Gold futures remain one of the best places to start for traders looking to invest in precious metals. They allow you to enter the gold market even with relatively low capital. Gold has a history as a hedge against inflation and other forms of economic downturns. The inherent volatility of gold prices also makes it more attractive to speculators. However, it’s still an option worth considering for anyone looking to diversify their portfolio.
In simplest terms, a gold futures contract is a legally binding agreement between an investor and a seller. It stipulates the sale and delivery of the gold at an agreed-upon price in the future. In other words, you reach an agreement with someone that you will purchase or sell gold in the future for a price you both agreed on today.
Whether you buy or sell the gold depends on the kind of position you choose to take. A long position is a buy, while a short position is a sell. This is a part of the financial jargon we use to describe these positions. The point is you’re taking a good look at the gold market to decide according to the price movements. You take a long position if you expect the price of gold to go up. Conversely, you take a short position if you expect the price to fall.
Example of How Gold Futures Work
Like other investment strategies, the futures market is concerned with turning in a profit or, at the very least, minimizing the risk exposure to price volatility by agreeing to a gold price in advance. For example, let’s say you have an interest in owning gold. You decide to buy 100 grams of gold from the futures market at an agreed price of $ 5,000. Next, you schedule the delivery five months from now. The current price of one gram of gold is approximately $50. Let’s say in five months when you take delivery of the gold, the price rises to $55 per gram. That means you made a profit of $500 from your long position at current rates. This is a 10% 5-month return on your initial $5,000.
What about if you choose to take a short position? Same scenario, but this time you’re the one selling. An investor approaches you and wants to buy 100 grams of gold at $5,000 for delivery in five months. When the time comes to deliver, the price per gram has fallen to $45. That means you made a profit of $500 by locking in the price at $50 per gram five months ago. There are many other scenarios on how a futures contract will play out, but you get the general idea.
Gold Futures Contract Specifications
The COMEX began trading gold futures contracts in 1974. That makes it one of the oldest exchanges for this particular asset. It is also the largest. Let’s take a look at their contract specifications for gold futures:
Gold Futures Contract Specifications
100 troy ounces
Minimum of $0.10 per troy ounce
USD dollars and cents per troy ounce
CME Globex: Sunday – Friday 6:00 PM. – 5:00 PM (5:00 PM. – 4:00 PM /Chicago Time) with a 60-minute break each day beginning at 5:00 PM. (4:00 PM Chicago Time) CME ClearPort: Sunday – Friday 6:00 PM – 5:00 PM (5:00 PM – 4:00 PM. /Chicago Time) with a 60-minute break each day beginning at 5:00 PM (4:00 PM Chicago Time)
Monthly contracts listed for three consecutive months and any February, April, August, and October in the nearest 23 months and any June and December in the nearest 72 months.
Delivery may take place on any business day beginning on the first business day of the delivery month or any subsequent business day of the delivery month, but not later than the last business day of the current delivery month.
Termination of Trading
12:30 PM Chicago Time on the third last business day of the delivery month.
Data Source: CME Group
Micro Gold Futures
The contract specifications for the micro and E-mini contracts are quite similar. They mainly differ in that the contract sizes are 10 ounces and 50 ounces, respectively. The minimum price fluctuation for the E-mini gold futures contract is also different, with a $0.25 per troy ounce value.
From the above data, we can begin to understand how gold futures are actually traded. For example, since gold is traded in dollars and cents per ounce, an investor taking a long position at $1,500 per ounce has a futures contract worth $150,000 ($1,500 x 100 ounces). If he then decides to sell at an ask price of $1,510, then he makes a profit of $1,000 ($1,510 – $1,500 = $10; $10 x 100 ounces = $1,000). On the other hand, if he sells at $1,490, then he loses $1,000.
Breaking Down Tick Movements in a Gold Futures Market
Consider the minimum price movements of gold futures. For the standard gold futures contract, the minimum price movement is pegged at $0.10 x 100 ounces = $10. This movement is called a “tick.” It typically determines how much profit or loss is made depending on how many ticks the price moved away from the original price when you entered the market. That means if you entered the market and the price moves 12 ticks above or below your entry price, your profit or loss amounts to $120 ($10 x 12 ticks = $120).
The same principle applies whether you’re trading an E-mini or micro gold futures contract. The tick movement is pegged at $12.5 ($0.25 x 50 ounces.) This means any movements in price are measured at $12.5 per tick. The tick size amounts to $1 ($0.10 x 10 ounces) for the micro gold futures contract.
What Factors Drive the Price of Gold in the Futures Market?
Price plays a huge role in determining what position you take in a gold futures market. That’s why it only makes sense to understand what factors influence its movement. The price of gold fluctuates every day. However, the starting point is typically coordinated through the London Bullion Market Association (LBMA) and is usually referred to as the London Fix. At 10:30 AM and 3:00 PM London time every business day, a consortium of large financial organizations dealing with major bullion purchases and sales set the starting trading price for the day. This is then used as a benchmark for the initial pricing of gold products and derivatives across the world’s markets.
Since several exchanges trade in gold futures across different time zones worldwide, it is important to have a “spot price” of an ounce, gram, or kilo of physical gold. This way, it is easier to track daily gains or losses based on this starting point. After that, it’s a matter of market forces coming into play and causing the price of gold to go up or down throughout the day. In this regard, the gold futures market is similar to how the stock exchange works; investor sentiment brings about a continual price discovery process. Except with gold futures, trading is done through standardized contracts instead of shares.
Other factors influencing the price of gold
Central Bank Reserves – Central banks typically hold both paper currencies and gold in reserves. As they diversify these reserves in favor of gold, the price of gold will usually rise. According to Bloomberg, the last few years have seen central banks buying up most of the world’s gold, with Russia, Turkey, and Kazakhstan leading the pack.
The Value of the Country’s currency – Across many countries, including the United States, the price of gold tends to have an inverse relationship with its currency value. Using the U.S. as an example, a stronger U.S. dollar usually means a lower gold price and vice versa, all things being equal.
Worldwide demand and supply – Like any other commodity, the economic principle of demand and supply plays a critical role in the price movements. Higher demand and restricted supply lead to higher prices, while lower demand and increased supply can bring down the price.
Wealth Protection – Because of its enduring value, gold is often considered a safe haven during times of economic turbulence. More and more people tend to invest in it once their returns on bonds, equities, and real estate start to decline or during times of currency devaluation or inflation, or even in times of political instability. This naturally drives up the price of gold.
Exchanges Where Gold Futures Are Traded
If you’re looking to invest in gold futures, then you’ll need to decide which exchanges you would like to utilize. A futures exchange standardizes the contracts’ terms, clearly stipulating the quantity, quality, settlement time, and place of delivery, but the price remains variable. It also matches bid prices from buyers with ask prices from sellers and then oversees the futures contract’s creation when both parties reach an agreement. Here are some of the most popular options in the world for trading gold futures:
Commodity Exchange – The COMEX is the arm of the CME Group responsible for precious metals trading. Their gold futures products include Gold Futures, Micro Gold Futures, E-mini Gold Futures, Gold Kilo Futures, and Gold TAS Futures. We’ll touch on the contract specifications for gold futures on the COMEX in a minute.
London Metal Exchange – The LME officially started trading gold futures in July 2017. Investors are also provided with gold forwards curve data, allowing them to have a long-term view of the precious metal.
Multi-Commodity Exchange – The Indian exchange is often favored by investors who have a smaller capital base since the contracts offered here range from one gram (gold petal), eight grams (gold guinea), and all the way to one kilo (standard gold contract).
New York Mercantile Exchange – NYMEX quotes its gold futures contracts in U.S. dollars per ounce in 100 troy ounces contracts. Trading usually closes on the third to last business day of the agreed month of delivery. You should note that NYMEX and COMEX have been merged since 1994, so this distinction is merely informational.
Tokyo Commodity Exchange – The contract size on this exchange is typically where one kilogram per contract is approximately 32.15 troy ounces.
Entering the Gold Futures Market
Dealing with gold futures means finding a good futures broker. This organization is usually a member of the futures exchange you’ve chosen to trade on and will virtually manage your relationship with the futures market.
You’ll need a minimum amount in your trading account before entering the market. This amount varies depending on the broker’s policies. Still, you can expect it to cover not just the cost of the futures contract but also enough to accommodate for potential losses. This amount is known as the intra-day margin. The type of contract you’re buying also dictates your intra-day margin. If you’re trading a standard gold futures contract, the amount required is usually different from what is expected to open an E-mini gold futures contract position.
Advantages and Risks of Gold Futures Trading
Obviously, there are other ways to dabble in the gold market, like gold options, gold ETFs and even just buying gold bullion and storing it safely in your vault. So what’s the big deal with gold futures anyway?
Advantages of Gold Futures
One potential problem that often comes with trading commodities is the need to have a suitable place to store them if you have taken delivery. In the case of gold, you’ll need a secure facility, which won’t come cheap. However, in a gold futures market, you don’t need to take physical delivery of the gold since you can initiate a short position in the same contract before the delivery date. Then you can long the next period’s futures contract to “rollover” your exposure. This means that there’s no need to worry about storage.
Gold futures contracts allow traders to enter the gold market even with relatively lower capital than they would normally need when trading using a different strategy. As a buyer, you can choose to pay a certain amount when the deal is being made and pay the remaining amount at a later date as agreed with the seller. This provides you with financial leverage.
It’s easy to track the value of a futures contract since you only need to follow the price listed on the exchange.
You can use gold futures contracts to diversify your portfolio and hedge against inflation and other forms of economic downturns.
Risk Associated with Gold Futures
The gold futures market does experience its fair share of volatility. Therefore, you’ll need to be prepared for unfavorable price movements.
Financial leverage has often been described as a double-edged sword; while it is possible to make significant gains, it’s also possible to make considerable losses. This is especially true if prices crash from signing the agreement to the time of taking delivery.
Trading Tips for the Savvy Gold Futures Trader
Obviously, you shouldn’t take this as explicit trading advice but rather a selection of handy tips that successful traders have used to profit from the futures market. As a beginner, you’ll want to start your journey into gold futures trading with a detailed fundamental analysis of the market. Pay attention to which way the market sentiment swings, whether positive or negative. If the former, then gold is deemed undervalued and will likely adjust to its expected higher price; and if the latter, then gold is deemed overvalued and will probably go down to its expected lower price.
Consider all the factors that can influence gold price, especially if there is a sudden shift in other financial markets and the Central Bank’s rate of buying and selling gold. You’ll also want to look at the current industrial demand for gold to have an informed idea of which way the market will likely swing soon.
Lastly, keep an eye on the market movements of bitcoin. The continuing rise in bitcoin’s market share may someday pose a serious threat to the gold market. This is mainly due to the number one cryptocurrency’s strengthening fundamentals. The fact is that it has been referred to as “digital gold,” and there is a good reason for that.
Is it worth it to invest in Gold?
Before we get into the nitty-gritty of trading gold, it is important to have a general idea of why it is so appealing as an investment vehicle. Gold is one of the world’s most popular assets. It has proven its value over and over through the years as a medium of exchange. It also acts as a safe haven against financial uncertainty.
Gold is extremely ductile. This means you can stretch one ounce of gold into a gold thread around eight kilometers (5 miles) long. It is a highly valued commodity thanks to its rarity, density, and uncommon beauty.
Gold falls under noble metals, meaning it is relatively unreactive to air, moisture, and most solvents. Antarctica is the only continent where gold is not mined. This is not because there is no gold there (there actually is.) Instead, it’s because of the Antarctic Treaty. This agreement prohibits mining in the region among other things
Due to its rarity and virtual indestructibility, most of the gold mined throughout history still exists to this day. Usually, you’ll find it being melted and re-melted and repeatedly used in different forms.
No doubt about it; the futures market is complicated, risky, and can be quite expensive. But if you know what you’re doing, your journey to becoming a bonafide gold bug through the gold futures market may be a profitable venture. If you embark on it, the asset could become a substantial addition to your portfolio. Part of the solution is to arm yourself with as much knowledge as possible about the gold futures market. The other half is having a viable strategy for navigating its volatility.
And if you feel like this investment strategy is not for you, there are several other options for trading gold. What’s important is that you are adequately prepared. Once you are prepared, take the next step and start The Gauntlet Mini™ here. It’ll allow you to prove your trading skills and become a professional trader.