Throughout its history, gold has been praised for its natural beauty and radiance. Gold has always been considered precious, but wasn't used for monetary value well up until 643 B.C. At first, people carried around gold or silver coins. If they found gold, they could get the government convert them into tradable coins. Because of its value and its usefulness as currency, the evolving value of gold can be traced back as far as 30 B.C.
Emperor Augustus, who reigned in ancient Rome from 30 B.C. to 14 A.D., set the price of gold at 45 coins to the pound. In other words, a pound of gold could make 45 coins. The next revaluation occurred in the period of 211-217 A.D., during the reign of Marcus Aurelius Antoninus. He debased the value to 50 coins for a pound of gold, reducing the value of each coin and making gold worth more. From 284 A.D. to 305 A.D., Diocletian further debased gold to 60 coins per pound. Constantine the Great debased it to 70 coins per pound in the years 306 A.D. to 337 A.D.
Why would they do that? The answer is simple: they did this to finance the military so they could stay in power. They also increased taxes. These emperors lowered the value of the currency so much that it created hyperinflation. To illustrate, in 301 A.D., one pound of gold was worth 50,000 denarii, which is another coin based on silver. By 337 A.D., it was worth 20 million denarii.
As the price of gold rose, so did the price of everything else. Middle-class people could not afford their daily needs. That's one of the reasons why the Roman Empire eventually began to crumble.
In 1257, Great Britain set the price for an ounce of gold at 0.89 pounds. It raised the price by about 1 pound each century.
In the 1800s, most countries printed paper currencies that were supported by their values in gold. This was known as the gold standard. Countries kept enough gold reserves to support this value. The history of the gold standard in the United States began in 1900. The Gold Standard Act established gold as the only metal for redeeming paper currency. It set the value of gold at $20.67 an ounce.
Great Britain kept gold at 4.25 pounds per ounce until the 1944 Bretton-Woods Agreement. That's when most developed countries agreed to fix their currencies against the U.S. dollar since the United States owned 75 percent of the world's gold.
United States: a Year-by-Year Snapshot
Before the Gold Standard Act, the United States used the British gold standard. In 1791, it set the price of gold at $19.49 per ounce but also used silver to redeem currency. In 1834, it raised the price of gold to $20.69 per ounce.
Defense of the gold standard helped cause the Great Depression. A recession began in August 1929, after the Federal Reserve raised interest rates in 1928.
After the 1929 stock market crash, many investors started redeeming paper currency for its value in gold. The U.S. Treasury worried that the United States might run out of gold. It asked the Federal Reserve System (the Fed) to raise rates again. The rise in rates increased the value of the dollar and made it more valuable than gold. It worked in 1931.
Higher interest rates made loans too expensive. That forced many companies out of business. They also created deflation, since a stronger dollar could buy more with less. Companies cut costs to keep prices low and remain competitive. That further worsened unemployment, turning the recession into a depression.
By 1932, speculators again turned in money for gold. As gold prices rose, people hoarded the precious metal, sending prices even higher.
1933 - Roosevelt outlawed private ownership of gold coins, bullion, and certificates.
1934 - Congress passed the Gold Reserve Act which essentially prohibited private ownership of gold in the United States. It also allowed Roosevelt to raise the price of gold to $35 per ounce. This lowered the dollar value, creating healthy inflation.
1937 - Roosevelt cut government spending to reduce the deficit which in turn reignited the Depression. By that time, the government stockpile of gold tripled to $12 billion. It was held at the U.S. Bullion Reserves at Fort Knox, Kentucky, and at the Federal Reserve Bank of New York.
1939 - Roosevelt increased defense spending to prepare for World War II, and the economy expanded. At the same time, the Dust Bowl drought ended. The combination ended the Great Depression.
1944 - the major powers negotiated the Bretton-Woods Agreement, making the U.S. dollar the official global currency. The United States defended the price of gold at $35 per ounce.
1971 - President Nixon told the Fed to stop honoring the dollar's value in gold. That meant foreign central banks no longer could exchange their dollars for U.S. gold, essentially taking the dollar off the gold standard. Nixon was trying to end stagflation (a combination of inflation and recession). However, inflation was caused by the rising power of the dollar, as it had now replaced the British sterling as a global currency.
1976 - unhinged from the dollar, gold quickly shot up to $120 per ounce in the open market.
By 1980, traders had bid the price of gold to $594.92 as a hedge against double-digit inflation. The Fed ended inflation with double-digit interest rates but caused a recession. Gold dropped to $410 per ounce and remained in that general trading range until 1996 when it dropped to $288 per ounce in response to steady economic growth. Traders returned to gold after each economic crisis, such as the 9/11 terrorist attacks and the 2001 recession.
Gold shot up to $869.75 per ounce during the 2008 financial crisis. The price of an ounce of gold hit an all-time record of $1,895 on Sept. 5, 2011, in response to worries that the United States would default on its debt. Since then, it has fallen, as the U.S. economy has improved and inflation remains low.
Contemporary Gold Market
Despite gold’s dramatic historical role as a valuable asset, the contemporary gold market is rather young. Until March 15, 1968, when a two-tier market for gold was established, the price of gold was maintained at a predetermined level. From that time, the market forces shaped the price of gold. In 1971, the gold standard was abandoned and the two-tier market came to an end and central banks started transactions in gold at market prices. As the International Monetary Fund pointed out in the paper “The Structure and Operation of the World Gold Market”, “since then, a global market for gold as an asset in its own right has developed, remaining open around the clock and using a full range of derivative paper instruments”.
Despite its young age, the gold market is one of the largest and more liquid markets in the world. The estimated daily turnover in the international gold market in 2011 was 4,000 metric tons, equivalent to over $240 billion. This is approximately the same as the daily dollar volume of trade on all of the world’s stock exchanges combined.
The gold market is truly global and unlike other commodities, continuously operates around the clock, thanks to a cross-continents trading network: when London closes, New York trades; when Americans sleep, Australian and a few hours later Asian investors begin to trade; when Asian markets close, London is already in operation. Moreover, in 2006, Comex moved to the fully electronic system, nearly 24-hour Globex platform available for investors from all over the world. The international and continuous market for gold is similar to currency trading and indeed gold behaves more like a currency than commodity.
Only a few of the dozens of gold markets around the world have international significance. The London market, the U.S. market, the Swiss market and Hong Kong market create the core, while others are auxiliary (the most famous are Tokyo, Sydney, Dubai, Singapore, Mumbai, Rio de Janeiro and Shanghai, which is recently gaining in importance). The physical bullion is traded at the London market – the largest gold market in the world (we should not also forget that there is large and active OTC swap market for gold). In London, there is also set a LBMA Gold Price, the world benchmark for pricing the gold. The second most important market is the U.S. which dominates the market in gold derivatives (futures and options), or paper gold, and has a major (along with London market) influence on the price of gold.
Major Gold Trading Hubs
The three most important gold trading centres are the London OTC market, the US futures market and the Shanghai Gold Exchange (SGE). These markets comprise more than 90% of global trading volumes and are complemented by smaller secondary market centres around the world (both OTC and exchange-traded).
Other important markets include Dubai, India, Japan, Singapore and Hong Kong. There are exchanges in all these markets offering a range of spot trading facilities or listed contracts but these have not attracted the liquidity seen on the market’s primary venues. Nonetheless, these markets play an important role to varying degrees in serving local demand or acting as regional trading hubs. For example, Hong Kong has long acted as a gateway to the Chinese market and Singapore is establishing itself as an important focal point for trading in the ASEAN region.
Market Structure Trends
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.
- From West to East
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.
- Regulatory Change
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.
- Exchange Trading
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.
- Market Newcomers
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.
- New Technologies
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.