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London bullion market

The London bullion market is a wholesale over-the-counter market for the trading of gold and silver. Trading is conducted amongst members of the London Bullion Market Association (LBMA), loosely overseen by the Bank of England. Most of the members are major international banks or bullion dealers and refiners.
Contents [hide]
1 Gold trading
2 Market size
3 Account Types
3.1 Allocated Accounts
3.2 Unallocated Accounts
3.3 Unallocated Risks
4 Other London markets

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. Because interest rates for gold tend to be lower than US domestic interest rates--it 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 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.
[edit]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.[1]. Clearing data substantially understates the true amount of gold traded due to the netting of trades in the calculation of Clearing Statistics. Actual turnover is perhaps 4 [2] times greater than clearing turnover so that 2008 turnover is estimated as 2,134 tonnes [2].
Account Types

Allocated Accounts
Allocated Accounts are accounts held by dealers in clients’ names on which are maintained balances of uniquely identifiable bars, plates or ingots of metal ‘allocated’ to a specific customer and segregated from other metal held in the vault. The client has full title to this metal with the dealer holding it on the client’s behalf as custodian. To avoid any doubt, metal in an allocated account does not form part of a precious metal dealer’s assets. [3].
[edit]Unallocated Accounts
Unallocated Accounts represent the most popular way of trading, settling and holding gold, silver, platinum and palladium. Transactions may be settled by credits or debits to the account while the balance represents the indebtedness between the two parties. Credit balances on the account do not entitle the creditor to specific bars of gold or silver or plates or ingots of platinum or palladium but are backed by the general stock of the precious metal dealer with whom the account is held. The client in this scenario is an unsecured creditor. [3]
Unallocated Risks
The total quantity of unallocated gold is estimated to be 15,000 tonnes at the end of 2008[4] which supports the 2,134 tonnes on average of spot gold trade through London every day representing 14.2% of the pool. This compares to average daily turnover in UK equities of between 0.34% and 0.63% for the 12 months ending September 2009 [4]. While members of the LBMA provide no information on the backing for unallocated gold the improbably high turnover is suggestive they are operating a fractional reserve system where unallocated accounts are only partially backed by physical gold. Similarly to a bank run this makes LBMA unallocated gold accounts susceptible to loss if a sufficient number of market participants request delivery of physical bullion.
Other London markets

The London bullion market is distinct from the London Metal Exchange (LME). The latter is the futures exchange with the world's largest market in options, and futures contracts on base and other metals

Money managers go for the gold

Gold is one of the more mysterious assets in the financial markets. It's volatile at times to the point of inducing vertigo and fans of the precious metal assert, somewhat contradictorily, its prowess as a hedge against both inflation and deflation.

Business

It's also been one of the best investments of the last several years, outlasting the equity bull market and performing well when so many assets have succumbed to big declines.

That's why it's become a key component among the strategies of the world's largest money managers even as it streaks to never before seen heights of roughly $1,250 an ounce hit last week.

"The outlook for gold is very, very strong," Evy Hambro, co-chief investment officer of BlackRock's natural resources equity team, said in a recent telephone interview from London.

BlackRock's assets under management totalled $3.36 trillion (2.33 trillion pound), as of March 31.

"Gold is certainly nowhere near as volatile as the moves we've seen in currencies," Hambro added. "Look at the euro!"

On Tuesday, spot gold shot up to a session high above $1,200 an ounce, though a bit off the record $1,248.95 per ounce set on May 14. Against the U.S. dollar, the euro is down 14.2 percent so far this year, while gold is up 9 percent for the same time period, Reuters data show.

Similar to hedge funds, money managers are further adopting gold exposure, by way of gold-linked equities and exchange-traded funds, into their asset allocation strategies despite gold's stomach-churning swoons.

FOLKS WITH THE MIDAS TOUCH

In fact, assets in the popular SPDR Gold Shares ETF on Tuesday hit a record $48.8 billion, according to State Street. This is partially due to the rise in the price of the underlying asset, but also reflects increased investment from ordinary investors looking for exposure to commodities.

Mom and pop investors have shown just that.

Commodity sector funds, with gold exchange-traded funds driving the interest, have attracted nearly $7 billion in net cash over the last four weeks, according to EPFR Global.

Mohamed El-Erian, who as co-chief investment officer helps oversee more than $1 trillion at Pimco, said his firm took some profits off the table last week in the SPDR Gold Shares, but emphasized gold exposure remains "very much" a part of the firm's asset allocation.

The proximate cause for money manager's giddiness over gold?

Festering inflationary pressures stemming from the extensive printing of money by the world's central banks to offset collapsing credit markets and avoid depression-like economies. World central banks have been opening the money spigots to buy securities in emergency measures, such as those the European Central Bank has recently undertaken to stabilise euro-zone government bond markets.

Moreover, the flight into gold reflects investors' concerns about the potential for paper currencies to depreciate because of central banks' looser lending policies. For example, the U.S. Federal Reserve's key policy interest rates are still at near zero percent -- which will lead to inflation.

A GOLDEN CURRENCY

While the dollar is seen by many as preferable to the euro or yen, the extent of U.S. indebtedness worries some who believe more problems face the United States in coming years.

All of this has led prominent hedge fund managers to gold.

"As an investor, I became very concerned about having my assets denominated in U.S. dollars," Paulson said in December during a luncheon presentation in New York. "So I looked for another currency in which to denominate my assets in. I feel that gold is the best currency."

Last fall, David Einhorn of Greenlight Capital also spoke along those lines at an investor conference: "Picking these currencies is like choosing my favourite dental procedure. And I decided holding gold is better than holding cash, especially now that both offer no yield."

Einhorn echoed the sentiment at Greenlight Capital Re's investment meeting last week, saying he still holds physical gold for "we tend to think of gold as a currency." He added: "I think there's going to be a lot of inflation."

Emphasizing the phenomenon of hedge funds' growing scepticism of the creditworthiness of countries, the European Union and the International Monetary Fund announced a nearly $1 trillion bailout for ailing member states to halt potential contagion from the spiraling deficits in the euro zone.

El-Erian put it this way in his latest letter to clients:

"Too many balance sheets deleveraged simultaneously, threatening a global depression and forcing governments to step in with their own balance sheets to arrest an increasingly disorderly process."