Information Transmission Among World Major Gold Futures Markets

Exploring Global Gold Futures Markets: Insights from Synchronous Trading Data

This study focuses on the interconnectedness of three major gold futures markets: New York Mercantile Exchange’s Commodity Exchange (COMEX), Multi Commodity Exchange (MCX) in India, and Tokyo Commodity Exchange (TOCOM) in Japan. Using vector error correction model and information share approaches, it assesses how pricing information flows across these markets, which all trade in the same underlying asset: gold.

Gold, a long-standing cornerstone of investment portfolios, has recently seen increased interest due to economic uncertainties, such as the crisis in Greece. Its appeal lies in portfolio diversification, inflation and currency hedging, and lower volatility compared to other commodities and equities. Notably, gold’s performance has been impressive, with significant annual returns reported in recent years.

Investment in gold is rising, with new futures markets, exchange-traded funds (ETFs), and other products emerging. This study highlights gold’s unique characteristics like standardization, durability, and storability, which make it a consistent asset globally. Despite variations in purity, contract specifications, or trading currencies, gold prices tend to follow a similar pattern across different markets.

The concept of “informationally linked markets” is central to this study. It posits that assets sharing fundamental characteristics, like gold, should exhibit a long-term relationship in pricing across different markets. If prices diverge, arbitrage opportunities arise, leading to price adjustments and market efficiency. This study aims to show how information is shared across these markets and identify which market primarily influences price discovery.

Price discovery, a key market function, involves finding an equilibrium price that reflects all available information. Market efficiency relates to how quickly prices adjust to new information. This study probes the dynamic nature of price discovery, examining how new information impacts prices and the speed at which markets reach a consensus.

This research investigates how the three major gold futures exchanges (COMEX, MCX, and TOCOM) interact in terms of price discovery and information transmission. With India’s growing prominence in the global gold market, this study offers fresh insights into these inter-market relationships.

U.S. Markets’ Dominant Role in Global Gold Futures Information Flow

Critical Impact on Price Transmission in Equity and Derivative Markets

This study focuses on the significant influence of U.S. markets in the domain of equity and derivatives, particularly in gold futures trading. Numerous studies have shown that U.S. financial markets, including derivative markets like gold futures, predominantly transmit information to other international markets rather than receiving it. This phenomenon is evident in the mechanisms of price discovery and information transmission within markets that are informationally linked. Two primary methods are used in these studies: first, exploring the time-based precedence between futures and spot returns through lead-lag return regression and models like Vector Autoregressive (VARs) and Vector Error Correction Models (VECMs); second, assuming that securities share common factors, thus enabling the calculation of each market’s contribution to price discovery.

It is widely noted that futures markets often lead in the price discovery process, likely due to lower transaction costs for investors. Evidence supporting this includes studies showing that markets with lesser trading costs respond more quickly to new information, thus taking precedence in price discovery. The lower trading costs in futures markets are cited as a reason for their lead in price discovery, as shown in studies by Fleming et al. (1996). They find that differences in trading costs between cash and futures markets influence the rate of price discovery.

International Investigations into Gold Futures Market Dynamics

Exploring Cross-Country Information Transmission and Market Influence

Beyond domestic settings, research into the cross-country relationship between spot and futures markets is limited. Notable studies include Dhillon, Lasser, and Watanabe (1997), who conducted an hourly comparison of gold futures price volatility on an international scale. Their data included gold futures contracts from COMEX and TOCOM between 1987 and 1992, examining different trading periods and volumes.

Xu and Fung (2005) extended this research to include gold, platinum, and silver futures contracts traded in both U.S. and Japanese markets from 1994 to 2001. They applied a bivariate ARMA-GARCH model to assess pricing transmission and volatility spillover, finding significant and strong information transmission between the U.S. and Japan. Their results indicated that U.S. market information plays a leading role in futures markets.

Other studies, like Bhar and Hamori (2004), have explored the link between price change and trading volume in gold futures, using daily NYMEX data and AR-GARCH models. Their findings highlight the sequential information linkage between price changes and trading volumes.

Most research on international linkages in futures markets suggests stronger connections in highly traded commodities, with developed markets often playing a dominant role in the price discovery process. This research aims to add to this body of knowledge by focusing on the specific dynamics of gold futures markets across major global exchanges.

Analyzing the World’s Leading Gold Futures Markets

In the realm of gold futures trading, three major markets stand out based on their trading volumes: COMEX (New York), TOCOM (Tokyo), and MCX (India). COMEX, 80-85% of the global trading volume, notably leads the global gold futures trading, while TOCOM and MCX collectively contribute around 8% to 10% of the global trading volume

This study pays special attention to the most liquid gold futures contracts in each market, focusing on standard contracts due to their high trading volumes. The contracts’ specifications, including contract size, quality, and pricing, are varied, with COMEX trading in USD per troy ounce, TOCOM in Japanese Yen per gram, and MCX in Indian Rupee per 10 grams. To ensure comparability, this study converts MCX and TOCOM prices into USD per troy ounce format.

Investigating Price Discovery and Information Transmission in Gold Futures

Utilizing Vector Error Correction Model for In-Depth Analysis

This research employs a multivariate vector error correction model (VECM) to explore the intricate lead-lag relationships among gold futures traded in the United States (COMEX), Japan (TOCOM), and India (MCX). The model is designed to analyze how prices in these interlinked markets influence each other. If these market prices are cointegrated, meaning they move together over time, the VECM can elucidate the short-run price transmission mechanisms.

VECM is a powerful tool for understanding price interactions among different markets. It helps identify both short-term and long-term effects of price changes. In the short term, the model looks at how prices in one market respond to changes in another market. Long-term effects are captured through equilibrium errors, which show the price differences between markets over time. A significant long-term effect suggests that one market can predict returns in another. The error correction terms within the model measure the speed at which prices adjust to find equilibrium. A significant error correction term indicates which market is leading in price adjustments and, therefore, in price discovery.

Key Findings on Price Discovery and Information Transmission

Dominance of COMEX and Rapid Information Flow

This study focuses on the contribution of each gold futures market to price discovery, employing the Hasbrouck information share model. This model assesses each market’s contribution to the variance of efficient price innovations. The findings reveal that COMEX, with an information share of 37.09%, contributes more to price discovery than MCX (34.66%) and TOCOM (28.25%). This underscores the leading role of the U.S. market in global gold futures trading.

Empirical results also indicate that COMEX responds to new information with a lower level of price adjustment compared to MCX and TOCOM. This suggests that COMEX is more efficient in processing information, possibly due to its massive trading volume. Furthermore, this study highlights the rapidity of information transmission across these markets. Trading information from one market, especially between COMEX and MCX, is quickly impounded into the others within a five-minute trading interval.

In conclusion, this study provides valuable insights into the dynamics of information transmission in the global gold market. It emphasizes the significant role of the U.S. gold futures market in price discovery and information processing. The findings are crucial for market participants, particularly in an era where gold investment is gaining prominence.

Bhar, R., & Hamori, S. (2004). Information flow between price change and trading volume in gold futures contracts. International Journal of Business and Economics, 3, 45-56.

Dhillon, U. S., Lasser, D. J., & Watanabe, T. (1997). Volatility, information, and double versus walrasian auction pricing in USand Japanese futures markets. Journal of Banking and Finance, 21, 1045-1061.

Xu, X., & Fung, H. (2005). Cross-market linkages between U.S and Japanese precious metals futures trading. InternationalFinancial Markets, 15(2), 107-124.