The structure of the gold market is facing an unprecedented wave of change resulting from evolving gold demand patterns, regulatory change, new types of participants and innovation. How individual gold market centres respond to these opportunities and potential threats will shape the gold trading landscape over the next decade and beyond.
West to East shift
The market’s demand profile continues to shift towards the East with China and India alone comprising more than half of global gold demand in recent years. Moreover, Asian countries have been investing in all stages of the value chain from production through to refining and fabrication. China today is both the largest producer and consumer nation, which is reflected in the country’s appetite to play a more influential role in gold trading and pricing. An undoubted shift in influence towards China and its market infrastructure, primarily the Shanghai Gold Exchange, is taking place.
Financial markets have seen a wave of new regulations introduced since the financial crisis in 2007/8. Most of the regulations are aimed at improving the resilience of the financial system by increasing the capitalisation of banks, addressing systemic risks and increasing levels of market transparency. Most of the new regulations apply across asset classes and are not unique to gold. While the regulatory direction of travel is consistent around the globe, there are naturally differences in regulation and implementation by region and jurisdiction. Overall, regulations have imposed costs on market participants and have had some unintended consequences such as a reduction in market liquidity. It will likely take a few more years until regulatory change stabilises and the full impact on the gold market structure becomes clear.
Partially as a function of regulatory change, there is a broad shift across asset classes from OTC markets towards transparent trading on exchanges. This trend can also be observed in gold as regulators seek to raise the relative cost of bilateral OTC trading and incentivise a move towards central clearing of contracts. Banks, the primary intermediaries in the wholesale market, typically face higher capital and collateral costs by trading OTC. Additionally, central clearing (which underpins exchange-traded contracts) offers netting benefits, operational efficiencies and a degree of transparency largely absent from OTC markets. These gold market trends underpin the World Gold Council’s desire to partner with players like the London Metal Exchange to catalyse the evolution of the gold market’s structure.
Banks have historically always played a dominant role in the gold market, performing financing functions, facilitating risk transfer, providing investor access and offering physical market services (e.g. physical distribution and custody). In recent years many banks have retrenched or exited the commodity markets due to capital constraints, market consolidation and cyclical considerations. Coupled with banks’ restraints on taking proprietary positions, non-bank players have become increasingly important providers of liquidity and influence price discovery. These players include hedge funds, algorithmic traders and high frequency trading firms. Retail investors increasingly also interact directly with the wholesale market (e.g. through ETFs in the West or the futures market in China) and can meaningfully influence gold prices.
Technology innovation is disrupting many sectors and the way gold is traded will likely not be immune. Blockchain technology, in particular, holds promise in offering a more robust, operationally and cost efficient mechanism for facilitating the settlement of gold transactions. Notwithstanding a series of challenges, it could enable the move towards true ‘delivery vs. payment’ spot trading that could eliminate settlement risks and realise other benefits. More broadly, blockchain technology could become an integral component of the gold value chain, facilitating tracking of gold from ‘mine to consumer’ and thereby strengthening the market’s chain of integrity. Establishing tamper-proof gold provenance would make the gold market more transparent, efficient and help eliminate illegal practices such as smuggling of conflict-gold.