Of all precious and industrial metals, gold futures are the most popular contracts on commodity exchanges all over the world. Its beauty, luster, and uniqueness make it the most ideal store of value. With about 6.1 billion ounces of gold in existence as of 2018, the gold market is estimated to worth over $9 trillion, making it the largest metal market on the planet.

Gold futures provides investors with the opportunity to play in the gold market without necessarily being in possession of the physical commodity. More interestingly, futures are leveraged instruments, so an investor can trade a gold futures contract with only a fraction of the total worth of the contract.

Gold Futures Contract Specifications
Symbol
GC
Exchange
CME
Tick Size
$10
Contract Size
100 troy ounces
Contract Months
Feb, Apr, Jun, Aug, Oct, Dec
Trading Hours
Sunday- Friday 5:00p.m. - 4:00p.m.
Settlement
Deliverable
Last Trading Day
The third Last business day of the delivery month

 

What you should know about gold

In its purest form, gold is a bright, orange-yellow, dense, soft, ductile, and malleable metal. It has a high thermal and electric conductivity, which makes it very useful in certain industries. However, its value is far more than its industrial applications — gold has historically been viewed as a proxy for money and affluence. Here are the things you should know about gold:

History

Gold has been in use for thousands of years. The first known use of the metal dates back to 5,000-6,000 B.C., in the ancient Egyptian civilization, where it’s seen as a symbol of immortality and was used to embellish the kings both in life and death. By 1500 B.C., gold was already in use as a medium of exchange for inter-regional trades.

In 1792, the United States started a bimetallic standard, which meant that all paper currency was backed up with its face value in gold to ensure that a physical valuable asset existed in conjunction with the currency. This was known as the gold standard but was stopped in1971.

Production

Gold is mined from underground deposits in every continent except Antarctica. South Africa was, for many years, the largest producer of gold, but it has since been overtaken by China, Australia, Russia, and the United States. Other top producers include Canada, Peru, Mexico, Indonesia, Uzbekistan, and Ghana. The countries that have the most gold reserves are the US, Germany, Italy, France, and China.

Uses

Gold has a wide range of uses, from coins to jewelry making. Due to its high thermal and electrical conductivity, gold is used in making computers and electronic devices. It is also used in space vehicles to reflect radiation. Both individual and institutional investors buy and keep the metal as a store of wealth.  Some governments even hold substantial gold reserves.

What does gold futures mean?

Trading in gold futures started on the Commodity Exchanges Inc. in 1974. Gold futures are derivative financial instruments whose value depends on the prevailing value of gold. A futures contract is a tradable contract issued by a futures exchange, which denotes an agreement to make or take delivery of a specified quantity of the underlying commodity on a specified future date, at a presently agreed price. In the case of gold futures, the underlying commodity, which is to be delivered at the expiration of the contract, is physical gold bars or ingots.

Commodity futures exchanges create standardized gold contracts, with the quantity, grade and quality, dates of delivery, and the value of the contract clearly specified in the terms of the contract. To ensure that none of the buying or selling parties defaults, the clearinghouses of the exchanges act as the middlemen between the transacting parties.

As a matter of fact, the contract is between each of the transacting parties and the exchange’s clearinghouse. That is, the seller is in a contract with the exchange to supply the stipulated grade and quantity of gold on the delivery date in accordance with the contract terms, while the buyer is in a contract with the exchange to take the delivery of the gold after completing the payment for the contract, since the contract trades on margin — a small percentage of the total worth of the contract is enough to trade the contract.

The contract is marked to market to make the final settlement easier. This means that the daily differences in prices are settled at the end of each trading day. A trader in a losing position is asked to deposit additional funds to maintain the margin level, while the profit accrued to the person in the opposite trade is added to his equity.

Does buying gold futures contracts mean owning gold bullion?

A trader who buys a gold futures contract doesn’t necessarily get to own the physical gold bars. The commodity is delivered at the expiration of the contract if the buyer intends to take delivery of the metal and holds the contract until expiration date. However, settlement and delivery of the physical metal can be a complicated process.

Most people who trade gold futures don’t intend to get involved in making or taking delivery of the commodity anyway, so they usually find a way around it. There are two ways to avoid the delivery process before the contract expires:

Closing the position before expiration: To avoid the settlement and delivery process, most speculative traders, especially short-term traders, close their positions before the contract expires in order.

Rolling over to the next contract: Traders and hedgers with a longer-term interest tend to rollover their expiring contracts to another contract with a further expiration date by simultaneously closing the current position and opening a new one with a further expiration period.

However, if a trader, who doesn’t want to get involved with the delivery process, unknowingly allows his position to expire, he can retender the commodity after paying a retendering fee.

How do gold futures contracts trade?

Trading Gold Futures

Trading Gold Futures

Gold futures contracts are standardized contracts, which trade on commodity exchanges. The important features of gold futures contracts include the following:

Exchanges where gold futures contracts trade

Gold futures trade on almost all metal commodity exchanges in the world, with the most popular ones being the London Metal Exchange (LME), Shanghai Gold Exchange, Istanbul Gold Exchange, Tokyo Commodity Exchange (TOCOM), Multi Commodity Exchange (MCX), India National Commodity and Derivatives Exchange (NCDEX), and the Dubai Gold and Commodities Exchange (DGCX).

Of course, the Commodity Exchange Inc. (COMEX) and Chicago Mercantile Exchange (CME), both of which are part of the CME Group, also offer gold futures contracts.

Margins and leverage

When trading gold futures, a trader is required to deposit a minimum amount to be able to carry the contract. This is known as the initial margin, and it varies with the market condition and the exchange involved. Generally, it ranges from 2% to 20% of the total value of the gold contract.

For an on-going trade, the trader’s equity should be maintained above a certain amount known as the maintenance margin. On the CME Group, the maintenance margin for a full gold futures contract is $4,500. If the trader’s equity falls below that value, the trader will be required to make additional deposits (known as margin top-up or variation margin) to keep his equity above $4,500.

Since only a small percentage of the total worth of the contract is required to trade futures contracts, gold futures are considered a leveraged instrument. By definition, leverage is the factor by which a trader’s capital can be multiplied to get the total value of the contract (Leverage = total worth of contract / trader’s capital).

On the CME Globex platform, for example, a full gold futures contract settles for 100 troy ounces of gold, and the price quote for April 2020 contract is $1480.8. So, the total contract value is $1480.8 x 100 = $148,080. If a trader is using $5,000 to carry a full gold contract, the leverage factor will be $148,080/$5,000 = 29.62 times. In other words, the trader can potentially multiply the profit or loss he would make if trading without the leverage by more than 29 times. Thus, leverage is a double-edged sword.

Contract specifications

On the CME Globex marketplace, one full contract of gold futures (GC) is equivalent to 100 troy ounces of the gold, and the price quotation is in the U.S. dollar and cents per troy ounce. The minimum price fluctuation is $0.10 per troy ounce or $10 per contract.

Apart from the standard full contract, there are also other variants of gold contracts with a fewer number of troy ounces of gold per contract. The E-mini gold futures contract, with the symbol QO, is equivalent to 50 troy ounces of gold, while the micro gold futures contract, with the symbol MGC, is equivalent to 10 troy ounces of gold.

For the standard contract, monthly contracts are listed for three consecutive months and any February, April, August, and October in the nearest 23 months and any June and December in the nearest 72 months. Trading terminates at 12.30 p.m. CT on the third last business day of the delivery month.

At expiration, the contract is settled by physical delivery, and the delivery may take place on any business day beginning on the first business day of the delivery month or any subsequent business day of the delivery month, but not later than the last business day of the current delivery month. Gold delivered under this contract shall have a minimum of 0.995 fineness and must be stamped and serialized by an exchange-approved refiner.

Trading at Settlement (TAS) is subject to the requirements of Rule 524.A and may be allowed in the active contract month. The active contract months will be February, April, June, August, and December, and on any given date, TAS transactions will only be allowed in a single contract month. TAS uses the exchange-determined day’s settlement price or any valid price increment ten ticks higher or lower than the settlement price.

Roll over and roll-over cost

Rollover is a way gold futures traders carry their positions from an expiring contract over to a new contract period. It involves simultaneously closing positions the expiring contract and opening new positions in the new contract period. But it can be an expensive process, which gives investors something to worry about.

Investors who keep long-term positions are the ones that are mostly affected by roll-over costs. Unfortunately, there is no better option for them — they either roll over their positions or have to deal with the delivery of the commodity. Since offsetting the position is not an option, they have to bear the roll-over costs. The situation is worst for those in losing positions. However, some brokers offer to roll their customers into the new period at a reduced rate.

Daily settlements

Gold futures contracts are marked to market. At the end of each trading day, a trader’s profits or loss is credited or debited from his account. If any trader’s equity is falling below the maintenance margin, he will be required to top up his account to be able to continue carrying the trade.

These settlements continue on a daily basis until the contract expires. At expiration, the buyer pays up the balance, while the seller delivers the commodity. The clearinghouse of the exchange oversees both the daily settlement and the delivery process at expiration.

Gold Futures Seasonality

Here is a seasonal chart of the market.

Gold Futures (GC) Seasonal Chart

Source

Factors affecting gold futures prices

Although there are many factors that can affect the prices of gold futures, here we will discuss only a few of them:

Monetary policy rates: Interest rates can have significant effects on gold prices. When interest rates are low, gold prices tend to rise because Treasury instruments become less attractive to investors. Conversely, when interest rates are high, gold prices tend to decline.

Demand and supply imbalances: Gold is a rare commodity, and in recent times, gold demand has consistently been more than the supply, which explains why gold has been in a bull market for a while.

Inflation: When there is rising inflation, gold prices tend to go up because the prices of goods and services are on the rise. Conversely, when inflation is low, gold tends not to perform so well.

Uncertainty: The market hates uncertainty. Any event that causes uncertainty in the market will push gold prices up. Examples of such events are the Brexit vote, U.S. presidential elections, terrorist attacks, and others.

Why do people trade gold futures?

The reasons for trading gold futures are many. It could be for speculative purposes but could also be a way of hedging against inflation or diversifying investment portfolios. But for the main stakeholders in the gold production-utilization chain, gold futures trading offers the best way to manage price risks.

Managing price risks

Gold producers and those who make use of gold in their manufacturing processes, such as jewelry makers and electronics producers, approach the gold futures market to hedge against future price fluctuations.

To understand how gold futures can help in managing price risks, let’s take a look at a few examples. Assuming a manufacturer of gold medals is to provide gold medals for a sporting event in seven months’ time, and gold is currently trading at $1480. If this manufacturer is concerned that gold prices will rise in the next six months when he will be making the medals, he can buy a gold futures contract now to lock in the purchase price at $1480.

Similarly, if a gold-producing company is concerned that the price of gold may decline in the future and cut down its profitability. The company may approach the futures market now and sell a number of gold contracts that can cover its anticipated production level. If, by the time it produces the gold, the price has declined, the company must have already secured some profits.

Inflation hedge

Unlike paper currencies that lose their purchasing power as governments print more money, gold appreciates in value over the long term. So, it’s normal that investors continue to acquire the precious metal as a way to store their wealth and protect it against inflation.

Portfolio diversification

Many stock investors and fund managers come to the gold market to diversify their portfolio. By investing in commodities like gold, these investors are spreading their risk across different asset classes, so if there is a bear market in the stock market, their portfolio won’t suffer a major hit.

Speculation

The great majority of traders in the gold futures market trade for speculative reasons. These traders are not interested in the physical metal; their only interest is to benefit from the daily changes in gold prices.

Gold Futures Trading Strategies

Gold Futures Trading Strategy

Gold Futures Trading Strategy

The gold futures market has a lot of interesting quirks that can be used to create a trading strategy. For instance, the market tends to work quite well with momentum trading strategies.

In the image above you see a trading strategy for the gold futures market that has been performing well in our portfolios for many years!

If you’re interested in getting edges for a variety of markets, we recommend that you have a look at our edge membership. As a member, you get new edges sent right to your inbox each month!

Risks to consider

While trading gold futures can be quite profitable, there are risks involved. Not every trader or investor may be able to cope with the risks. The main risk associated with gold futures arises from the extremely low margin levels allowed in gold trading. The maintenance margin for gold futures contracts is about 3%, so a relatively small adverse price move can force some traders to close their positions with a loss.

In situations where the traders are unable to close their positions, the brokers have the right to close the positions. But sometimes, the adverse price movements can be very swift that traders end up hugely indebted to the clearinghouses, leading to high rates of defaults — similar to what happened in 1929.

Conclusion

Gold futures are the most popular metal futures in the commodity market. It is offered on several commodity exchanges around the world.

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