Gold has a certain popularity that goes beyond just its physical appearance and utility. Many savvy investors recognize its potential for profit, as well as being an effective way to insulate wealth. If you are thinking about rebalancing your portfolio to include more gold, it’s important to keep in mind that there are a few options available to you.
One that is certainly worth a closer look is through gold futures. Indeed, futures are a common strategy used to invest in many commodities.
Precious metal futures like gold and silver are traded on stock exchanges around the world. They provide interested investors with exposure to gold and silver, yet they only have to put up a limited fraction of the contract’s total cost. This gives a degree of leverage to gold and silver futures that should not be easily dismissed, yet they may not be appropriate for all investors.
Insights On Precious Metal Futures
Futures contracts started being used in the middle of the 19th century in the central grain market. They gave farmers the ability to sell the grain they produced for immediate delivery to the spot market, or they if they preferred the farmer also had the option to sell their grain at an agreed upon price for a future delivery date. Essentially, a futures contract is a binding legal agreement held between the buying party and the seller for an asset that will be delivered on a specific date.
Futures exchanges help facilitate the process of purchasing futures contracts. They are standardized when it comes to quality, quantity, and the time of delivery. They also help specify the delivery location.
It’s important to keep in mind that the price of a futures contract is not necessarily fixed. This is because it is always in a perpetual state of discovery through a special auction process that occurs on exchange trading floors as well as through electronic trading platforms. When it comes to precious metals like gold or silver, a futures contract specifically outlines a time of delivery as well as a location for good or safe delivery of the gold or silver bullion.
Who Invests In Futures Contracts?
It’s important to understand that there are two general categories for future contracts. Choosing the one that is right for you requires a little bit of a closer look.
Hedging future contracts are often used to try to reduce the price risk associated with a specific asset. However, a speculative futures contract accepts the price risk in an attempt to turn a profit from a favorable movement in the asset’s price. These two purposes mean that the market essentially needs participation from both types of future contracts.
Hedgers in futures contracts often include producers, and portfolio managers as well as the asset’s consumers. Take for example a farmer who produces corn. Let’s say that they are concerned about the falling price of corn per bushel, which could potentially reduce their net profit. The farmer could sell futures contracts at a price of $4 per bushel with a specific delivery date set a few months later. Should the price of corn fall between the date of sale and the date of delivery the farmer would essentially lose money on the crop. However, that loss would be offset by the gains made on the sale of the futures contract.
On the other end of the hypothetical spectrum. Let’s say that the farmer sells their corn futures contract at $4.00 per bushel only to see the price of corn increase to $4.50 per bushel. In a scenario like this the farmer will end up making more money on his crop of corn, but he will also be losing money on the short futures contract!
With a hedger, they must accept the risk of this potential profit loss in order to establish future prices. Ultimately, the producers and consumers end up giving up the potential for additional profit to try to protect themselves from a potentially significant loss.
The Value Of Precious Metals Futures Contracts
Let’s look at another hypothetical example, through the lens of precious metals futures contracts. Let’s say that a gold futures contract can be purchased for 100 troy ounces of .995 percent of fine gold. At the same time, a silver futures contract is available for 5000 troy ounces of .999 percent of fine silver.
If we assume that gold’s price per ounce is approximately $1,300 then that gold futures contract would be worth around $130,000. If silver’s price per ounce was also trading at $20.60 then the silver futures contract would have a value of $103,000. This demonstrates how the gold and silver prices can move up or down based on the precious metal price per ounce on the open market.
How Does A Precious Metals Contract Work?
With a gold or silver futures contract, the investor is essentially entering into an agreement facilitated by an exchange to either buy or sell the precious metal at a specified date in the future. In general, COMEX is one of the most well-recognized exchanges for metals trading. Currently, it is part of Chicago’s CME Group.
If you wanted to buy or sell a futures contract, you don’t necessarily have to purchase the entire amount of the contract’s value. You only need to put up what is called a “Margin Deposit.” This is a good-faith deposit demonstrating your ability to make good on the futures contract.
This minimal margin deposit essentially makes futures a leveraged instrument. Hypothetically, let’s say that a gold futures contract has a total value of $130,000. In a scenario like this, you would only have to make a deposit of $5940 to buy or sell the contract. This would allow you to basically control $130,000 worth of gold for only around $6000. This could provide you with return on your investment, but it could also lead to a major loss.
This is due to the nature of these investment vehicles. If your loss can exceed the total account equity. Ultimately, leverage like this is a double-edged sword, which means it might not be right for all investors.
Do I Actually Own Gold When I Buy A Futures Contract
When it comes to physical ownership of precious metal futures contracts, the devil is in the details. When you purchase a contract of physical gold, you can take delivery of it. However, the process is somewhat complicated and may take a prohibitive amount of time.
It’s important to keep in mind that you don’t personally have to take possession of the gold or silver. It can be held in a secure and insured depository. With most precious metals futures the physical gold or silver is rarely ever delivered in person.