Gold (XAUUSD) – as a trading tool on Forex

Gold is a noble metal of yellow color, element 11 of the group of periodic system of chemical elements of Mendeleev, with atomic number 79. It is designated by the symbol Au (latin – “Aurum“).

Gold bullions

Gold due to its unique physical and chemical properties has been used throughout the history of mankind – both as jewelry, as a metal, and as money. The main properties of gold – homogeneity, divisibility, wastelessness, portability, convenience of transportation, sustainability (wear resistance) and universality. Thus, as a result of the natural selection of monetary materials, the role of money for a long time was assigned to gold.

The period of use of gold as money is several thousand years. However, in the XVII-XVIII centuries, with the development of capitalism and the emergence of commercial banks, gold is gradually being pushed out of the sphere of cash circulation by credit money.



Nevertheless, it remains, in fact, the only reserve asset in both domestic money turnover and international monetary relations. All world central banks actively use gold in the form of reserves, and the production and circulation of gold in many countries are under state control.

Gold reserves of central banks

The complete separation of money from the peg to gold, was caused by objective reasons. The main one is that, in conditions of a developed international economy, gold can not perform the functions of a means of payment, primarily because of the physical, quantitative limitation of the commodity itself. Today, gold is the same commodity as oil, gas or metals. The price for it is determined by the demand and supply in the world market.

Despite the loss of gold monetary functions, due to special qualities and historical traditions, it continues to cause increased interest in difficult periods for the economy and serves as a safe asset.

Gold - world production

World gold mining began from time immemorial. Since then, not one thousand years have passed, and the methods of mining have not changed much. In the developed twenty-first century, the method of washing river sand continues to be used. Yellow metal in a closed way began to be mined in the Renaissance (approximately in the XVI-XVII centuries), when the necessary technical means appeared.
Gold is extracted from the ore by amalgamation and chlorination. About 40% of the extracted resource is melted down into ingots, the rest goes to making jewelry (about 50%) and technical needs (about 12%). According to experts, in the whole world history only about 190,000 tons of gold were mined.

Gold mining by countries of the world

What factors affect the value of gold?
Gold is in a dual position. On the one hand, this is a commodity, on the other – an investment and speculative financial instrument. Thus, the cost of gold is influenced by factors such as demand from jewelers and industry, the discovery of new gold deposits or the closure of depleted, the creation of new technologies for its extraction.



Another group of factors is the global political and economic situation, the investment climate, inflation, the political decisions of states and the actions of central banks with gold reserves (market implementation or replenishment of reserves).

Separately it is necessary to dwell on the dependence of the value of gold on the dynamics of the US dollar and the performance of the functions of the safe haven. Let’s compare the dynamics of gold prices and the US dollar index (USDX).

Correlation of gold prices and the dollar index

As can be seen from the chart above, the value of gold (red line) has the opposite dynamics when compared with the US dollar index (blue line). When the US dollar grows, gold decreases and vice versa. This is confirmed by the correlation of the course XAUUSD, calculated for 300 days, with the pair EURUSD (0,72) and USDJPY (-0,75). This is due to the fact that the price of gold is quoted on the world market in dollars. In case of dollar growth, the amount of dollars necessary for investors to purchase gold increases, which lowers the demand for it. This leads to a drop in the price of gold, which compensates for the growth of the dollar. As a result, gold acts as an “anti-dollar”. A similar picture is also present on the other largest commodity market in the world – the oil market.

In times of turmoil, military conflicts, economic crises and other periods of macroeconomic or political instability, investors tend to avoid risks and invest in reliable tools – and one of the most reliable investment tools are precious metals and gold, among others. Therefore, crises and raise the rate of gold. Let’s compare the dynamics of gold and the rate of another safest asset in the world – 10-year US bonds.

Correlation of gold prices and US bonds

As you can see, the relationship is clear and very close. When risks are growing in the world and investors are showing a tendency to “avoid risk,” the demand for the most reliable 10-year US bonds increases, which increases their value (yields decrease) and for the same reasons, the price of gold is growing.

Where is the price of gold set?

Under the international price of gold is understood the price in US dollars per troy ounce (XAUUSD) on a 24-hour global wholesale gold market. 1 troy ounce (“oz t”) is equal to 31.1034768 grams. In exchange quotations, the symbol for the troy ounce is the symbol X: XAU – gold, XAG – silver, XPT – platinum and XPD – palladium. Under the international price of gold can be understood as the quotation of the spot gold market and the price of the gold futures contracts of the next month of supply (front month).

Currently, there are more than 50 gold markets in the world. The largest European markets are in London, Zurich, Paris, Geneva and Frankfurt, in Asia – Tokyo, Shanghai, Beirut, Hong Kong, Singapore, in America – USA and some in Africa.
However, most of the world’s gold trade is in London and New York: in 2015, 78% of the world’s gold trade turnover was accounted for by the London OTC spot market, and another 8% by COMEX in New York.
In London, there is a so-called London Bullion Market. This is an over-the-counter (OTC) gold market controlled by the London Bullion Market Association (LBMA). The Association has 149 members. Of these, 85 permanent, including 13 Market Makers, and 64 associate members from more than 30 countries. The members of LBMA are the world’s largest banks and gold producers. The association operates under the supervision of the Bank of England. The prices fixed on the London market are spot prices. The price for gold is fixed twice a day at 10.30 and 15.00 London time (GMT).

Gold store of the London Bullion Market Association

COMEX (Commodity Exchange) is a division of the CME Group (Chicago Mercantile Exchange Group), which also includes CME (Chicago Mercantile Exchange), CBOT (Chicago Board of Trade – Chicago Chamber of Commerce) and NYMEX (New York Mercantile Exchange – New York Mercantile Exchange). COMEX specializes in trading in stock futures contracts for precious metals. Only every 2500th gold futures contract traded on COMEX is accompanied by the transfer of physical gold or 99.96% of gold futures contracts on COMEX – these are contracts with cash settlements. Trades on COMEX are held almost 24 hours a day using the CME Globex trading terminal.



Based on the statistics of the London gold clearing for 2016, the total trading volume in the London OTC gold market was equivalent to at least 1.5 million tonnes of gold. The trading volume of futures contracts for 100 ounces of gold at COMEX reached in the same 2016 57.5 million contracts, which is equivalent to 179,000 tons of gold. Thus, the volume of gold trading in the London OTC market in 2016 more than 8 times higher than the volume of trade in futures contracts on COMEX.
However, the most important thing is that in the case of both LBMA and COMEX, trade statistics are many times larger than the size of the basic physical gold markets in London and New York.

Despite lower trading volumes, COMEX has a more significant impact on price determination than the London OTC market. The reason is a combination of factors such as availability of COMEX, a long duration of trading sessions due to the use of the GLOBEX platform, greater transparency of futures trading in comparison with OTC trades, low transaction costs and ease of receiving financial leverage on COMEX. On the London OTC gold market, trading sessions take place only during the London business day, there are obstacles to participation, as this is an opaque wholesale market without centralized clearing, and the trading spread is dictated by a small number of market makers, LBMA member banks, and several large London commodity brokers.
All other trading floors for gold, in addition to LBMA and COMEX, mainly use the prices set by the gold markets in London and New York. Among them are physical gold markets around the world, using the international price of gold for their domestic pricing. These same quotes are visible in the MT4 terminal.

The yellow metal has not been synonymous with money for more than forty years: after the abolition of the gold standard in 1971, no currency is associated with the price of gold, and settlements between states are carried out in a form more modern than the physical movement of ingots from one storage to another.
However, gold is not going to surrender the position of one of the leading financial investment and speculative instruments. The gold reserve of states remains an essential factor of his power. This becomes especially noticeable during times of economic instability – any crisis inevitably entails a rise in gold prices. If we take into account the fact that the volumes of world gold production fall, and the demand for noble metal, on the contrary, should grow (not only from financial institutions, but also from the aviation, space, jewelry, medicine) that gold mining is still a profitable and socially significant business. So gold is an excellent trading tool for traders all over the world.

 

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