The turmoil in the financial markets in recent years has turned a lot of traders’ interests to speculating in gold. The question is always to find the best way to make a trade that allows you to profit from your intuition of where the price is headed. Some traders choose to invest in mining and exploration stocks, but this does not represent a direct trade on gold prices. Physical gold, whether bullion or coinage, has security and storage problems. The futures markets are another alternative, but a much easier and more accessible vehicle introduced in recent years is the gold contract for difference.
But what affects the gold price? Can the recent rally be sustained? And how can financial spread betting help you profit from fluctuations in the value of the gold price?.
Traditionally, gold has commonly been regarded as a safe haven during periods of financial turmoil. When there’s any sort of market calamity you are likely to see an uptick in gold as it’s considered as a safe haven which makes it an ideal vehicle for hedging against these events. This is partly due to the perception that a commodity with intrinsic value will hold its value better than an investment in less tangible markets such as foreign exchange or shares, both of which can tumble sharply on negative economic data. On the other hand when the global economy is enjoying a period of relative economic stability, the gold price is mainly driven by industrial use in medical and technological devices, as well as for jewellery. Of course gold doesn’t have any here near the industrial use as copper and zinc do. Gold price responds to demand due to its monetary store of value, whereas metals such as copper and zinc may respond to that demand, but also respond to industrial supply and demand pressures.
When the economy is strong, nobody cares about gold. The 1990s are a good example. Once we began this century, and had the dot-com bust and 9/11 recession, gold has been on investors’ minds.
Investors do not want to buy gold. They buy it out of necessity. What causes necessity is only one thing, systemic risk, which drives fear. I call this the fear trade, and it is the only thing that will take gold to $2500 and beyond.
Gold is also priced in dollars so will normally move in the opposite direction to the greenback; a dollar that is under pressure will positively impact the demand for gold as traders in international countries will perceive that they are getting a better deal due to the exchange rate (opposite is also true). Here it is worth noting that high gold prices may have a negative impact upon the jewellery market, an industry which still accounts for around 70% of physical demand for gold. Add the fact that the recession seems to have reached its nadir and stock markets, individual stocks and forex may all begin to see increasing appeal from investors and traders. Both factors may negatively impact the gold price and push it down again. Having said that there is only a limited amount of gold and it is not possible to manufacture the metal artificially – and demand keeps rising especially in India which happens to be the biggest consumer of gold (yearly events such as the Indian wedding season, which runs from September to December, spikes demand and often causing a spike in the price).
However, with interest rates lingering at all-time lows in the United Kingdom and low rates across the eurozone and the United States, many investors and speculators are now starting to worry about inflation – a side effect of a sudden recovery. An investment in gold is a great way to hedge against the spectre of inflation – in particular using gold as a hedge to offset losses in other parts of their investment portfolios. Gold has a negative correlation with real interest rates which means that as inflation rises and real interest rates fall, the gold price is likely to keep rising as it attracts investors who are unable to extract a decent return from traditional asset investments. Huge levels of government debt can also hit forex markets and cause traders to seeks refuge in gold. In particular gold also acts as a hedge against currency debasement – a quality which comes in useful as governments keep pushing their quantitative easing policies to boost their exports and reduce the levels of debt (which devalues their currency) – this can’t happen to gold so given stable demand the price will keep increasing. This could see gold prices carry on their upward surge. But then again, there is the question of how far beyond the $1000 per ounce mark the gold price can rise. When it hit similar levels a year or so ago, the gold market was unable to support much additional gains.
When the economy is strong, nobody cares about gold. Fortunately for us, the Fed implemented MMT (modern monetary theory) in 2008, and has been stuck with that strategy ever since. With MMT, they used artificially low interest rates to stimulate the economy and broke the free market. Plus, they used money printing to enhance these low rates. Now, they have nearly $9 trillion on their balance sheet and are stuck with this strategy. At the beginning of this century, they had $1 trillion on their balance sheet and were pursuing a strategy of using the free market for economic growth. When the GFC (great financial crisis) struck in 2008, the Fed had two choices. They could allow the free market to sort its way out, or follow the Japanese strategy of MMT and wreck the free market. Well, we know what they chose. Now they are stuck with constantly micro-managing and manipulating the economy with low interest rates and money printing (debt expansion).
Admittedly, this performance tends to come in short bursts of strong, very strong performance (e.g. late 2008 – mid 2011; and late 2018 – mid 2020), followed by longer periods where not very much happens. So the moral of this story is, when investing in commodities, and in particular in precious metals, you need to be in at the right time.
Gold is primarily what we call a financial commodity. While of course it is used for jewellery these days, its principal uses are as an alternative currency and a long-term store of value. It is the financial value of gold that is important here, and people hold gold bars, gold coins or funds which own physical gold such as exchange-traded funds (ETFs).
Think of Gold as a Datum
You will not understand gold, or its function in a portfolio, until you learn to think of gold as a datum, against which different currencies move, in different degrees and even directions. It is absolutely crucial to identify correctly the yardstick and the item to be measured. If you take man’s foot as the datum upon which to measure the length of a twelve-inch ruler, your measurements become meaningless at best and misleading at worst. You get different answers according to the individual man’s foot you select as your datum! If you think the $ is a reliable datum for measuring value (or even price), try comparing the purchasing power of a 1950 $ with a 2000 $ and a 2023 $. Do you find the dollar to be a reliable datum for measuring the value or price, of anything, where there is an elapse of time between measurements?
Profits and losses from trading gold are made in currencies of course, but that is a different matter altogether. If you can’t get your head around gold as a datum (imperfect, but better than most, certainly better than the £, the dollar, BTC or the peso), at least try to think of it as a commodity, and thus very different from a share in a trading company, or think of it as a currency. If you can get your head around that, you might begin to talk some sense about gold, or at least stop talking utter nonsense. Do you use Elliott Waves to work out the best time to buy your currency prior to a foreign holiday?
Governments (or more usually Central Banks) do not ‘invest’ in gold (or anything else) with a view to profit in the way that private investors do. When the BoE buys sterling when the the £ is under pressure for example, or Central banks buy bonds and other securities from banks in need of liquidity, they do not do so because they see a prospective trading profit! Their agenda is quite different. So while I agree with you that Central bank purchases are not a reason to buy gold, that is not because Central Banks are bad at market timing. It is a serious error to equate Central bank purchase and sale objectives with those of private investors.
Gold did not lose 46% of its value after 2011. Its price fell in one currency by 46% (and moved differently in others) over those years. The distinction between price and value is fundamental.
The key drivers of the gold price are threefold:
- Geopolitical instability. Well guess what, uncertainty in the world is good for safe haven assets. Gold is a safe haven store of value, so that’s typically a good thing. We have plenty of instability geopolitically today, what with the war in Ukraine and also with the tensions between the US and China.
- Long-term interest rates, what we call bond yields, particularly the real yield. This is the long-term bond yield, then subtracting long-term expected inflation. What is left is what we call the real underlying yield. When that rises, as it has done over the last twelve months, this is bad for gold because it provides a safe haven alternative which has a higher yield, whereas as we said, gold has no yield, no income.So what’s going to happen to the real yield? It’s been going up. My feeling is going to continue to drift lower now after a surge upwards, I don’t think it’ll get back to where it was before which was in negative territory. We had negative reels for quite a period of time following 2009. That being said, the real yields, the long term real deals can decline, I think meaningfully from here.
- US dollar. If you look at the performance of gold over this year to the end of November, gold has actually been a respectable performer. In a year when stocks have delivered on average a double digit negative return to the end of November, as have bonds, both government bonds and corporate bonds, and when real estate clearly is coming under pressure from the weakness in the economy and the sharp rise in financing rates.Gold has held up well in currencies other than the dollar. If you look in euro terms over the year to date you would have gained 6%, which is a lot better than negative performance than these other asset classes, in sterling 8%.
But for investors in dollars, gold can be thought of as an alternative currency. So when the dollar is strong, gold tends to be weaker, at least when expressed in dollar terms. The good news is that I expect the US dollar to weaken further. It has already started to weaken because US inflation is coming down. The US Federal Reserve, the central bank can therefore calm down the speed at which it raises interest rates and I think the Fed will even stop raising its Fed Funds benchmark interest rate as of January, which removes a key support for the dollar
Gold futures
A way of trading gold is by through gold futures which are traded on stock exchanges in London, Tokyo, Sydney, Singapore, at the New York Mercantile Comex Exchange (COMEX), the New York Mercantile Exchange (NYMEX) and at the precious metals department of the Chicago Board of Trade (CBOT).
The COMEX gold futures contracts are traded in the pit from 1.20pm to 6.30pm using the old traditional open outcry method. This is the time when these contracts are most heavily traded, although electronic systems allow the market to remain open all though the day.
Gold futures consist of contracts where one party binds itself to make or take delivery of a pre-determined quantity and quality of gold on a future pre-determined date at an agreed price. Parties to the contract (which can be mining companies, speculators, hedge funds..etc) may take or make physical delivery of the underlying gold on the maturity date, although, in practice this is unusual. Future contracts are traded on margin and such investments tend to be heavily geared to the price of the metal and thereby very volatile making them a high risk/high reward investment.
Trading Gold via A CFD
An alternative is to use CFDs to gain leveraged exposure to precious metals. A gold CFD is a theoretical order to buy or sell a certain amount of gold, and the profit or loss on the CFD is determined by the change in price of the gold. As it is a derivative, you never have to deal with taking ownership of the metal, but you can enjoy all the profits as if you had. The other advantage is that it costs you a fraction of the amount you would need to buy the gold.
Gold CFDs are amongst the most commonly traded and hence one of the most liquid commodities you can trade and the advantage of this is that the spread is tighter and you should be able to enter and exit positions easily irrespective of the trade size Do keep in mind that gold is a very volatile market and daily trading ranges of $40 (i.e. equivalent to 400-point moves) are common in a trading day.
Depending on how and where you trade, you will find variations on the gold CFDs available. For instance, you may take a CFD over the spot gold price, which is the currently quoted price, or can choose to trade a CFD based on the gold futures price. Typically, there are standard sizes of contract such as 10 ounces or 100 ounces of gold, and also mini contracts at 1/10 of the standard size.
Whatever the size of CFD contract, the profit (or loss) that you make comes directly from the change in value of that amount of gold. The margin, or amount you need to buy the contract, may be as little as 3% of the value. You will be charged interest for every day that you hold the CFD, as if you had borrowed the money from the broker to buy the full quantity. If the price goes down, and you have a long position, you may also receive a margin call, which is an order from your broker to submit funds to cover your losses to date.
An example will help illustrate how the process works. Say that gold is quoted at $1071 to $1071.50. The second price is the offer price that you pay if going long. As you are bullish on gold, you take out a mini contract for 10 ounces at the offer price, which represents $10,715 worth of gold. If the margin is 3%, this would require $321.45 in your account.
A week later gold is quoted at $1094.50 to $1095. To close your contract, you sell at $1094.50. The value of the gold that you controlled has increased from $10,715 to $10,945, which is $230. The interest for holding this position for a week would be taken off this amount, but it is still likely that you would profit on your money more than 50% in a week.
Let’s take another example. Suppose gold is trading at $1240 an ounce and you believe gold is due to start moving up. You could open a long ‘buy trade’. Each contract can either be $10 (mini-contract) or $100 (maxi-contract) per one dollar movement in gold. If gold rallies to $1,300 with a $10 (mini) contract you could stand to make a gain of $600, or with a $100 (maxi) contract you could net $7,000 pro?t. Of course should gold fall in value you would lose the same amounts.
CFD Trading Example: Spot Gold
Let’s suppose you discover that the Gold market has been especially active as speculators keep pushing up the price – you think there is still room for further rises. The broker’s quote for Spot Gold is 952.1-952.6.
You buy 30 Spot Gold CFDs at 952.6.
Points to note:
- The tick size for Spot Gold is 0.1, so if Gold moves from 952.6 to 953.6, that is equivalent to 10 ticks.
- The base currency of the underlying Spot Gold market is USA dollars, so USA dollars will be the currency that you will be trading in.
In the next few days, you note that the Gold price has risen further and the broker’s quote is now 965.2-965.7. You decide to close your position by selling at 965.2.
This realises a profit of (9652-9526) X your stake of 30 = USD$3,780.
Note: In this example daily financing costs have not been included for simplicity.
