Gold Futures Market

The futures market is widely regarded as high risk, but the reality is that futures can be either high risk investments or hedges against dramatic price fluctuations.

To understand the gold futures market, first one needs to have a firm understanding of the futures market in general.

Futures are obligations to buy or sell a specific quantity of a commodity on a specific day for a preset price.

A futures contract is actually once or even twice removed from the actual commodity. A gold futures contract, for example, is a bet on which way gold prices will move. What happens to the gold itself is of no concern to the trader.

Trading futures is considered speculation rather than investment.

For some traders, futures are actually a way to inhibit risk. Gold mining firms who commit themselves to sell gold at a certain price can protect themselves with futures if prices drop. However, most traders trade futures to make a big profit and should be aware of the risk involved and be willing to take that risk. The opportunity for a big gain is balanced by the possibility for a big loss. Individual investors play a very minor role in the futures market because the stakes are so high and the returns are unpredictable.

The opportunity for big gains and possibility of big losses is due to the leverage involved in a futures contract. Leverage means utilizing a relatively small amount of money to make an investment of much greater size. You can buy a futures contract worth thousands of dollars with an investment of as little as 10% of the total value.

For example, if you buy a gold contract worth $35,000 your cost would be $3,500 (exclusive of fees and commissions) and your leverage would be $31,500.

Every time the price of the contract gains 10¢, the value of your investment increases by $10. In a commodity like gold, price swings of $100 within the lifespan of the contract are not at all unheard of. So, if the price went up $100, the value of your investment would jump $10,000—almost a 300% gain.

Unfortunately, the opposite is also possible. If the price falls, the value of your investment falls much more and you might have to come out of pocket to make good on the loss. Leverage may make the initial investment easy, but it can also put you in a very serious financial loss very quickly.

Futures contracts offer traders the opportunity to profit from both increases and decreases in the price of the underlying commodity. Someone who expects the price to increase takes a “long” position.

Someone who expects the price to fall takes a “short” position.

The “future” in futures markets is not very far off. Futures contracts generally expire in a year or less, though it is possible to find contracts in certain futures markets that last longer.

When you trade gold futures contracts, you do not have any intention of taking physical delivery of the gold. To prevent that happening, you would simply close out your position before the delivery date. Only a very small number of futures contracts actually survive their entire lifespan. The way to close out your position is to buy or sell a contract that is the opposite position of your current contract. (You can unwind a contract to buy gold by selling a gold contract. This cancels out the obligation and you either keep the profit or take a loss in the process.)

There are 11 futures exchanges in the United States located in Chicago, New York, Philadelphia, Minneapolis and Kansas City. Gold futures trade in Chicago and New York only. There are also many overseas futures markets, including many that offer trading in gold. Examples are Dubai, London and Hong Kong.