Gold Futures Hit Record High

8th October 2009

Today we’re looking at the origins and nature of gold futures.

You’ll see we use gold futures as a technical indicator on Gold Price Today. If you’ve been tracking this over the past week you’ll have noticed gold spot and Futures hit a record high last night, with December’s price rocketing to $1042.70 an ounce.

This morning we see the trend continuing at a relentless pace, with Decembers gold future price hitting $1058.90 per ounce.

The reason behind this is the six month slide of the US dollar which fell to near lows for the year against the yen and the euro on Tuesday. As a result we’ve seen an elevation in price of pretty much every commodity.

[Note: Take a look at our weekly charts page to track the progress of gold against other indicators, including the US dollar, oil and the pound.]

We use the futures price as an indicator because the gold price is heavily influenced by day traders in the futures market. Usually 95% or more of the trading is done by day traders.

The origins of futures

In 1848 the Chicago Board of Trade (CBOT) was established. Its chief principal was to allow investors to trade in future contracts.

It wasn’t until the 1970s that financial futures took form. Eventually this system would allow investors to speculate on the future price of gold, and make investments based on this prediction.

For the first time people could buy contracts that would represent the price of gold at a given time in the future. This allowed people to buy or sell now, gambling on the fall or rise of gold’s price over time.

Future contracts and how they work

Gold Future contracts are deals that stipulate how much someone is willing to pay for Gold at a certain time in the future. The seller of the contract is said to be going short, whilst the purchaser of the contract is said to be going long.

One of the main advantages of going short is when the seller anticipates a drop in price, they can actually go short now and purchase later when the price of gold has gone down, thus pocketing the difference… If I was thinking the value of the commodity is going to rise I would hold on to it as it appreciates. If I think the price will decline then now is a good time to sell because the gold price today is higher than it will be tomorrow.

The investor who has gone long is expecting the price of gold to rise in the future. They are buying now in the hope that the price will appreciate, earning them interest on their contract.

Bullionvault notes

‘Most futures traders use the delay to enable them to speculate – both ways. Their intention is to sell anything they have bought, or to buy back anything they have sold, before reaching the settlement day. Then they will only have to settle their gains and losses. In this way they can trade in much larger amounts, and take bigger risks for bigger rewards, than they would be able to if they had to settle their trades as soon as dealt.’

The Margin in Gold Futures

The Margin is a ‘safety net’ for both the seller and the buyer. The margin acts as compensation in case either party walks out of the deal at a later time.

The margin can range between 2% to 40% of the total value of the contract, however, it is typically around 7%. If the gold price starts to fall the investor going long will be obligated to pay more into the margin, this is known as a margin call. If the investor cannot make the margin call then the broker will sell the holding and the investor is left with a loss.

On top of the margin cost there is also commission to consider. The broker will charge a fee to both open and close a trade which is done frequently, usually every quarter, in order to keep the contract rolling. A Brokers commission is typically 0.25%, however, they are negotiable.

The potential gains and losses

The real benefit of futures is that it allows the investor to leverage.

The margin is the only capital needed when entering into the contract. It allows someone to put down only a small percentage (approximately 5% as mentioned above) of the entire payment. Which means if you had $10k in your pocket you could afford to buy 10 ounces of bullion (at $1000 per ounce) on the open market. If you were to put $10k into a futures contract that would act as your margin of 5% meaning you would have bought $200k worth of gold which is 200 ounces.

There’s the potential to own a lot more gold in futures than there is in just purely buying bullion. This means the potential reward is extremely high, if the gold price goes up 10% then you would make $1,000 on buying bullion. However, with the same investment you would make a whopping $20,000 if you had purchased on the futures market.

But with greater returns comes higher risk, if the gold price were to drop 10% then you would only lose $1,000 with bullion, but you’d lose $20,000 in futures, double what you’d originally invested, at which point you should walk away from the contract and lose your margin.

Gold futures offer great potential because of their leveraging ability. It’s a game of speculation and prediction. It’s a double edged sword.

Market News

It’s been hundreds of years but Mongolia is finally in the news again.

The Mongolian empire may be long gone but the Mongolian land is far from depleted. On Tuesday Ivanhoe Mines, who are partnered with Rio Tint, have finally struck up a deal with the Mongolian government to develop the Oyu Tolgoi copper and gold project in the southern Gobi dessert region of Mongolia. It will be one of the largest copper and gold mining projects in the world.

The deal gives the Mongolian government a 34% equity interest in Ivanhoe Mines Mongolia Inc. According to a recent study Oyu Tolgoi could produce 330,000 ounces of gold and 440,000 metric tons of copper on an annual basis for at least 45 years. Production at the mine is expected to begin as early as 2013 with an approximate five-year ramp-up to full production. The negotiation is seen by analysts as a milestone in the development of Mongolia’s economy.

According to Chad Blewitt, Ivanhoe’s chief financial officer (on secondment from Rio Tinto), the project will ”double Mongolia’s GDP of $US5 billion ($A5.6 billion) and the mine deposit will become one of the five largest mines in the world”.

We’ll be back next week but in the mean time keep your eyes on the gold price today.

Regards,

Digger,

Gold Price Today

Important

Information in Gold Price Today is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Appropriate independent advice should be obtained before making any such decision.