Infographic: Bullion Banking Mechanics

20 Feb
Federal Reserve Bank of New York

Federal Reserve Bank of New York

Bullion banks are some of the most influential participants in the global gold market. But who are these players and what do they actually do? And most importantly, how can these bullion banks trade thousands of times more gold each year than is actually in existence?
This infographic lifts the lid on bullion banking, looking at the world of fractional-reserve paper gold trading built on the unallocated gold account system. Topics covered include:
  • The identities of these bullion banks
  • The fractional reserve nature of bullion banking and the paper gold creation process
  • How the staggeringly large paper gold trading volumes are generated
  • The gold price discovery process and how the price of gold is set in London by unallocated trading which channels gold demand away from real physical gold and into paper
  • The secretive nature of the bullion banking club and how its activities in the City of London are deliberately shrouded in secrecy
  • How new competitors into the London Gold Market claim to be providing competition but are actually perpetuating the underlying unallocated gold account system of trading

For more information about the mechanics of bullion banking, please also see BullionStar Gold University article Bullion Banking Mechanics.

Bullion Banks and Bullion Banking Mechanics

Gold trading

Internationally, gold is traded primarily via over-the-counter (OTC) transactions with limited amounts trading on the New York Mercantile Exchange (NYMEX) and Tokyo Commodity Exchange (TOCOM). These forward contracts are known as gold futures contracts. Spot gold is traded for settlement two business days following the trade date, with a business day defined as a day when both the New York and London markets are open for business. Unlike many commodity markets, the forward market for gold is driven by spot prices and interest rate differentials, similar to foreign exchange markets, rather than underlying supply and demand dynamics. This is because gold, like currencies, is borrowed and lent by central banks and in the interbank market. Interest rates for gold tend to be lower than US domestic interest rates. This encourages gold borrowings so that central banks can earn interest on their large gold holdings. Except in special circumstances the gold market tends to be in positive contango, i.e. the forward price of gold is higher than the spot price. Historically this has made it an attractive market for forward sales by gold producers and contributed to an active and relatively liquid derivatives market.

Market size

The bulk of global trading in gold and silver is conducted on the over-the-counter (OTC) market. London is by far the largest global centre for OTC transactions followed by New York, Zurich, and Tokyo. Exchange-based trading has grown in recent years with Comex in New York and Tocom in Tokyo generating most of the activity. Gold is also traded in forms of securities, such as exchange-traded funds (ETFs), on the London, New York, Johannesburg, and Australian stock exchanges.

Although the physical market for gold and silver is distributed globally, most wholesale OTC trades are cleared through London. The average daily volume of gold and silver cleared at the London Bullion Market Association (LBMA) in November 2008 was 18.3 million ounces (worth $13.9 billion) and 107.6 million ounces (worth $1.1 billion) respectively. This means that an amount equal to the annual gold mine production was cleared at the LBMA every 4.4 days, and to the annual silver production every 6.2 days. The Gold Anti-Trust Action Committee claims that clearing-data substantially understates the true amount of gold traded, due to the netting of trades in the calculation of Clearing Statistics. They claim the LBMA market is $21.6 billion per business day ($5.4 trillion a year).

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