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Going for Gold

The last major gold bull market saw prices rise to nearly $2,000 per ounce in 2011 only to see prices fall to a low near the $1000 level in 2016. As current prices continue to rebound from multi-year lows, many analysts are looking at the gold market for potential trading opportunities in coming months.

This is an introduction to gold futures and options and helps explain why some investors seeking a defensive play against a declining U.S. Dollar and an uptick in inflation – or simply a higher-risk/higher-return trading proposition – are taking such an interest in the yellow metal. 

Buying and selling gold futures

Those willing to incur the risk seek to profit trading gold futures the same way they look to profit with any other investment – by buying low and selling high. In the world of futures trading, though, it’s just as easy to go “short” as it is to go “long.” If you believe the market is poised to trade lower, you can sell futures contracts now, and buy them back later, hopefully at a lower price. Conversely, if your view is that prices are set to strengthen, buy futures now, in hopes of selling them at a higher price later.

Futures lend themselves to a variety of different trading timeframes: short, medium, or long-term. The rapid price changes associated with gold futures create practically continuous trading opportunities.

A trader with an open position in a futures market can take one of the following paths:

  • Exit your futures position by placing an equal but opposite trade (for example, sell 5 contracts to close out an open position of 5 long contracts; or buy 3 contracts if you’ve been carrying an open position of 3 short contracts). Most futures are offset in this fashion; few traders hold their positions all the way until expiration.
  • Shift your open position to the next available contract. If you hold a long position in one expiration month, you can sell that expiration month and buy the next expiration. You can roll your position in two separate trades, or you can place a single “spread” order to close your position in the nearby contract and open a new position in a more distant expiration month. The opposite is also true - you can roll a short position from one expiration month to the next just as easily (an example would be buying April Gold futures to close your position and selling June Gold futures to reestablish a short position in the next available contract).

Factors driving the price of gold higher

There are plenty of theories for what drives gold prices, but as in many past market moves, a handful of common factors seem to be in play, including:

Dollar Woes: With the U.S. Dollar in the midst of a months-long swoon against the major global currencies, many investors are turning to gold as a commodity that tends to move inversely with the beleaguered greenback.

Inflation Hedge: Gold is widely viewed as a sensible hedge against inflation – a store of value even as the purchasing power of traditional currencies erodes.

Geopolitical Concerns: Gold has long been considered a “safe haven” investment during turbulent and uncertain times, and with the constant threat of terrorism, rogue nations, and energy shocks, many investors have been turning to precious metals.

Alternative Ways to Invest: Exchange-traded funds – such as SPDR Gold Shares, which trade under the ticker “[GLD]”or the VanEck Merk Gold Trust, which trades under the ticker “[OUNZ]” – have become a potent force in the market. 

Diversification: Many investors on the lookout for new ways to spread their money across a number of economic sectors have flocked to gold. The draw is due not only to gold’s inherent attractiveness as a commodity component, but because it touches on so many disparate areas of the economy – from interest rates and the equities markets to investor sentiment and foreign exchange.

Gold vs. the Dow vs. crude oil

Typically, gold is considered relatively expensive when 5 or fewer ounces of gold are needed to match the level of the Dow Jones Industrial Index. Today, by this standard, the price of gold appears to be just above historic averages. To provide some context, in 1929, just before the Wall Street Crash, it took 18 ounces of gold to buy the Dow Jones, but within three years, it took just two ounces of gold to buy the Dow. In 1966, the ratio surged to 28 ounces, but by 1980, one ounce of gold bought the DJIA. In July of 1999, at the height of the dotcom stock market frenzy, it took 44 ounces of gold to buy the DJIA. In 2011, it took only 7 ounces.

Gold also has traded historically at prices between 15 and 20 times the price of a barrel of crude oil. Some analysts feel that the current gold-to-crude ratio signals that gold may be relatively overvalued relative to crude and could be poised to move lower. For those interested in the relationship between different commodities, futures spread trading may be an interesting proposition.

Going for Gold Image 1

 

The relationship between gold and the currency markets

There are other potential opportunities for savvy futures traders. In the foreign exchange world, many consider no major currency to be as safe and stable as the Swiss Franc. The country’s traditional policy of political neutrality, as well as the fact that a significant percentage of its currency reserves traditionally have been backed by the precious metal, contributes to the “Swissie’s” image as “Liquid Gold.” In fact, if you were to compare charts of gold and the Swiss Franc in recent rallies, you may notice that the Swissie’s performance often correlates closely with that of gold. Therefore, sophisticated traders who expect a rally in gold might also consider establishing a long position in the Swiss Franc.

The Swiss Franc might not be the only beneficiary of a bull market in gold, however. Both Canada and Australia possess substantial reserves of the precious metal and are among the world’s top gold producers, and both countries have very strong and well-developed mining sectors that account for a significant percentage of their GDPs. If gold maintains its uptrend, the Australian Dollar and Canadian Dollar might very well follow its lead. You’ll be glad to know that a wide variety of currency futures and options are available on the Charles Schwab Futures platform – along with a full complement of trading tools and educational resources.

Gold futures and options specifications

The COMEX division of CME Group hosts the world’s most actively traded and most liquid gold futures contract. Just as you’d expect, it’s available for trading at Charles Schwab Futures. Trading takes place on CME Group’s proven and reliable Globex platform nearly 24 hours per day during the trading week.

  • Root symbol GC. Primary gold futures contracts are February, April, June, August, October, and December. Six other months also trade, but with lesser volume and open interest.
  • Contract size is 100 troy ounces, and the minimum tick is $0.10 per troy ounce, worth $10.00 per contract.
  • Trading begins Sunday through Thursday evenings at 6:00 PM ET and continues uninterrupted until 5:00 PM ET the following day. You may capitalize on opportunities whenever they arise – day or night.
  • Electronic trading on CME Group’s Globex system means real-time prices, fast executions, and near immediate fill confirmations, so you should always know exactly where you stand in the market.

Like most futures contracts, gold is “optionable.” If you have experience with equity options, you should have little difficulty transferring your knowledge to options on futures. Like equity options, futures options allow investors with just about any timeframe, market outlook, and risk appetite to construct appropriate strategies. Though the underlying instrument is different – in this case, it’s one gold futures contract – all the same principles of options apply, and the same types of strategies you might employ with equity or index options are available to you when it comes to futures options.

Gold options also trade on CME Group’s Globex platform, which means continuously updated and fresh bid/ask prices, prompt executions, and nearly around-the-clock trading opportunities. Primary gold option expiration months include February, April, June, August, October, and December, with serial expirations also available though not as actively traded.

Conclusion

Gold futures and options offer investors numerous trading opportunities. Like any other investment, the ultimate decision of whether or how to incorporate gold futures into one’s portfolio should be based upon your personal goals and risk tolerance. But it’s important to remember that the strategies available to you are practically limitless – futures and options can be used separately or together to set up innumerable risk/reward profiles.

 

Want to learn more about trading futures at Schwab? Call the Schwab concierge team at 877-903-7544.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.


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