Gold and Silver Bullion: What It Is and How to Invest

What Is Bullion?

Gold or silver bullion is officially recognized as at least 99.5% pure in the form of bars or ingots. Gold and silver are discovered by mining companies, removed from the earth as ore, and then extracted from the ore using chemicals or extreme heat.

Bullion is commonly kept as a reserve asset by governments and central banks. Investors can purchase precious metals in physical bullion or paper form or hold shares in exchange-traded funds(ETFs) or futures contracts.

Bullion and Banks

Gold bullion can be considered legal tender, held in reserves by central banks, or used by institutional investors to hedge against inflationary effects on their portfolios. Central banks use gold to settle international debt or stimulate economies by lending bullion reserves to bullion banks as part of the precious metals market.

Some activities include clearing, risk management, hedging, trading, vaulting, and acting as intermediaries between lenders and borrowers. Nearly all bullion banks are members of the London Bullion Market Association (LBMA), an over-the-counter (OTC) market. The eleven LBMA market makers include:

• BNP Paribas
• Citibank
  
• Goldman Sachs
• HSBC
• ICBC Standard Bank
• JP Morgan Chase
• Merrill Lynch
• Morgan Stanley
• TD Bank
• UBS
• Standard Chartered Bank

Bullion Trading and Lending

When a central bank lends gold to bullion banks, it receives the cash equivalent of the gold. The central bank lends this money on the market at a lease rate known as the Gold Forward Offered Rate (GOFO), published daily by the LBMA. The higher the lease rate, the more incentive a central bank has to lend gold from its reserves.

If the bullion bank sells the gold on the spot market, it will receive cash for the transaction. The spot market is where bullion and other commodities are traded at the prevailing market rate. Bullion banks that lend gold to mining companies usually do so to finance a project run by the company.

A mining firm may borrow gold if it enters into a forward hedge contract in which gold that has not yet been mined or extracted is pre-sold to buyers. If some or all of its buyers expect a physical delivery of the gold bullion, the mining firm may borrow the gold from the bank, which would subsequently be delivered to the buyers on the other end of the forward agreement.

Bullion OTC Market

Bullion is traded in the bullion market, which is primarily an OTC market open 24 hours a day. Trade volume in the bullion market is high since it includes the vast majority of bullion trading prices throughout a given day. Most transactions are completed electronically or by phone. There are various bullion markets globally, including London, New York, Tokyo, and Zurich. 

The price of gold bullion is influenced by demand from companies that use gold to make jewelry, electronics parts, and other products. Gold is a popular investment during times of economic instability. Although gold tends to have greater demand, both gold and silver bullion are viewed by many investors as safe-haven investments.

Rising prices or inflation in an economy erode the return on investments. If an investor, for example, earned 4% on a bond and prices rose by 2%, the return on the bond investment was only 2% in real terms. If overall prices are rising, commodities tend to increase. As a result, gold and silver bullion are used to hedge investment portfolios against inflation.

How to Invest in Bullion

• Physical: Gold or silver bars or coins can be purchased from a reputable dealer and kept in a safe deposit box at home, in a bank, or with a third-party depository. The client has full legal ownership of the gold. If the bank faces bankruptcy, its creditors have no claim to the bullion in the allocated account since it belongs to the client or owner.
• Exchange-Traded Funds (ETFs): Investing in gold or silver through exchange-traded funds (ETFs) allows investors access to the bullion market. ETFs contain a collection of securities, while the fund typically tracks an underlying index. With Gold or Silver ETFs, the underlying asset might be gold certificates or silver certificates, not the physical bullion itself. ETF funds can be bought and sold like equities using a standard brokerage or an IRA account.
• Futures Contracts: Investors can buy a bullion futures contract, an agreement to buy or sell an asset or commodity at a preset price, with the contract settling at a specific date. With gold and silver futures contracts, the seller promises to deliver the gold to the buyer at the contract expiry date. Until the delivery happens, the buyer will not own the gold and will only be the owner of a paper or digital gold contract. However, if the buyer does not want to own gold bars or coins, the contract can be sold before the expiry date, or the contract can be rolled forward into a new one.

The Bottom Line

Bullion is the physical form of gold and silver held as bars, ingots, or coins. It is commonly held as reserves by central banks. In the United States, gold is held by the U.S. Mint at Fort Knox, Kentucky. Individuals can buy or sell bullion through dealers or invest in gold and silver bullion via ETFs or futures contracts.