In spite of gold’s historical monetary significance, a freely functioning world market for gold has just recently come of age. When the price of gold was maintained by monetary authorities at a pre-determined level, the gold market had functioned more as a distribution mechanism than as a price-setting device. However, market forces took on a driving role on March 15, 1968, when a two-tier market for gold was established. For a time, central banks refrained from dealing in gold on the new free market, but agreed to transact in gold among themselves at the then official price of $35 a fine ounce. However, the two-tier market came to an end when the U.S. dollar’s convertibility into gold was formally suspended in August 1971, which effectively deprived gold of its pivotal role in the international monetary system. 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. In this market, the price of gold has been highly volatile, falling from a high of $850 an ounce in January 1980 to below $285 an ounce in February 1985, and since then, trading in a limited range around $330 an ounce (Chart 1).
Gold Prices, 1968–92
(In U.S. dollars an ounce)
Sources: Data provided by the World Gold Council.As an instrument for private investment, gold has generally been viewed as a hedge against inflation or devaluation and as an object of “safehaven” investment. Although some analysts have questioned the importance of gold in this regard,1 the prominence given to the gold market in the financial press, where daily price movements are generally reported, suggests that gold remains an asset whose price and investment performance are widely monitored. Moreover, even though gold’s historical significance as a monetary anchor has passed away, it retains its importance as an official reserve asset, with some 30 percent of the world’s monetary reserves (at market valuation) held in the form of gold as of 1991.2
A wealth of published information is available on different aspects of the gold market, including numerous studies on its efficiency.3 This paper attempts to integrate the available information on the working of the market, thereby identifying gaps in the availability of data and delineating the complementary roles played by the various submarkets. The submarkets for gold have some unique characteristics. For example, the Zurich Gold Pool operates at a set daily price at which it may have excess demand or supply. Any such excess will then be transmitted to the London fixing. This mechanism serves to disguise the magnitude of physical flows through Switzerland, which is the major entrepot for physical gold. The paper provides a framework that could be used to fill gaps in information, thereby providing a basis for further research. The paper also tries to answer questions that often arise about the relative sizes of physical and paper trading centers, what influences the flow of physical gold, where it is stocked, who now holds it, and how much there is.
