Investment in gold has been broadly considered an alternative to a more traditional asset class such as stocks, bonds, currencies, and property.
Dealers who trade in the commodity at spot gold prices and cash in on their expectations of future price movements create gold futures.
They offer a convenient way for investors to speculate on their expectations while using derivatives.
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Gold Futures Definition
A gold future is a derivative traded on the Commodity Exchange Inc. (COMEX), a New York Mercantile Exchange subsidiary, and regulated by the CFTC.
The futures contract is for 100 ounces of gold, valued at a preset price. The laws of supply and demand and speculator actions influence the final future price.
Buying and selling futures contracts often result in speculative trading and hedging activity. For example, suppose a futures contract for 100 ounces of gold is trading at $1,200 per ounce.
An investor who believes the price will go up may have a bullish position. As this investor goes long on his expectations, he may purchase one contract worth $120,000.
The gold futures market is a source of liquidity for speculation and hedging. It is a way for investors with different actionable trading strategies and gold investment goals to consistently find reasonable precious metal prices.
It’s also used by speculators looking for favorable price opportunities and arbitrageurs who can profit from price discrepancies across gold markets.
What Are Gold Futures Contracts?
Gold futures contracts are exchange-traded derivatives based on the price of gold bullion. They’re standardized as 100 troy ounces of gold, valued and traded at a preset price.
For instance, when gold trades at $650, the contract values are at $65,000 ($650 multiplied by 100 ounces). The trader can sell at $670, making a $20 profit.
The commodity’s value fluctuates and can be affected by several factors, such as the volatility of gold prices is subject to changing supply and demand conditions, political issues, and market sentiment.
Position limits maintain an orderly trade gold futures market. All speculative trading position limits on COMEX gold contracts get listed within the futures position limit report.
While gold futures contracts can speculate on price movements, they’re also used to hedge against price fluctuations.
Traders buy and sell gold futures based on their outlooks for gold prices in the future, with some taking short positions that pay off if prices fall.
How Gold Futures Trading Works
Four phases in the gold futures trading process set it apart from other commodities. The first phase is to determine the future price of gold at a set date; this anticipated price is the settlement or cash price for gold futures contracts.
The supply and demand for the commodity determine the anticipated price. The price includes how much investors agree to pay for it at a future date and whether this amount will increase or decrease.
The second phase is to ascertain what amount of physical gold will be required to settle the contract. The delivery of gold limitation ensures that investors can’t manipulate actual metal ratios by exchanging more than they’re required to trade with by law.
The third phase is for investors to decide whether they will receive the total price, called the settlement value. The buyer must pay the entire purchase price for the sale of gold up front.
If the investor can’t afford to take on this obligation, they may decide to wait for a future settlement date when prices and supply and demand are more specific.
In that situation, the gold futures contract will not get settled because the initial payment might be inadequate or exceed physical delivery limits.
The fourth phase is closing out an early settlement. If an investor believes in the gold price trend, he may close out his positions before the expiration date. In this case, he would buy back all his contracts at the same price he sold to open up a long contract position.
These four phases give the futures trader a choice on what to do with speculative positions, depending on outlook and strategy.
For example, if a futures trader predicts gold prices will be going up in the next few months, it makes sense to close out his short positions before expiration so that he can take advantage of high prices and make more money with long contracts.
Gold Futures vs. Gold ETFs: What’s the Difference?
Gold exchange-traded funds (ETF) and gold futures contracts have different traits that make them attractive as long-term investments.
Gold ETFs are investor-managed commodity funds, while futures are professional market investments. The main difference is the trading method.
The ETF shareholders buy and sell shares of the fund, while futures contracts transact through an intermediary such as a futures broker, banks, and clearing organizations.
These third parties are responsible for taking care of any deliverables investors require. Gold futures can be subject to price volatility due to supply and demand factors.
Still, their prices can also vary based on issues that affect the quantity of gold worldwide. The price of gold doesn’t move independently from the price of silver and other commodities as a gold ETF would.
Instead, investors use derivatives based on gold to speculate on their expectations of future price movements.
The futures market also allows investors to purchase precious metals based on different positions taken by traders betting against them.
How to Invest in Gold Futures
First, each investor has to decide if they want to take a long or a short position in the gold futures markets. They should go long and buy futures contracts to profit from rising gold prices.
However, if the price of gold falls and they want to benefit from lower prices, they should bet against rising prices by selling or shorting primary gold futures contracts.
Next, the investors must decide how many contracts they will trade and at what price per contract size. Current price forecasts are essential to this decision because any profitable strategy needs them to be accurate for high potential gains with low capital risk.
The next step involves drafting a futures trading plan that outlines their reasons for buying or selling gold-related derivative securities.
Most investors will be happy if gold prices remain steady, but the potential for high profits makes it worthwhile to speculate on a change in the gold stock markets.
Lastly, investors can create a risk management plan to place stop-loss and limit orders. The steps help control cash loss because futures contracts have no fixed final value.
Their settlement value, or price when the contract expires, is determined by current market prices.
Gold futures are one of the oldest commodity markets. They allow investing in gold stocks without buying them physically.
The futures market provides an opportunity for traders to speculate on the future price movements of gold. Investors can profit by taking positions that will grant them more income with less risk if prices rise or less income with less risk if prices fall.
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Here are some of the frequently asked questions regarding gold futures.