Your Guide to Gold Futures and ETFs

- September 30th, 2019

Interested in gold futures and ETFs? INN has put together a guide to help you determine which investment may be right for you.

With the price of gold on the rise, now may be the perfect time for investors to enter into the gold space. 

While investing in gold stocks or physical gold are prominent forms of accessing the yellow metal, gold futures and exchange-traded funds (ETFs) are growing in popularity.

Read on for a break down of gold futures and ETFs and the different ways that market participants can invest in them.

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Gold futures and ETFs: What are gold futures?

Putting it simply, futures are financial contracts, called futures contracts, between an investor and a seller. The investor agrees to purchase assets from the seller at an agreed-upon price based on a date set in the future.

In 1972, the Chicago Mercantile Exchange launched futures trading in seven currencies, but it wasn’t until 1974 that the first gold futures contract was traded on the COMEX exchange in New York. Since then, gold futures have continued to grow in popularity as an investment strategy on various stock markets.

Gold futures are compelling because they give investors the opportunity to trade the commodity without having to pay the full amount right away. An agreement is made between two parties, including the spot price and weight of gold, and a delivery month — set in the future — is decided upon.

In other words, gold futures can be described as a contract in which an individual agrees to take gold at an agreed upon date by making an initial payment, with an agreement set in place to complete the payment.

A Daniels Trading publication notes that gold futures are offered in 100 ounces, 33.2 ounces and 10 ounces, and are an alternative to bullion coins, mining stocks and leveraged bullion dealers.

There are high rewards and high risks with gold futures investing, meaning it is certainly not for everyone. That being said, CME Group (NASDAQ:CME) notes that they provide global gold price discovery and opportunities for portfolio diversification, and that there are ongoing trading opportunities associated with gold futures.

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Gold futures and ETFs: Pros and cons of gold futures investing

As previously noted, there are both risks and rewards to gold futures investing; however, they may not necessarily apply to everyone. Still, it’s important for investors to use their own discretion when they invest in gold in this manner.

Here are some tips for investors to keep in mind when considering this opportunity.

Pros

As mentioned, gold futures contracts allow investors the flexibility of paying a certain amount when the deal is made, and then paying the remaining amount on the agreed upon date.

That means if investors are able to sell quickly, it’s likely they will never pay for all the gold they purchased. Rather, they will likely pay 2 percent up front, while any loss will be adjusted on a down payment and paid back in net.

Tracking the worth of a futures contract is easy; an investor will simply follow along with the exchange price. Finally, investors don’t need to keep gold futures stored anywhere — at least not right away.

Cons

The gold futures market can be volatile, which means there is the possibility for collapse.

On that note, the gold price is constantly fluctuating. This means that an investor may lose money if there is a large drop in the price from the time their agreement is made to the date of delivery.

Similarly, gold futures have a “built in” price differential, which can skew their true value. For example, if an investor signs a futures contract at US$1.50 above the gold price 30 days before closing, its value will drop approximately US$0.05 per day until the closing date.

There is also the chance for default risk — which means someone may be entitled to a profit but can’t collect it.

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Gold futures and ETFs: How to invest in gold futures

In the US, investors can buy or sell gold futures contracts on the New York Mercantile Exchange (NYMEX) in contracts of 100 troy ounces and are quoted in US dollars per ounce.

Typically, NYMEX contract months include February, April, June, August, October and December, with trading closing on the third to last business day of the delivery month.

Another place gold futures can be traded is the Tokyo Commodity Exchange, on which the contract size is 1 kilogram per contract, which is approximately 32.15 troy ounces.

As of July 2017, gold and silver futures trading has been available at the London Metal Exchange. Since then, the exchange has reported high volumes of futures trading.

Gold futures and ETFs: Gold options

Although this is not a gold futures contract nor an ETF, it is important to touch upon this investment option due to how similar it is to gold futures.

A gold option is much like a gold futures contract due to the fact that the price, expiration date and the dollar amount are preset for both. However, with a futures contract, market participants are required to uphold the agreement and either buy or sell the previously agreed-upon quantity of gold at the agreed-upon price. For investors who hold gold options, they have the right to buy and sell the gold but they are not pigeonholed to doing so.

Call option vs put option

The call option gives investors the opportunity, but not the obligation, to buy a specific amount of gold at a price set by the seller until the expiration date. A call option becomes more valuable as the price of gold increases because they locked in a buy at a lower price.

However, when it comes to the put option, the owner of the precious metal has the ability, but not the obligation, to sell a specific amount of gold at a price set by he or she until the expiration date. Because of this, a put option is more valuable when the price of gold decreases as they locked in a sell at a higher price.

As with most gold investments, market participants that hold gold options would only want to buy the yellow metal when market conditions are working in their favor.

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Gold futures and ETFs: What are gold ETFs and how do you invest in them?

Although exchange-traded funds, or ETFs, have existed since the 1990s, their prevalence in the market became most notable in the early 2000s.

Gold-focused ETFs became popular as a result, and they remain a good option for investors who want exposure to the precious metal without personally trading physical gold, gold futures or gold stocks.

Like all other ETFs, gold ETFs act in the same manner as individual stocks, meaning that investing in a gold ETF is similar to trading a stock on an exchange.

There are two main types of gold ETFs: those that track any price changes that the metal goes through and those that deal with investing in gold companies.

ETFs that follow the price of the yellow metal give investors access to gold by holding either physical gold bullion or gold futures contracts. It is important to keep in mind that investing in these gold ETF platforms does not allow investors to own any physical gold — even a gold ETF that tracks physical gold cannot be redeemed for actual gold.

Alternatively, ETFs that invest in gold companies provide exposure to gold mining, development and exploration stocks, as well as gold streaming stocks.

Gold futures and ETFs: Benefits of investing in gold ETFs

As mentioned, gold investors have plenty of options for getting exposure to the yellow metal, including investing in gold bullion, gold futures and gold stocks. But gold ETFs are often considered a lower risk investment and have a number of benefits for market participants.

For example, physical gold is known for being a hedge against economic and political uncertainty, and owning shares of a physical gold ETF provides investors with this same security — without the hassle of buying and storing the yellow metal.

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Since gold tends to rise when the US dollar is weak, purchasing a gold ETF could balance out any investment that has the potential to decline when the greenback does. Conversely, selling gold ETF holdings can be beneficial when the US dollar is making gains.

“The end result is that Canadian investors looking to add gold exposure to their portfolios should strongly consider looking at gold ETFs that hedge US dollar exposure,” Alan Fustey, portfolio manager at Adaptive ETF, told the Investing News Network via email.

Gold ETFs that track gold companies let investors access multiple companies in the space rather than choosing specific stocks. This is an appealing option for those who want exposure to the sector without having to make minute decisions.

Gold ETFs as a whole also offer security in that they are managed by yellow metal experts, so there is a better chance of making a profit than if investors are going it alone. Of course, it is important to keep in mind that, despite their less risky nature, gold ETFs are still affected by the rise and fall of gold prices.

Mutual funds are often compared to ETFs, but in the case of gold ETFs, there are some tax advantages that make them more desirable than traditional mutual funds. ETFs typically garner fewer capital gains when compared to mutual funds, because there is no necessity that ETFs sell the underlying securities in order to finance investment inflows and outflows. Due to this factor, those who hold gold ETFs over mutual funds will generally owe less come tax time.

Lastly, due to the fact that mutual funds can only be bought or sold at the close of the trading day, gold ETFs become more beneficial as they can be traded whenever the stock market is open, meaning movement is more free and not tied down by the end of day trades.


INNdepth

Want more details? Check out these articles for more INNdepth coverage.

Want and overview of investing in gold stocks? Check An Overview of Gold Stocks and Price.


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Securities Disclosure: I, Nicole Rashotte, currently hold no direct investment interest in any company mentioned in this article.

Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.

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