What Are Gold & Silver Futures Contracts?
Precious metals investors looking to buy gold and silver have several options available to them depending on their investment strategies, available capital, and the ability and willingness to store the gold and silver bullion securely. In addition to these baseline considerations, investors motivated by a speculative nature have investment vehicles that lets them bet big on the commodities market, using gold and silver futures contracts, which has the added advantage of allowing speculators the ability to leverage their cash pool to purchase gold or silver by paying only a fraction of the total cost of a futures contract.
Types of Investors
This mechanism is not right for all investors. To begin with, those who collect physical gold for a hedge against societal collapse are obviously not candidates for playing in the precious metals futures market. Typically, those involved in buying gold or silver futures contracts fall into broad-based categories: Those who hedge and those who speculate. Indeed, for the market to operate correctly, participation from both sides of the equation is required. A hedger is seeking a way to mitigate their price risk of a particular asset, while the speculator revels in that price risk as the cost of doing business in a market that demands movement to achieve profitability.
What is a Gold or Silver Futures Contract?
A futures contract is a legal agreement between a buyer and seller that stipulates a future sale on a specific day during an identified month. Obviously, because of the volatility of the futures market, and the ability to buy on leverage, the futures market is not for the faint of heart or every investor. These trades are conducted at Futures Exchanges, and are fairly strait forward in terms of quantity, quality, and terms of deliver time and locations. Two Exchanges facilitate trades in the United States, COMEX and eCBOT.
For example, gold future contracts mandate a block sale of 100 Troy ounces comprised of .995 % minimum fine gold, while silver contracts stipulate that purchases must include 5,000 Troy ounces of .999 % minimum fine silver.
Whereas the spot price delineates the price of a commodity, in this case gold or silver bullion, if purchased or sold for immediate delivery, the futures market represents the price of those commodities at a specific time and place. Future contracts on commodities helps producers, sellers, and buyers hedge against price risks moving forward, and can easily extend quite far into the future depending on the commodity. When contracts are made for precious metals, the future contract price is based on the price of one ounce of either gold or silver.
Advantages of Trading in Gold and Silver Futures
Despite the financial risk associated with your position going “pear shaped” if you are heavily leveraged, there are certain advantages associated with using this investment vehicle beginning with the ability to leverage your holdings.
This is the way it works:
As mentioned, financial leverage is the ability to trade in a product with just a fraction of the item’s total value. As such, if one futures contract represents ownership of 100 ounces of Troy gold, a leveraged approach will greatly expand an investor’s portfolio. If the market value of an ounce of gold is $800, the value of that futures contract would be $80,000. Under exchange trading rules, the investor would be able to control $80,000 dollars worth of gold for around $5,000.
Another advantage of utilizing precious metal futures contracts is the safety built into the system. Owing to the exchange’s clearing services, buyers and sellers suffer from no counter-party risks, and as a central clearing point for futures contracts, this decreases the risk should either party default on their obligations and responsibilities.