Investing in precious metals has become more prominent over the past few years as investors look to diversify away from turbulent stocks and shares to more stable markets. Investors generally look to buy gold and silver to hedge against economic uncertainty, burgeoning national debt and even social unrest.
Gold and silver futures are the ideal investment vehicle if you’re looking to hedge against inflation or as a pure speculative play during economic turbulence such as the current Euro crisis. In this article, we’ll cover the basics of gold and silver futures and show you how to profit from them.
What Are Gold and Silver Futures Contracts?
Gold and silver futures contracts are legally binding agreements for delivery of gold or silver at a predetermined price at some point in the future.
Investors use these contracts to manage risk by locking in the price of precious metals before purchasing or selling the underlying asset. They also provide speculators with an opportunity to participate in the precious metals market without having to physically take delivery of the underlying asset.
There are two possible positions that can be taken: A long (buy) position, which is an obligation to accept delivery of the physical metal, while a short (sell) position is the obligation to make delivery.
COMEX Gold Futures Contract
Gold trades on the COMEX exchange which is a subsidiary of (NYMEX) New York Mercantile Exchange. A typical COMEX gold futures contract is made up of 100 ounces.
To ensure the market is fair and limit the possibility of price manipulation, position limits are imposed by the exchange. A position limit is the maximum number of contracts a single participant can hold.
Gold Futures Trade Example
Lets say gold is trading at $720 per ounce, therefore the contract has a value of $72,000 (720 x 100 ounces). If you were to go long at this price and sell at $730 per ounce you’d make $1,000 (730 – 720 = $10, 10 x 100 ounces = $1,000). If on the other hand you went short (bet the price would fall) and sold at £$730 you’d lose $1,000.
NYMEX Silver Futures Contracts
Silver is often overshadowed by its more illustrious sister gold. But silver futures are on the rise and set to overtake gold futures by 2014 in terms of number of contracts traded.
The majority of silver futures are traded on the (NYMEX) New York Mercantile Exchange with a small amount also traded on the (TOCOM) Tokyo Commodity Exchange.
NYMEX silver futures are traded in lot sizes of 5000 ounces and quoted in dollars and cents per ounce.
TOCOM Silver futures are traded in lot sizes of 10000 grams with a minimum price movement of 0.1 yen per 1 gram.
Silver Futures Trade Example
Let’s say you think the price of silver is undervalued, so you buy one NYMEX silver futures contract at $27.80 per ounce. Each silver futures contract represents 5000 ounces of silver, so the value of your contract is $139,000.
Fast forward two days and the price of silver has risen to $28.40 per ounce, your contract is now worth $142,000. You can now sell this contract and realize a profit of $3,000 less commission.
Margin Requirements & Leverage
In the above gold and silver examples you made a profit of around 15% despite the fact that the underlying asset only moved around 3%. This is because you only have to deposit around 12% of the value of the contract to open the trade.
This is called trading on margin and can result in prolific gains. Don’t be fooled however, margin works the other way as well. If the value of your contract falls you can lose more money than you have deposited in your account and be required to make further deposits to keep the trade open, this is called a margin call.
Precious Metals Hedgers and Speculators
The precious metals futures market allows hedgers to reduce the risk associated with volatile price movements in the underlying market. Hedgers take opposing positions in the futures market to offset losses due to price fluctuations.
For example, a jeweller who’s fearful that she’ll pay higher prices for gold in the future can buy a contract to lock in a guaranteed price today. Then if the price of gold rises, she won’t be bothered because she took out a long position in the futures market; she would therefore be offsetting the increase in the cost of purchasing the gold.
If on the other hand the price of gold falls, she would lose out on her futures positions, but this loss would be cancelled out by buying her gold at the lowest market price.
Speculators on the other hand have no interest in taking delivery of the actual metal. They intend to profit by assuming the market risk that hedgers try to avoid.
Gold and silver futures are becoming more and more popular, this is largely due to the current turmoil hitting the financial markets. Gold and silver are seen as safe havens in rough seas and money pours in from all quarters when times are bad. This makes the market more volatile which is exactly what speculators are looking for.
If you want to learn more about trading precious metals, sign-up for an account with OptionsXpress. Here you’ll find some useful tutorials that teach you about futures trading, but most important of all you’ll get access to a virtual trading account complete with $25,000 of virtual funds to practice with.
You shouldn’t underestimate the importance of practice; you don’t become a professional trader overnight, in some cases it takes years. But with a little perseverance you can master all the skills you need to become an accomplished successful trader.