When you buy (or sell) precious metals the seller will reference a market or ‘spot’ price and add to (or subtract from) this. The spot price plus this difference – called a premium – is what a retail investor pays to obtain gold and silver coins and bars. The premium includes a profit margin plus all dealer costs of selling to you including any markups paid to suppliers. In fact every intermediary between you and the mine pays a referenced price plus some markup.
Spot prices are determined by futures contracts that are auctioned on international exchanges as well as at the twice daily fix by the London Bullion Market Association (LBMA) in London. As a result, spot prices are available on numerous electronic markets around the world and continuously updated in real time. The chart below shows the evolution of the gold spot price throughout the last trading 3 days.
Chart provided by goldprice.org
There are futures contracts for every month extending out for years into the future but only trading activity in the most active nearby month determines the spot price. By moving around the globe from exchange to exchange the spot price is continuously adjusted from Sunday 18:00 to Friday 17:15 New York time. In practice, the Comex in New York (NYMEX) and the LBMA have by the far the greatest influence on spot price.
“..The spot price plus [the dealers] ‘premium’ is what a retail investor pays to obtain gold and silver coins and bars.”
Spot gold close
Because the Comex so heavily dominates the entire global futures market there is also the New York (NYMEX) Comex ‘spot gold close’. This is another reference price and it’s calculated as the average of the highest and lowest spot prices achieved during the last two minutes of daily trading in New York. Since the Comex is open limited hours the spot gold close is set each Monday through Friday excluding public holidays.
By convention, spot and the Comex spot gold close are accepted de facto by the precious metal dealing community with no local variations. A dealer in London will reference these prices when calculating bid/ask spreads as will another dealer in Hong Kong or New York.
“..a dealer in London will reference [spot price] when calculating bid/ask spreads as will another dealer in Hong Kong or New York.”
When dealers (of all types including Bailment services) sell precious metals to customers they apply a premium to the spot price as explained above. Their premiums include all of their costs of selling to you plus a profit margin. Dealers will quote an above-spot ‘ask’ price when selling to you and (typically but not always) a below-spot ‘bid’ price when buying from you – this is the so-called bid/ask spread around spot price.
As mentioned above referring to spot in this way is by convention only. Some dealers source their inventory in bulk directly from commodity exchanges. Some very large gold importers such as in India source metals directly from mines. However the majority of retail level dealers buy in smaller quantities from refiners, mints, and via buy-backs from the general public. Therefore if the spot price doesn’t match the reality of dealer inventory costs don’t expect ask and bid prices to closely relate to spot price.
Once the ask premium is added on then the sales or value-added tax (if any) are calculated on top of this total amount. A higher ask premium means therefore you pay proportionately more in sales tax relative to spot.
A looming crisis for the spot price?
The Comex dominates gold and silver futures trading and the notional volumes traded on this exchange are very high. This depth to the market allows for extensive long and short options trading. For years now there have been massive and highly concentrated short positions on silver and gold on the Comex. While delivery rarely takes place, Comex contracts are technically contracts for delivery so this situation has raised questions as to whether there is sufficient physical metal for on-time settlement.
According to pro-gold and silver lobby group GATA these short positions are held by JP Morgan, Bank of Nova Scotia, HSBC (USA), and Citibank. In early January 2013 one entity controlled almost half of the entire silver short position on the Comex. This amounted to 73 days of world production or 150,000oz of silver. GATA believes JP Morgan is this entity. Interestingly, there is no equivalent situation on the long side which has thousands of participants with none having any notable size or concentration of position.
Ed Steer from GATA explains this situation in the video below (skip to 17:00 to see Ed’s presentation)
Another interesting and perhaps related development is that gold and silver contracts on the Comex have gone from permanent contango (the normal state of affairs) to being sporadically in backwardation. Backwardation means the current cash or spot price is higher than the next nearest future contract. This is not normal for any commodity unless people fear a future shortage. Backwardation occurred again in early February 2013 where it was possible to make a profit by selling physical gold and “re-buying” it again with an April contract.
As a result of the concentrated short position and increasing backwardation in the Comex market many believe one of two events will happen in the future: either gold and silver spot prices will rise dramatically, or real world shortages will emerge and the Comex will become much less relevant for setting prices of gold and silver.
For now at least, the spot price and the Comex spot gold close are what dealers still refer to when setting their bid/ask spreads and the resulting premiums.