Spot Metal Trading
Gold trading in one form or another has existed for thousands of years. It has been used as a currency in its own right in many parts of the world or has served for the creation of “gold standards”, where the total amount of paper currency issued has been backed by a corresponding reserve of gold. Gold standards ceased as national economies grew significantly in the twentieth century and the overall production of gold, already unable to keep pace with the amount of money in circulation, decreased in relation to previous levels. The last country to stop using the gold standard was Switzerland. Prior to joining the International Monetary Fund in 1999, Switzerland had backed 40% of its paper money with its gold reserves.
The value of gold
As a commodity, gold has a reputation for keeping its value despite turbulence in other markets. Points of view differ on the intrinsic value of gold. As an element, it has properties that make it particularly well suited to certain industrial applications and esthetically its pleasing appearance makes it a metal of choice for jewelry. However, its value in gold trading is also driven by its scarcity compared to other commodities. 165,000 tonnes (the equivalent of 5.3 billion troy ounces) of gold had been mined in the world by 2009. Total yearly world supply is currently under 4,000 tonnes. Around half the world consumption of new gold is for jewelry. Investments account for another 40% and industry for the remaining 10%. This distribution means that the value of gold on the market is determined in a different way to that of major currencies such as the dollar or the Euro.
The price of gold
The universal benchmark price of gold, known as the London Gold Fixing, is determined to a large degree by the International Monetary Fund and central banks. Gold prices have recently been around $1,600 per ounce, a long way from the $35 per ounce fixed at the Bretton Woods conference of over 50 years ago when the gold standard was applied. When the gold standard was abandoned by the United States in 1971, gold trading prices increased dramatically to over $800 per ounce in the 1980’s. Between that peak and today’s level, gold prices have varied considerably, dropping as low as $260 per ounce in 1999.
How gold trading is done
Gold trading can be done in a similar way to currency trading. Gold prices are quoted in relation to the US dollar, the currency pair thus formed being XAU/USD. In the same way that traders will examine market conditions and price history to predict how one currency will perform against another, they can also do this for gold in relation to the dollar. A number of currency (forex) brokers also offer trading in commodities such as gold for this reason: it is a natural extension of the techniques and infrastructure required for successful trading in currencies. Leverage is also used in gold trading, allowing investors to make larger trades but only using a smaller amount of their own funds. In transactions like these, there is no physical delivery of the gold involved, just as there is no physical delivery in forex of a currency that you buy.
Factors affecting gold trading
US dollar: there is already a recognized relationship between the US dollar and gold prices. As the US dollar weakens in the market, gold prices tend to rise, and vice versa. Given the financial liabilities of the United States and the possibility that devaluation of the dollar may be the result, this would push gold prices up.
Demand for jewelry: with 50% of new gold being absorbed by this market, the jewelry sector and the consumption in countries like India, China, Italy, Turkey and the US have a significant influence on the price of gold. Of these, the Indian market for gold jewelry is the biggest. Specific events in that country alone can therefore bring about sizable swings in the market price of gold. Examples include the overall success or failure of harvests (farmers buy gold to hold when they have surplus cash), the seasonal demand generated by particular religious festivals and any natural disasters that perturb the economy and consumer demand with it.
Exchange-traded products: now that gold can be traded in exchanges and online as easily as any other paper currency or financial product, trading volumes and demand increase. Institutions handling gold for investor speculation in this way include the London Stock Exchange, Australian Stock Exchange (Gold Bullion Securities), the New York Stock Exchange (StreetTracks Gold) and the Electronic Traded Funds initiated by the World Gold Council.
“Safe haven” reactions: when political problems or increases in inflation occur with international impact, investors tend to move towards gold as a “safe haven”, meaning a commodity that is likely to hold its value even if other markets suffer.
Gold trading for diversification
Gold trading is of course just one possibility for investors seeking profits. It has specific advantages nonetheless in terms of diversifying an investment portfolio, particularly for investors who operate on a longer term basis. Gold has a low or negative correlation with other assets, meaning that decreases in the value of other assets either do not affect gold prices or in fact cause gold prices to rise. Gold prices are not linked to the performance of the economy or industry, and for this reason open positions in gold against the dollar can improve the consistency of results for investors in otherwise stable or unstable periods.