fix or Comex: Which is More Important?

A look at how the gold price is determined...

OVER THE last two of weeks, we've noticed the variance of the Gold Fix price and the open market price, writes Julian Phillips of GoldForecaster.

In the past, the two tended to dovetail giving the appearance of synchronicity. But in the last week, open market prices have tried to take the Gold Price down only to be pulled up by the price established at the London Gold Fix. 

There is a structural change happening in the market, bringing the relevance of the physical market to a far more important pricing role that it has had before. As with other markets, it is the small amounts of gold sought after in the open markets – to top-up unforeseen needs, as opposed to the amounts directly contracted with suppliers that dictates the Gold Price. With these alterations, that pattern is beginning to change. Why?

First we look at what the Gold Fix is and why it's important, then at the speculative trading hedging gold/silver markets on Comex to see what influence they're having on the precious metal prices.

Five member bullion banks make up the Gold Fix, at which around 90% of the world's physical gold transactions take place.

These are prime gold bullion banks, globally. Their role in the Gold Fix assures that because it's at this Fix that 90% of the world's physical gold transactions are transacted. The reason lies primarily with the processes involved that ensure that these gold buyers and sellers achieve a price for gold that's the most accurate reflection of the current supply and demand for gold.

There are two Fixing sessions – one in the morning at 10.30 hours GMT and then, to ensure inclusion of US participants, one at 15.00 hours GMT. In these, the five members used to sit linked to their offices and looking at each other in a fairly small room, each with a desk on which there was a flag. 

Now they are connected to each other through a dedicated conference line, while also connected to their clients, who are kept informed of the price as it's moved in line with the buying bids and selling offers.

At the start of each Gold Fix, the Chairman announces an opening price to the other 4 members who relay this price to their customers, and based on orders received from them, instruct their representatives to declare themselves as buyers or sellers at that price. Provided there are both buyers and sellers at that price, members are then asked to state the number of bars they wish to trade. 

Bear in mind that each member's office is netting out the orders in the office and only submitting the 'net' order to their dealer at the Fix. If at the opening price, there are only buyers or only sellers, or if the numbers of bars to be bought or sold does not balance, the price is moved, and the same procedure is followed until a balance is achieved. The Chairman then announces that the price is fixed. It should be noted that the Fix is said to balance if the buy amount and the sell amount are within 50 bars [2000 ounces, 400 ounces each] of each other. The Fixing will last as long as necessary to establish a price that satisfies both buyers and sellers. 

Customers may leave orders in advance of the Fix. Alternatively, they may choose to be kept advised of price changes throughout the Gold Fix and may alter their orders accordingly at any time until the price is fixed. To ensure that the price is not fixed before the member has had an opportunity to communicate any changes each member has a "verbal" flag. As long as any flag is raised, the Chairman may not declare the price fixed. These negotiations go on for as long as it takes to reach a balance of demand and supply. It appears that the longer the time taken to fix the Gold Price, the larger the amount of gold being dealt.

This ensures that every buyer or seller of gold gets not only the best price at that time but also allows large orders to be met without driving the Gold Price one way or the other by dealers with limited amounts to supply or provide as is the case outside the Fix.

For instance, when the SPDR Gold ETF buys gold for its shareholders, it buys through HSBC, a Gold Fix member who holds it in its vaults for the shareholders. 

This is how gold has a global but centralized market.

It may seem reasonable to you to assume that the 'net' position on Comex would be covered by Comex actually ensuring that this amount of gold or silver is held in one of their four Comex-approved depositories, all located in New York City. 

After all, delivery of the gold and silver is affected via electronic warrant. This would reassure us that Comex dealings did affect the gold or silver price, would it not? After all, supposing someone went short and could not deliver –who would supply the metals? The implications: Comex is constantly adjusting their gold & silver holdings to make sure that no-one would be left without the metal they bought there. Not so!

The Comex gold and silver markets are a futures and options market place where speculators and commercial dealers buy or sell for future delivery of the metal. Originally, an ideal market where both miners and manufacturers (via the Commercials) could remove the risk of gold and silver prices from their physical positions—by opening an opposite and equal futures or options position to their physical one — it filled a secondary function of allowing speculators and traders to make money through 'open' (not 'hedged', but 'long' or 'short' positions) from highly leveraged positions. These players included major banks and small individuals.

The Comex gold and silver market is not a physical gold or silver market, except for approximately 1% - 5% of its dealings. Even on those contracts, traders must first stipulate that they will take delivery of the underlying metals so that the counterparty is aware that they too are involved in a physical transaction. The balances of 95% of the transactions are simply financial transactions that are usually closed out before maturity, so that no physical delivery need take place.

The larger speculators, such as the banks, may also be dealing in the physical metal – not simply to hedge positions as is usual with the 'commercials' but to act in the physical markets to move the price to make their Comex positions profitable, when they close their positions. 

The large US banks used to do this on a large scale, but once they were challenged in public as 'price manipulators' they have retreated from these markets, leaving individual and smaller speculators dominating the markets. 

Consequently, the size of the gold and silver Comex markets has shrunk tremendously. There was a time when for every $100 on the Gold Price, 100 tonnes of gold was held in the 'net long speculative position.' Since the banks have retreated from these markets, the 'net long speculative position' has dropped to 649 tonnes while the Gold Price is around $1,750.

The conclusion that can be drawn from this is that the accompanying trades in the physical gold markets in support of their Comex positions has also lowered, reducing the impact of large traders on the Gold Price

With lower volumes involved in these markets and lower physical market trades to support these positions, the trading market has thinned out, whereas the physical market continues to grow. This is important, as it reduces the extent and the size of traders in the precious metals markets, allowing the physical market in these metals to increase their influence on the gold and Silver Prices. It also makes market prices better reflect the overall demand and supply patterns without the exaggerating influence of short-term traders. 

With the entire futures and options markets shrinking in size and influence and the presence of the large banks diminishing drastically, Comex influence, both directly and indirectly, on precious metal prices, has shrunk. As the global gold and silver trade has expanded over the last few years and promises far more expansion, the size of the London physical gold market in London is growing steadily. In the future, expect to see the Hong Kong physical gold market grow and perhaps see HSBC establish a far eastern gold Fixing there to compliment the one in London, perhaps even with the same member banks? As Chinese and Indian demand grows this would be a logical step.

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JULIAN PHILLIPS – one half of the highly respected team at GoldForecaster.com – began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the "Dollar Premium". On moving to South Africa, Julian was appointed a macro-economist for the Electricity Supply Commission – guiding currency decisions on the multi-billion foreign Loan Portfolio – before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

There he specialized in gold, before moving to Capetown, where he established the Fund Management department of the Board of Executors. Julian returned to the "Gold World" over two years ago, contributing his exceptional experience and insights to Global Watch: The Gold Forecaster.

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