Gold is traded in the form of securities on stock exchanges in Australia, France, South Africa, the United Kingdom and the United States. By design, this form of securitised gold investment is expected to track the gold price almost perfectly. Unlike derivative products, the securities are 100% backed by physical gold held mainly in allocated form, and are generically referred to as “exchange traded gold�. The securities are all regulated financial products. Financial advisors and other investment professionals can provide further details about these products.
Futures and options
Gold futures contracts are firm commitments to make or take delivery of a specified quantity and quality of gold on a prescribed date at an agreed price. Investors may take or make delivery of the gold underlying the contract on its maturity although, in practice, that is unusual. The major benefit is that such contracts are traded on margin, that is only a fraction of the value of the contract has to be paid up front. As a result an investment in a futures contract, whether from the long or the short side, tends to be highly geared to the price of bullion and consequently more volatile.
Futures prices are determined by the market's perception of what the carrying costs ought to be at any time. These costs include the interest cost of borrowing gold plus insurance and storage charges. Where the future price is greater than the spot price, as is almost invariably the case, the difference is known as the"contango". Very rarely, the future price is lower than the spot price in which case the difference is known as a "backwardation".
The cost of a futures contract is determined by the "initial margin", that is the cash deposit that has to be paid to the broker. This is only a fraction of the price of the gold underlying the contract thus enabling the investor to control a value of gold that is considerably greater than the cash outlay. In the event of significant movements in the gold price which could lead to losses the broker will call for additional, so called variation, margin.
While such leverage can be the key to significant trading profits it can also give rise to losses in the event of an adverse movement in the price of gold.
Futures contracts are traded on regulated commodity exchanges, the largest of which are the New York Mercantile Exchange Comex Division (www.nymex.com) and the Tokyo Commodity Exchange (www.tocom.or.jp).
Gold options give the holder the right but not the obligation to buy ("call option") or sell ("put" option) a specified quantity of gold at a pre-determined price by an agreed date. The cost of such an option depends on the current spot price of gold, the level of the pre-agreed price, known as the "strike price", interest rates, the anticipated volatility of the gold price and the period remaining until the agreed date.
As is the case with futures contracts, an option position can give the holder substantial leverage. Of course, if the strike price is not achieved then there is no point in exercising the option and any loss is limited to the premium initially paid for the option.
Futures and options can be traded through brokers, just as shares can. Note that when calculating options prices, the higher the strike price, the less expensive call options become and the more expensive put options become. Both call and put options become more expensive the longer the time to expiration.
Warrants
Gold warrants originated in the mid-eighties and were mostly related to gold mine issues. These days, they are commonly issued by leading investment banks and give the buyer the right to buy gold at a specific price on a specific day in the future, for which the buyer pays a premium. Warrants can usually be sold back to the issuer at any time prior to the expiry date. Despite their resemblance to options, warrants are securitised instruments and trading them is less complex than options trading. Some warrants are traded on stock exchanges.
Although warrants are generally leveraged to the price of the underlying asset (in this case, gold), this is not necessarily the case, i.e. gearing may be on a one for one basis. Although purchasers of warrants may choose to take delivery of the underlying asset, in practice this is unusual.
