How the gold price is set

Why there is no single official gold price

Ask what a share in a listed company costs and there is one honest answer: whatever it last traded at on the exchange that lists it. Gold does not work that way. There is no single exchange where the world's gold price is struck the way a share price is struck on the London Stock Exchange, and no institution anywhere that arrives at its desk in the morning and decides what an ounce of gold is worth.

What exists instead is a very large wholesale market in which banks, refiners, miners, dealers and central banks trade with each other directly, plus a published benchmark price that comes out of a formal auction twice a day and that a great many contracts refer to. When a news site says "the gold price", it is quoting either the level the wholesale market is currently trading at or that benchmark.

Understanding the difference between those two things is most of what you need. The rest of this lesson explains where the price is formed, who publishes the benchmark, why it is quoted in US dollars, and what pushes it around.

The wholesale market: over the counter, loco London

The bulk of wholesale gold trades over the counter, which means two parties agree a trade directly rather than matching through a central exchange. A bank sells a quantity of gold to another bank, a refiner or a dealer at a price the two of them agree, at that moment, over a phone line or an electronic platform.

The live spot price is the price for gold bought or sold for near-immediate settlement, as distinct from gold to be delivered on some future date. It is less a single published figure than the level at which the market is currently dealing. Two participants may quote very slightly different numbers at the same instant, and those numbers move continuously while the market is open, which is almost around the clock through the working week as activity passes between Asia, Europe and North America. That is the number people mean when they talk about the spot price, and it is the number a dealer's quote to you starts from.

London sits at the centre of this. The convention that most wholesale trades settle loco London means the gold changes hands in the London vault system rather than being physically shipped anywhere. "Loco" comes from the Latin for "at the place": a loco London price is a price for gold already sitting in London, held to the market's accepted bar standard, with ownership transferring by book entry between accounts held at the bullion banks. That convention is why London remains the market's reference point even though comparatively little metal physically moves in or out.

The LBMA Gold Price, set twice a day

A continuously moving over-the-counter price serves traders well, but a great many people need one agreed number instead: a refiner invoicing a client, a fund valuing its holdings, a mining company settling a supply contract, an auditor marking a vault to market. That is what the benchmark exists for.

The London Bullion Market Association (LBMA) is the trade body that oversees the London wholesale market. Among other things it maintains the Good Delivery standards that determine which refiners' bars are accepted in the London vault system, and it is the authority behind the benchmark that carries its name. The auction itself is administered by ICE Benchmark Administration.

The LBMA Gold Price is produced by an electronic auction run twice on every London business day, once in the morning and once in the afternoon. It works like this. The administrator publishes an opening price. Participating firms enter the quantity they wish to buy or sell at that price, for themselves and on behalf of their clients. If buying and selling do not balance closely enough, the price is adjusted and another round runs. Rounds continue until the imbalance falls within a permitted tolerance, and the price at which that happens becomes the benchmark for that auction. The process usually takes a few minutes, and the final price for each auction is published.

Two features are worth holding on to. First, the benchmark is discovered from real orders to buy and sell, so it reflects prices at which firms were willing to transact. Second, there are two settings each day, so "the LBMA Gold Price" on any given date means either the morning or the afternoon one, and contracts say which.

One point of precision, because it is easily muddled: the benchmark is a regulated financial benchmark, but that is a separate matter from buying gold itself, which is not a regulated investment activity in the UK.

Futures, and where price discovery happens

Alongside the London over-the-counter market sits the futures market, and the most important venue for gold futures is COMEX, part of CME Group in New York. A futures contract is an agreement to buy or sell a set quantity of gold at a set price on a set future date. Most contracts are closed out before that date rather than resulting in delivery of metal, so the majority of the activity is financial.

Futures matter to the price because of the volume traded and because the venue is transparent and continuous. Prices in the futures market and the spot price in London are tied together by arbitrage: if the two drift apart by more than the cost of financing and carrying metal between them, traders act on the gap and it closes. So price discovery, the process by which a market works out what something is worth right now, happens in both places at once, with London anchoring physical settlement and COMEX supplying enormous liquidity.

Dollars, ounces and the sterling question

Gold is quoted in US dollars per troy ounce, the troy ounce being the traditional unit for precious metals and a little heavier than the ounce used for groceries (the next lesson takes that arithmetic apart properly). The dollar convention is a matter of market history and of the dollar's role in international trade, rather than anything intrinsic to the metal.

For a UK buyer this has a consequence worth seeing clearly. The price you pay in pounds has two moving parts: the dollar price of the metal, and the exchange rate between sterling and the dollar. Both move, independently of each other, and either can change your sterling price while the other stays still. If sterling weakens against the dollar, a given dollar gold price converts into more pounds. If sterling strengthens, the same dollar price converts into fewer.

The LBMA publishes the benchmark in sterling and euros as well as dollars, converted at prevailing exchange rates, and UK dealers quote in pounds. The currency component sits inside the price whether or not anyone points it out. A change in the sterling gold price is therefore not always a statement about gold.

What moves the price

Price is what settles between supply and demand, so it helps to know what sits on each side.

Supply

• Mine production. New gold comes out of the ground at a fairly steady annual rate. Mines take many years and a great deal of capital to bring into production, so supply cannot respond quickly when the price moves. Gold behaves differently here from commodities that can be planted or drilled at shorter notice.
• Recycling. Old jewellery, scrap and industrial recovery return gold to the market, and this source is genuinely price-sensitive: when the price is high in a given currency, more metal comes back for refining.
• Central bank sales. Central banks hold gold in their reserves, and can be sellers as well as buyers.

Demand

• Jewellery. One of the largest and most consistent sources of demand, concentrated in a handful of countries where gold carries deep cultural and savings roles.
• Central bank buying. Reserve managers hold gold as a reserve asset that is nobody's debt. Their purchases tend to be large, deliberate and slow-moving.
• Investment. Coins, bars and exchange-traded products, driven by how households and institutions feel about currencies, inflation and risk.
• Industry. Electronics, dentistry and specialist applications. Real, but a small share of the total.

Interest rates and opportunity cost

Gold pays no interest, no dividend and no rent. Holding it costs you whatever the same money could have earned elsewhere, and that opportunity cost rises and falls with interest rates, particularly rates after inflation has been accounted for. This is a structural relationship rather than a rule, and it explains why the gold price is sensitive to expectations about rates.

None of these forces is predictable, and no combination of them tells you where the price is going. Gold can fall in value as well as rise. Buying physical gold is not a regulated investment activity in the UK, which means there is no FSCS protection and no recourse to the Financial Ombudsman Service, and nothing in this Academy is financial advice.

What you should now be able to do is read a dealer's quote and know what is inside it: a metal price formed in a global wholesale market, a currency conversion into sterling, and a premium for turning that metal into a specific coin in your hands. The next lesson takes apart the weights and fineness figures that decide how much metal a given coin actually contains, and the lesson after it takes apart the premium.