gold, page-18

Slange

"Why would you need derivatives in a physically backed market."?

You plainly don't know very much about markets and market making.

Those ten banks will act as market makers. It is their job to quote Buy and Sell prices in physical gold to all comers. Their basic business model is to make money from "the spread", the difference between the two prices (buying low and selling high).

In a perfect world bullion price makers buy and sell large amounts of gold similtaneously, without owning (or being short) gold for very long while locking in profits as they go.

Unfortunately the world is perfect. Prices move and bullion price makers can be caught long or short while the price moves against them eating their margin and causing loses. In that situation, the price maker has two choices:
1. They can go back into the physical market and ask for a price from another price maker to close out the position. (This involves paying away the spread and being seen as a price taker.)
2. They can go to COMEX and buy or sell futures to hedge their physical position.

The second option is very attractive to prices makers and widely used. It allows them to stand as a public figures in the physical market taking on all comers, while anonymously backing out the risk on the other side. It allows them to appear much bigger than they are.

If these Chinese banks don't use the same model, they will all be broke in a year.