Understanding the Gold Market
Gold is an increasingly popular investment, but the gold market can be complex and overwhelming to new investors who are more familiar with equities like stocks and exchange-traded funds (ETFs).
The term "gold market" refers to a worldwide network that includes wholesalers and exchanges, and it involves the physical exchange of the precious metal or trading non-physical gold using contracts or gold ETFs. Gold is traded continuously, and there are many trading hubs, but few central locations.
Let’s take a look at some of the different aspects of the gold market and what you can expect if you decide to trade or invest in gold.
Physical gold
One reason that gold is considered a good investment is its tangibility. Miners, refiners, banks, fabricators, depositories and end-users contribute to the gold market. Miners or scrap gold dealers send the metal to mints or refiners to be smelted. Once smelted, the gold is generally turned into ingots, bars, rounds or coins. Be mindful that, when investing in physical gold, it’s critically important to understand its purity.
Physical gold can be stored in approved warehouses or shipped directly to buyers. If you have gold held in a warehouse, you’re usually issued information about your lot number and pay an ongoing storage fee as well as gold insurance. Banks can also store physical gold and might even help finance transactions or manage consignment selling.
It’s important to note that the gold market has what’s sometimes called a “circle of integrity.” It includes approved refiners and warehouses, as well as gold mined and recently collected as scrap. Outside the approved circle of integrity are dealers, jewelers, manufacturers and others. They often trade gold items close to market price, but without being within the market of approved refiners and warehouses.
Learn more about how to buy gold from the best gold dealers.
The commodities market
Buying and selling on the commodities market represents ownership of physical gold, even if you don’t usually have the gold actually shipped to you (or a different storage facility).
Gold options allow you to potentially buy gold in the future for a set price. For example, if you think that gold prices will rise, you might purchase an options contract that allows you to buy gold at today’s market price at some point in the future. If prices head higher, you can exercise your options and get the price at the agreed-upon lower price.
Gold futures are contracts that allow you to buy gold in the future at an agreed-upon price. You might be required to take possession of the gold at that time. When you buy gold futures, you can own the underlying physical asset.
Major gold trading centers
Acknowledged as the historical center of the gold trade, the London OTC market is known for offering the benchmark for gold prices, which are determined twice daily.
The U.S. futures market (COMEX) is also an important player in commodities. While most contracts traded on COMEX never settle physically, the active-month contracts are closely related to physical prices and are often used as a spot price proxy.
Finally, India is one of the emerging players for physical gold. While regulation is loose in India, efforts to create a spot exchange are underway to help control the chain of custody and quality.
Non-physical gold
Gold ETFs are becoming an important part of the gold market since they can impact the price of gold, even though physical gold doesn’t actually change hands with these investments. You don’t own the underlying gold when you purchase shares of a gold ETF. Instead, the ETF often holds contracts or future options, and in some cases, the fund holds the shares of gold mining companies.
Buying and selling gold ETFs is easy since they are traded on stock exchanges. However, the interesting quirk with gold ETFs is that the IRS might tax them at the higher collectible capital gains rate, with a top rate of 28%. It’s important to understand how your gold investment is taxed. In this case, it largely depends on how the ETF is structured.
Because gold ETFs are becoming increasingly popular, they can impact the price of gold because they’re still connected to the yellow metal, even though they only represent “potential” gold.
OTC vs. exchanges
Over-the-counter (OTC) trading differs slightly from using an exchange to trade gold on the market.
London is well-known for OTC gold trading, but it also occurs elsewhere. With OTC trading, parties trade directly with each other. They can create custom transactions, and it’s often relatively easy to engage in large transactions anonymously. At the same time, costs can be higher, and participants might not have the transparency they desire. OTC gold trading is considered to be a higher risk than trading on an exchange.
Exchanges are a major part of the gold market, offering greater regulation and creating a centralized place for participants to use a third party to manage transactions. Rather than offering full customization, you choose from different pre-set contracts. There’s less flexibility, but the exchange helps manage some of the risk.
Bottom line
There are many ways to participate in the gold market. You don’t have to buy physical gold to add the precious metal to your portfolio. You can use contracts and ETFs to diversify your portfolio and gain exposure to gold.
Carefully consider how you want to be involved and where gold might fit into your overall portfolio strategy before moving forward.