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Gold futures

Gold Futures Contracts – or simply gold futures – are standardised, binding contracts to buy and sell gold at an agreed price on an agreed date. Gold futures are a key driver for the gold price today when trading physical bullion, whilst also operating as a speculative vehicle for other investors.

Gold futures definition

A simple way to think of a Gold Futures Contract is to imagine it as a traditional sale of gold but with payment and delivery to be made at a later date. This date is usually referred to as the ‘settlement day’. Gold futures allow traders to speculate on their purchases, buying back anything sold, or selling anything bought prior to the settlement day. This allows people to trade much larger amounts, much quicker, than if they had to trade the actual physical gold and wait for delivery.

Assume a manufacturer needs one hundred ounces of gold to make their products. They can hedge their risk over the production period. To do this, when buying the physical metal for production, they also buy future contract options on one hundred ounces of gold. When they sell their products, based on the gold price at that time, they buy back their options. This will cover any cost fluctuations as prices moved in the gold market.

Gold futures trading basics

Mines, refineries, mints, dealers and consumers of gold can manage the risk from gold's fluctuating price by buying and selling Gold Futures Contracts. Gold suppliers buy "short" to lock in a selling price for their gold. Gold consumers can buy "long" to secure a purchase price for the commodity they need.

The gold futures derivatives markets also attract many pure speculators. Those who expect a rise in gold price will take a ‘long position’ and buy gold futures. Those anticipating a fall will take a ‘short position’ and sell.

COMEX gold

Gold Futures Contracts are traded in their own right on Gold Derivatives markets. The Gold Derivatives markets are separate from the actual Gold Commodities Market, and futures prices do not follow exactly the commodity’s movements.

Operating in real time, the world's largest derivative markets are the Chicago Mercantile Exchange – CME or Comex – and the New York Mercantile Exchange. Trade on these and other derivative markets uses standardised contracts for futures exchange.

Access to the markets is only through authorised trading intermediaries and not directly available to private investors. Individuals can however gain exposure to futures by investing through intermediaries such as hedge funds, exchange traded funds (ETFs) and other trading firms.

Gold futures risks

There are potential substantial profits to be made on the gold and precious metal futures markets, but the risks are equally high. The delay between contract agreement and settlement day means prices could rise or fall considerably. The fear that one side might back-out means that a high ‘margin’ is attached to gold futures. Depending on the state of the market this could be anything from a 2% to 20% margin and will eat into any profits that might be made.

If prices start to fall you are obliged under the contract to top up the margin. A surprise drop in prices can see these margin top ups become incredibly costly. This explains why futures are mostly a tool for institutions, hedge funds, trading firms and wealthy investors. It is difficult for individuals to raise capital or borrow enough money to start, and continue, trading in such markets. The stress of setting up and then ‘rolling over’ these gold futures can be incredibly high. Without a deep understanding of the market and costs involved, it is easy to see your money disappear.

Pyramid of risk for buying gold.

The use of brokers or investment firms also exposes you to further costs and risks; brokers fees and mismanagement could see your profits vanish, and in worst-case scenarios you can end up losing money.

Future Contracts exist independently of the Gold Commodities Market and do not usually represent actual physical gold. Because of this, the amount of gold listed in Futures Contracts does not necessarily equate to any real metal. Futures contracts often expire prior to the settlement day so that those who do want to take possession of the gold have time to pay, and suppliers time to arrange delivery. For many Futures dealers though the physical gold does not exist, and they do not allow customers to ever take delivery of the gold they’ve paid for.

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