Gold trading, derivatives and the price of gold

[Bumble]

For those who are interested in the mechanics of gold trading and how it affects prices, this week's research article from Alasdair Macleod of Goldmoney is worth a read.

https://www.goldmoney.com/research/goldmoney-insights/the-looming-derivative-crisis

If you have even more time, here is a lengthy post from 2017 about how the gold trade works.

http://fofoa.blogspot.com/2017/05/how-gold-is-different.html

[Bumble]

I think I understand most of it. One of the interesting takeaway points is that the bullion banks lease out gold on a fractional reserve basis, i.e. they lease out more gold than they possess. This creates a kind of virtual gold in the same way that fractional reserve lending by banks creates currency and is responsible for the majority of what makes up the M2 money supply. The upshot is that the more unallocated gold the bullion banks possess, the more virtual gold they can lease into existence and so the price becomes depressed. So whereas you might suppose that someone buying some gold through a bullion bank, or for that matter buying GLD, would tend to push the gold price up because they are generating demand, in fact this just creates more unallocated gold for the bullion banks to lease out on a multiple, which tends to depress the price. A corollary is that just as the fractional reserve banking system is vulnerable to a run on a bank, because there is more M2 currency issued by the bank than it possesses in reserves, a bullion bank could experience a run on its gold, because it has more customers with a paper claim over that gold than the bank physically possesses. This is another reason to avoid unallocated gold vehicles and always to buy allocated gold, i.e. gold for which you are the legal owner.

[Martlet]

I thought (though its confusing) the FOFOA chap was highlighting that the bullion banks are their own market. They create both supply and demand largely to themselves, and others trade derivatives off the back of this.  It may correlate with the explanation for the spread gap on 23rd March: that the Comex price and London price diverged as long holders of physical on LMBA covered short positions (hedges) over on Comex.