London bullion market
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The London bullion market, is entirely different from, but often confused with the London Metal Exchange. Only base metals are traded at the London Metal Exchange (LME), while gold and silver are traded by 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. Five members of the LBMA meet twice daily to "fix" the gold price in a process known as the London Gold Fixing.
Gold is traded primarily over-the-counter (OTC) with limited amounts trading on the New York Mercantile Exchange (NYMEX) and Tokyo Commodities 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 New York and London 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 forward 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 (to encourage gold borrowings so that central banks can earn interest on their large gold holdings), except in exceptional circumstances the gold market tends to be in contango (i.e. the forward price of gold is higher than the spot price). This has historically made it an attractive market for forward sales by gold producers and contributed to an active and relatively liquid derivatives market.
[edit] Size of the market
The bulk of global trading in gold and silver takes place 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-traded trading has grown in recent years with Comex in New York and Tocom in Tokyo generating most of activity. Gold is also traded as a security 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 December 2004 was 15.4 million ounces (480,000 kg, worth $6.8 billion) and 102.2 million ounces (3,180,000 kg, worth $730 million) respectively. This means that an amount equal to the annual gold mine production was cleared at the LBMA every 5.4 days, and to the annual silver production every 5.8 days.[1]
