Golden cityscape transforming into a silver landscape, symbolizing spot precious metals market making.

Decode Market Making: Your Precious Metals Trading Edge

Theo Raines in Business & Economy December 2025 • 3 min read.

"Navigate the Complex World of Gold and Silver Trading with a Smart Market-Making Strategy"

The world of finance has undergone a massive digital shift. Electronic trading is now the norm, and new tools have emerged to aid market makers in their decision-making. Systematic market making has become essential across all asset classes.

Traditionally, models focused on stocks traded through central limit order books, but now these frameworks extend to Over-the-Counter (OTC) markets as well. Early models helped dealers manage inventory risk through strategic hedging and quote adjustments. In single-asset models, quotes adjusted based on inventory, risk tolerance, and external market liquidity.

Dealers prioritize internalizing client flow to cut down on external execution costs and lessen market impact, hedging only when inventories exceed certain thresholds. Multi-asset extensions further assist dealers in managing portfolio-level risk, especially with assets of varying liquidity. Illiquid assets, though difficult to internalize and costly to execute, can sometimes be offset by positions in more liquid instruments, providing opportunities for strategic unwinding.

Mastering EFP Spreads: Your Key to Precious Metals Market Making

Golden cityscape transforming into a silver landscape, symbolizing spot precious metals market making.

A unique aspect of precious metals market making is the dominant role of futures contracts in providing liquidity. The Exchange for Physical (EFP) spread, or the price difference between futures and spot, is critical. EFP spreads exhibit various relaxation modes corresponding to different trading horizons.

A sophisticated approach involves modeling the EFP spread using a nested Ornstein-Uhlenbeck process, mirroring the two-factor Hull-White model for interest rates. This framework maximizes expected profit and loss (P&L) while minimizing inventory risk across both spot and futures markets.

Nested Ornstein-Uhlenbeck Process: Adapts to different market conditions.
EFP Spread Modeling: Provides a competitive edge.
Risk Management: Reduces inventory risk across markets.

Utilizing computationally efficient techniques to approximate the solution of the Hamilton-Jacobi-Bellman equation enables on-demand strategy optimization. This paves the way for advanced algorithmic market making that leverages the co-integration properties inherent in precious metals.

The Future of Precious Metals Market Making

By integrating co-integrated liquidity for hedging, the stochastic optimal control framework enhances decision-making for both electronic and voice traders. This methodology offers real-time strategy optimization, exemplified by the spot gold market analysis.

About this Article -

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This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2404.15478,

Title: Market Making In Spot Precious Metals

Subject: q-fin.tr q-fin.rm q-fin.st

Authors: Alexander Barzykin, Philippe Bergault, Olivier Guéant

Published: 23-04-2024

Everything You Need To Know

What is the role of systematic market making in today's financial markets, particularly when dealing with precious metals?

Systematic market making has become essential in all asset classes due to the digital shift in finance and the rise of electronic trading. It helps dealers manage inventory risk, internalize client flow, and reduce external execution costs. In precious metals, systematic market making leverages tools like the Exchange for Physical (EFP) spread to maximize profit and minimize risk across spot and futures markets.

How do dealers manage inventory risk in precious metals trading, and what role do single-asset and multi-asset models play?

Dealers manage inventory risk by strategically hedging and adjusting quotes based on inventory levels, risk tolerance, and external market liquidity. Single-asset models help adjust quotes based on these factors, while multi-asset extensions assist in managing portfolio-level risk, particularly when dealing with assets of varying liquidity. Positions in illiquid assets can sometimes be offset by more liquid instruments.

What is the significance of the Exchange for Physical (EFP) spread in precious metals market making?

The Exchange for Physical (EFP) spread, which represents the price difference between futures and spot prices, is critical in precious metals market making. It serves as a key indicator of market conditions and provides liquidity. Modeling the EFP spread, often using a nested Ornstein-Uhlenbeck process, allows for optimizing profit and loss (P&L) while managing inventory risk across both spot and futures markets.

Can you elaborate on how a nested Ornstein-Uhlenbeck process is used in modeling the EFP spread, and what advantages does this approach offer?

A nested Ornstein-Uhlenbeck process is used to model the EFP spread by mirroring the two-factor Hull-White model for interest rates. This sophisticated approach adapts to different market conditions and trading horizons, allowing market makers to maximize expected profit and loss (P&L) while minimizing inventory risk across both spot and futures markets. It provides a competitive edge by enabling more accurate and responsive trading strategies.

How does integrating co-integrated liquidity and the stochastic optimal control framework enhance decision-making for traders in the precious metals market, and what does this mean for the future of trading?

Integrating co-integrated liquidity for hedging, along with a stochastic optimal control framework, significantly enhances decision-making for both electronic and voice traders. This methodology allows for real-time strategy optimization, exemplified by the spot gold market analysis. By using computationally efficient techniques, such as approximating the solution of the Hamilton-Jacobi-Bellman equation, on-demand strategy optimization becomes possible. This paves the way for advanced algorithmic market making that leverages the co-integration properties inherent in precious metals, potentially leading to more efficient and profitable trading in the future.