The price of physical gold is set by supply and demand for physical gold. The global physical market can be divided into exchange trading and bilateral trading. In addition to the physical market there are multiple gold derivate markets that influence the physical market. To understand the entire machine, we will examine the workings of gold exchanges, bilateral trading (networks), and derivate markets separately, and finally how all derivatives are tied to the physical market. Derivatives are traded on exchanges and on a bilateral basis as well, but for the sake of clarity we will discuss them independently.
Important to mention is that there is not one physical gold price. As gold is a commodity and the forces of supply and demand for commodities are not equal at any and all locations—and energy and time are needed to transport commodities—the price of physical gold differs geographically. Moreover, physical gold comes in many shapes, weights and purities. Manufacturing costs for bars are more or less fixed, but relatively cheaper for larger bars due to their higher value.
What most people refer to as the spot gold price is the price per fine troy ounce of gold, derived from trade in large wholesale bars located in London ("loco London"). Large wholesale bars weigh roughly 400-ounces. The smaller a bar compared to "large bars," the higher the premium it will attract. Gold coins and jewelry enjoy even higher premiums per fine weight, due to even higher manufacturing costs. The "real price of physical gold" thus depends on where you are and what type of product you are trading.
A gold product's fine weight is calculated as:
Fine weight = gross weight * purity