Gold Derivatives: Gold Derivatives: - World Gold Council

some 4,000 tonnes. This is a small volume of gold to expect people to hold relative
to total above ground stocks of gold of some 140,000 tonnes. Given the
depth of international capital markets, it seems plausible that this gold (worth
$40 billion at current prices, spread over a decade or more) could have been
absorbed without much price impact.
It is worth seeing what can be learnt from other markets, and then considering
what is special about gold before examining the arguments more deeply.
3.2 The impact of derivatives generally
The debate on the impact of derivatives markets on cash markets is not confined
to gold. The issue has been raised frequently and over many years both in commodity
markets and in financial markets; there have been many scores of papers,
both theoretical and empirical, written on the subject.
It has been argued that the existence of derivatives enables short selling which
pushes down prices; that derivatives facilitate speculative trading which increases
volatility; that the leverage available from derivatives markets creates cycles of
boom and bust as momentum traders follow a trend and then are forced to unwind
their positions rapidly; that derivatives markets fragment order flow diverting
liquidity away from the cash market; and that derivative markets encourage
market manipulation.
Defenders of derivative markets argue that they improve liquidity, transparency
and increase possibilities for risk-sharing. It is possible to construct internally
consistent models of trading in which derivatives markets are beneficial, and also
models in which they are harmful. Ultimately, the question of whether derivative
markets are broadly beneficial or harmful to efficient price formation is an empirical
one. There is a considerable body of empirical literature covering both commodity
markets and, in rather more depth, financial markets.
We review the arguments and the empirical evidence at length in the paper at
Appendix 1. We conclude that the weight of evidence suggests that:
· derivative markets in general fulfil a valuable role in promoting the efficient
sharing of risk, and in aggregating information;
· while there are ways in which derivatives could in theory destabilise the price
of the underlying assets, there is little evidence that this has been a problem in
other markets;
· there is strong evidence that derivatives help make the underlying market more
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Gold Derivatives: The market impact