Commodity Derivatives: Markets and Applications

3

Gold

Boys, by God, I believe I’ve found a gold mine.

James Marshall^b

SYNOPSIS The purpose of this chapter is to describe the physical and derivative markets for gold.

 

The first section of the chapter outlines the main components of the physical gold market. This includes a description of the physical supply chain with special reference to the role of financial institutions. London is the home to the largest physical market and the main conventions such as fixing the price for gold are highlighted.

The second section considers the demand and supply of gold and the impact each component has on the market price. Given that there are substantial amounts of gold above ground and that it is virtually indestructible, the dynamics of the demand and supply equation for gold are different to other metals such as those considered to be “base” or industrial (e.g. copper and aluminium).

The third section outlines the features of the gold leasing market, which lays the foundation for a description of gold derivatives. The main emphasis is to describe those products that are, to an extent, unique to the gold market (e.g. a floating rate forward). In addition, since central banks hold a significant amount of the commodity within their reserves, the use of derivatives to help gold to “earn its keep” is considered.

The chapter does not include coverage of other precious metals such as silver, platinum and palladium but many of the principles within the text would also apply in these markets. ...