Gold is one of the most popular commodities in the world when it comes to trading and it is not difficult to see why. Not only is the gold market very liquid, it is also highly volatile, making it a common favourite for traders worldwide. In fact, it makes up the majority of RADEX MARKETS’ total trading by volume. Moreover, gold has a very tangible quality to it due to its historical and cultural significance; its use as a tradeable asset dates back millennia. It is consistently one of the most heavily traded assets in the world, behind US treasury bills and the S&P 500.
To give an idea of just how large the gold market has become, in 2021 the average trading volumes for gold were in excess of $130 billion per day. If we extrapolate this over the whole year, then the total volume of gold traded was just shy of $50 trillion. An enormous figure to say the least, but there is something even more interesting about it. As of today, roughly 200,000 tonnes of gold have been extracted out of the ground. At a price of $2000 per ounce, this leaves us with gold inventories in the realm of $14 trillion. That is to say, in just one year the world traded three times the entire amount of gold mined throughout history.
An even more startling comparison would be to look at the amount of gold extracted per year, which leaves us with a figure of about 3,000 tonnes. At current prices, this equates to about $200 billion. Meaning that in 2021, the world traded gold contracts worth 250 times the amount of gold extracted out of the ground for that year.
So what? It is not uncommon for derivative markets to become larger than the underlying assets they are based upon. Who cares if one ounce of gold is underpinning a couple orders of magnitude more in derivatives? If we were to perform the same calculations for the crypto market, we would get an even more egregious ratio. The problem, if you can call it that, is that there are effectively two distinct gold markets, and they are subject to different market forces.
In the case of paper contracts, the price of gold is intimately coupled to global markets at large. Geopolitical concerns, federal interest rates, treasury yields, inflation data, currency fluctuations all have a direct and immediate impact on XAUUSD, as many over-leveraged traders are aware.
The price of physical gold bullion on the other hand is still very much at the mercy of traditional supply and demand dynamics. Given the difficulty of transporting and storing physical gold, this can even lead to differences in regional pricing.
Due to longstanding historical practices, the bulk of physical gold trading occurs in the London over the counter (OTC) market. This market benefits from comprehensive storage infrastructure, extensive supplies of gold therein, and trusted custodial services. These factors make it the global hub of the gold trade, attracting roughly two thirds of trading volumes worldwide. It is also ideally situated to bridge the gap between Asian and American time zones.
More recently however, some of these trading volumes have started to flow to other markets, most notably the Shanghai Gold Exchange, now the largest purely physical spot exchange in the world. In late 2020, the price of gold on the SGE fell significantly behind the London price due to low demand during the Covid lockdowns. In 2023, the Shanghai-London spread went the other way, culminating in a $121 premium for Chinese bullion.
All this begs the question: what is the real price of gold? As with anything, the price is what someone else is willing to pay for it. The price of a physical ounce of gold is higher than its paper counterpart, although usually not by much. The spread can increase dramatically during periods of extreme fear and uncertainty, but often quickly returns to mean. The elephant in the room is that the derivatives markets utterly dwarves the physical gold market, and that as a result, the price of the former controls the price of the latter. It is this discrepancy that leads many so-called gold bugs to believe that the price of gold is being artificially supressed.
It is usually at this stage of the conversation that someone brings up the concept of reintroducing a gold-backed currency, often as a theoretical competitor to the US Dollar. A reminder that the USD hasn’t been backed by gold since 1971 (or 1913 depending on whom you ask). If such a system were to become commonplace once again, then each country implementing it would have to secure the gold reserves necessary to do so. If this were to occur, the gold derivatives market would implode overnight, supply and demand dynamics coming to the forefront once again. Maybe the pirates burying gold in the sand knew something we don’t.
Risk Warning : Trading derivatives and leveraged products carries a high level of risk.
OPEN ACCOUNT
