Currency Market, Commodity Market, and Government Securities

Lesson -> Gold - Part 02

8.1 - The London fix

We have already discussed the different Gold contracts available on MCX in the previous chapter. This chapter will discuss how spot gold prices are determined internationally and in India. This method of fixing gold prices is symbolic, and has very little relevance to trading futures on gold at MCX. This is an interesting fact that I want to share.

The price of Gold in London is set daily at 2 o'clock in the morning and 2 o'clock in the evening. The morning session at 10:30AM is known as the "AM Fix" and the evening session is known as the "PM Fix". The gold dealers at London's largest bullion desk fix the prices. Nathan Mayer Rothschild & Sons facilitates the entire process.

There are approximately 10-11 participating banks. These include JP Morgan and Standard Chartered as well as ScotiaMocatta (Scotiabank), Societe Generale, etc. The general public and other banks cannot participate in this process. These dealers call the dedicated conference number at the appointed time to submit their bids for buying and selling gold. The market is then informed of the average price by comparing all the offers and bids. This price becomes the benchmark for gold trading. This entire process takes about 10-15 minutes. This process is repeated in the "PM session", where the gold prices are once again discovered and sent to the markets.

AM and PM sessions are very close in relation to the actual price of gold traded on London’s international markets.

In this sense, bullion dealers and traders will not be surprised by the price relayed. Some participants believe that even this process is more traditional.

India follows a similar pattern, though it is less complex. India is the largest consumer of Gold and imports it. Designated banks import the gold, and these banks then supply the gold to bullion traders (after paying the required charges; more details later). The Indian Bullion Association bids for the gold via its network of bullion dealer partners. The quotes are based on the amount of gold that the dealers would like to purchase or sell at a particular price. These rates are then averaged and this sets the floor for Indian Gold prices. There is a bit of a circularity in this process, as dealers often look at the Gold futures prices traded on MCX before they place their bids with Indian bullion associations. This price is then relayed to dealers and jewellers, and the price for that day is established.

8.2 - Gold price disparity

Traders often compare the Chicago Mercantile Exchange's Gold Futures Rate (CME) with the MCX Gold Futures Rate (MCX) to determine if there is an arbitrage opportunity. This is because Gold, being an international commodity, should trade at the same price most of the time. In the absence of this an arbitrage opportunity exists. For example, 10 grams of pure 995 Gold in CME would be quoted at $430. On MCX, the price for 10 grams should be around $ 430.

This is not always the case. They trade at a significantly differing price and there is always a gap between CME gold futures and MCX. But the question is: Why does there exist this disparity between these two gold futures contracts?

Let's figure it out.

Understanding how India's Gold spot rate changes in India is key to understanding the difference between futures contracts.

Remember that India is a net gold importer. The international markets, especially the US, are quoted for gold on a per-troy ounce basis. A troy ounce equals approximately 31.1035g. Let's say that Gold is spot-traded in the US at $1320 per troy. What do you think the spot price for gold in India should be? Let's say $ 1 equals Rs 65.

 To find the USD price of 10 grams gold, multiply that number with the USD INR rate and then calculate the price.

31.1 grams equals $1320. 10 grams equals $424.43. The USD INR stands at 65 so the gold price in India should be approximately Rs.27.588/-.

This is unfortunately not the case. Importing gold (remember, it is the banks that import it) will attract duties and taxes. All these costs should be included in the spot price for Gold in India. Let me give you a list of all costs when a bank imports Gold.

  1. CIF in Dollars (CIF stands to cost, insurance and freight).
  2. Custom duty
  3. Cess
  4. Bank costs

The landed price for Gold tends to rise due to all of these charges.

For example, let's say that spot Gold is priced at $420 per 10g in the US. In India, however, after all the extra costs, the spot rate would be much higher. Let's say that the spot rate in India is $435. This would result in a $15 difference in the spot rates.

This explains the difference in spot rates. But what about futures prices? The futures prices are a function of spot rates. The formula that links futures price and spot price is -

F = S*e rt

In the US markets, the spot price for Gold in the US will be the basis of future pricing. $420. However, the basis for future pricing in India will be determined by the spot price of Indian gold, which is i.e. $435 This means that the futures prices of gold in CME or MCX will be different. This should not be misinterpreted as an opportunity for arbitrage.

8.3 - What drives gold's price?

This strange but predictable behavior is common among investors around the globe - they all rush to purchase gold when there are uncertainties. The gold standard has been viewed as a safe haven that can protect investments from any economic meltdown.

Take the Brexit (June 2016), the most recent global event that has shaken the world. The Gold market saw a sharp uptake before and after the event. In fact, the biggest candle you can see in this period was on the 24 th June, which was the day after the Brexit verdict. Due to the Brexit outcome, gold rallied naturally. Investors flock to gold when there is global or domestic uncertainty. This is due to the fact that Gold can be used to preserve your wealth.

Nearly all major world events have had an effect on Gold in the past. Think about the following: Oil crisis, Middle East uprisings, EU migrant crises, Greek economy and Euro crisis; the list goes on. The point is that gold prices are affected by every global event.

We can draw a crucial conclusion: Gold tends to appreciate in times of economic uncertainty. In reality, the backdrop of economic uncertainty tends to reduce the demand for risky assets like equities, while the demand for safe-haven assets like Gold tends increase.

Investors tend to invest in gold because it is a good hedge against inflation, despite the uncertainty. Investors believe that gold's value will rise over time. If you take a look at the long-term chart of gold, this perception is reasonable.

The chart shows that gold was $35 in 1970 and is now at $1360 in 2016. This is a 37x return. This translates into 8% annual growth if you consider it from a CARG perspective. The average global inflation rate is between 5 and 6. If you invest in gold, your expected return is 8%. However, inflation can cause you to lose 6%. This will net you a performance of 2%. In countries like India, where inflation is high investment in Gold doesn't really fetch much.

8.4 - Gold and Dollar, Rupee and Interest Rates

The movements in gold are also affected by the currency and interest rates of the economy. If you trade in Gold, it is important not only to track world economics but also to track currencies and interest rate movements. It's easy to see the equations. Let us begin with the dollar and work our way up.

Take a look at the graph below.

This is the USD/Gold graph. It is obvious that the relationship between these two currencies is inverted. Two reasons can be broadly attributed to this inverse relationship:

  1. The dollar's value relative to another currency decreases and the currency of the other currency will increase. The currency's value increases, which means that there is a greater demand for commodities like Gold. The demand for gold rises, and so do the prices.
  2. Investors find it less appealing to invest in the US dollar falling; they tend to park their money in safe havens like gold.

This being said, it is important to remember that this might not be the case all the time. In some cases, both gold and USD could increase. Think about the Saudi Arabia crisis. With falling oil prices, domestic investors might want to shift their investments away from Saudi Arabia and put it in USD and Gold. This would increase their assets' value.

It doesn't matter what, you should know that the USD plays a part in the direction of Gold's movement. To find out if there are any correlations between different variables and gold, it is important to study them. An example: A rise in US federal rates tends towards strengthening the US Dollar. This Gold should lead to a decrease in price. However, this doesn't always happen. If I'm correct, the correlation between Gold prices and Federal rates is less than 0.3.

Although I know the above discussion is counter-intuitive, I also mentioned earlier that a strong dollar tends towards pushing gold prices down. However, it is possible that the US may not have an impact on Gold.

Are you confused? It is confusing, yes.

How can one trade gold? The best way to trade gold is to study its demand and supply. For an international commodity like Gold, the demand and supply factors can be complex and many. The demand and supply pressures are reflected in prices. A sense of this can be seen in charts. You can read charts using Technical Analysis, which can help you to develop trading insights for gold.

Fundamental Analysis is my favorite when it involves equities. But when it comes commodities and currencies, charts are my go-to.

8.5 - Technical Analysis on Gold

Technical Analysis (TA) is a term I recommend you learn if you don't know what it is.

One of the most important attributes of TA, is its ability to be applied to all asset classes, including commodities and currencies. Let me use TA to create some trading notes for Gold. This will hopefully give you an idea of how to use TA on gold.

The objective of trading Gold is clear - it's a short-term trade and I don't intend to keep the trade open for more than a few weeks.

When developing a trading view, the first thing I do is look at the long-term chart of the asset. I am referring to at least two years. This is what I will do here. I'll be looking at the ETF chart of the Gold Bees (ETF).

These are the points I have noted from the chart.

  1. From late 2013 to late 2015, gold prices declined.
  2. In the last few months 2015, prices have fallen to their lowest point.
  3. In fact, gold formed a double bottom from Sept 2015 to Dec 2015.
  4. Since early 2016, prices have been rising.
  5. Since early 2016, traders have bought Gold in every downturn.
  6. Evidently, gold's bearish nature is gone. This is evident by the fact that gold prices have declined to 2013.

All this leads me to conclude that I would be more comfortable trading long than short. However, this does not necessarily mean that I won't short Gold. If the risk to return is compelling enough, I'd consider it. But, I know that traders are always looking for gold at every possible price. Therefore, I will cover my short position quickly if I short Gold. You might be able to see that I have a broad view of Gold, but have not explored specific price levels.

I am interested in seeing a chart of Gold for short term trading opportunities. Before we move on to identifying trading opportunities (which we will need to see the right side), In late 2015. It continues until the end of June 2016. There is virtually no activity. Both the volume and price are clear examples. Volume is virtually non-existent and prices tend to fluctuate. Can you guess the reason?

Remember that Gold contracts are generally introduced nearly a year ahead of time. For example, the Oct 2016 contract, which we are currently looking at, would have been launched around Oct 2015. This contract is not eligible for liquidity until it reaches its expiry date, which is October 2016. October 2016. October 2016.

Let's now examine the left side of this chart to identify trading opportunities, if any. I will repost the chart, focusing on recent candles. I have overlayed 9-day exponential moving averages and 21-day moving averages on the prices.


  1. The market price currently is lower than both the short-term averages and the current market price.
  2. In the past, there were three price action zones at around 30956 (I have circled the same in blue circles), so the current market price is lower than this level and 30956 becomes immediate resistance.
  3. A Bearish Marubuzo (circled in dark) was formed in the recent past. It has been successful. This one could be a profitable trade.

All of this being said, I would consider buying opportunities in Gold when it crosses the resistance level at 30956. This coincides with two short-term moving averages which encourage me to be long. For the reasons we have discussed, I wouldn't hesitate to shorten if gold prices remain below the resistance level. My trade would look something like the following -

  • Long Position
  • Price above 30956
  • Target: 31418 (have put a short blue line).
  • Stoploss: 30700 (current price on the market)
  • If I go long at 30956 and receive reward to risk: 1.8
  • % change from entry - 1.5%

From a reward-to-risk perspective, this is a good trade. We are seeing a 1.5% movement, so this could happen in one day.

However, the point of this article is to explain in detail how TA can be applied to commodities like Gold.

I trust the information in these chapters has been sufficient to help you get started with trading Gold.

Moving on to Silver!

To summarize

  1. If the price of gold is fixed twice a days in the AM & PM sessions in London, it will be deemed as a fix.
  2. Only banks that are designated can take part in the London fix.
  3. India has a similar gold fix to London. However, there is a circularity as traders tend to focus on the MCX prices.
  4. Due to India's additional duties, taxes and charges, the spot price for gold in India and the US differs.
  5. Since the spot prices vary, so does the futures price.
  6. Dollar and gold are inextricably related.
  7. Understanding the fundamentals of commodity prices is difficult. Therefore, traders tend to focus on demand and supply.
  8. The current price reflects demand and can see this in chart.
  9. Technical analysis can be applied to Gold and other commodities