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What IS Spot?
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(February 25, 2008) One of the most frequently asked questions we hear lately is, why are our gold spot prices lower than what is reported in the media, such as CNBC or other business news programs?
This is a good question, particularly since there is often a discrepancy of a few dollars between the popularly reported gold price and the true spot price. And in a normal market, the spot price is less than the futures prices. And as physical gold traders, it puts us in a bad light sometimes. People selling to us may think that we’re ‘cheating’ on the spot price, and people buying from us must sometimes think that we’re misinformed, because we are willing to sell gold to them using a spot price which is clearly less than what they saw on TV.

This has to do with how gold is traded, particularly on the Comex during the US trading day. All such gold trading is done on a ‘futures’ basis, wherein traders buy and sell contracts for delivery anywhere from a month to a year or more in the future. The most heavily traded futures contracts are “where the action is” in terms of volume and liquidity.

For instance, the currently most active market in NY gold is the April contract, so that contract’s price is the most commonly quoted on TV. And directly related to that price is what we call the “spot” price, which is the price for immediate physical delivery. This morning the difference between spot and the April contract is about $3.00.

So, at any time, there is always a “switch” from the most commonly quoted futures price to today’s spot price, and that difference is the EFP, which stands for ‘exchange for physical.’ If, as an investor, you didn’t want to take physical delivery of gold, but just wanted to do a short-term speculation, you would buy contracts (100 ounces each) in an active futures month of gold trading. By owning such contracts, you could control a set amount of gold, and you would have until that month (known as the ‘delivery’ month) to decide whether to sell, take delivery, or ‘roll over’ your position.

As we move closer in time to the trading month, the EFP shrinks. For instance, we will see the EFP versus the April 2008 contract get smaller as April approaches. And as that happens, an increasing amount of trading volume will start to occur in a yet further out contract (the June 2008 contract in this case), as traders look to establish positions with a bit more time on the clock, so to speak. So by the time that the last week in March rolls around, the EFP with April will be less than a dollar per ounce, and once April begins, major trading will have moved on to the June contract, with a consequently larger EFP versus that contract.

So, in conclusion, spot is a more or less imaginary number, continually determined by taking the price of the most active month’s price in futures trading, and subtracting the EFP.

Simple, eh?

 

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