So, you’ve made the decision that it’s time to add gold and/or silver bullion to your investment portfolio. Now it’s time to understand how the price of your coins and bars is calculated.
Spot Price & Futures Price
There are two benchmarks for precious metals – spot prices and futures prices. These prices are determined by ‘over-the-counter’ markets and ‘futures exchanges’.
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. The 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 customer set their spot price? They do so by considering the following factors into account:
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 “network” of over-the-counter traders
Even though Spot Price & Futures Price tend to be reported on TV and radio news, spot and futures prices are unavailable to retail buyers of gold and silver bullion coins and bars.
When setting the price of bullion for retail investors, the seller takes into account these international benchmarks. Our calculations include a ‘premium’ over the metal price to cover the cost of fabrication of raw gold into coins and bars. To ensure we have a viable business, the Mint’s premium also includes a profit margin.
There are a couple of general rules worth knowing about premiums.
They are lower on bullion cast bars because the fabrication process is fairly straightforward. Bullion coins, which offer a number of important benefits including legal tender status, greater divisibility, rarity and detailed designs, are more complex to fabricate. As a result, the premium paid is slightly higher.
Notice, however, that premiums per ounce are usually lower on larger coins. You’ll also be able to discount the premium per ounce by taking advantage of volume breaks.
Taking their lead from international benchmarks, retail prices of gold and silver bullion fluctuate during the course of the day. To reflect this, our advertised prices are constantly updated.
When placing an order for bullion on the Mint’s bullion website, you have one minute to lock-in the ‘live’ price of gold or silver before it is automatically revised – either up, down or no change.
The price of gold and silver bullion is also directly affected by the relationship between the U.S. and Australian dollars.
This is because precious metals are U.S. dollar denominated commodities. But for the convenience of local customers, The Australia market prices its bullion in Australian dollars.
So if the Australian dollar strengthens relative to the U.S. dollar, the local price of bullion will fall. Conversely, if the value of the Australian dollar weakens relative to the U.S. dollar, the local price of bullion will rise.
The Australian dollar last hit parity with the U.S. dollar in 2013, negating this effect. More recently, the Aussie’s value has declined somewhat, explaining why the price of gold in Australian dollars has remained strong.
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