Gold futures are complicated, and, like I said on previous sections, if you’re new to investing in gold, you should probably go with a more simple investment vehicle. Gold futures are another form of derivative, represented by a financial contract under which two parties agree to a future transaction involving gold at a certain price.
An investor agrees to purchase gold that the seller does not yet have in possession, for a predetermined price on a future date. The buyer must pay a down payment, called a margin, and is basically gambling on the fact that the price of gold will move in a certain direction.
For most, the intent of entering into a futures contract is not to sell or purchase gold, it is to hedge risk or speculate on demand, the direction of stock market indexes, currency exchange rates, or interest rates. Day traders engage in trading these contracts to profit from the difference between the contract purchase and sale price.
Like gold ETFs, gold futures are very risky, as the Enron debacle showed us, and they are also rather complex. If an investor is not highly skilled, the ramifications of a poor futures trade can be devastating. Investors must have razor-sharp timing when it comes to futures trading. The purchaser and seller of the futures contract must fulfill the requirements when the contract expires. Traders do not concern themselves with this because they do not plan to hold the contract until the expiration date.
Speculating in futures is known as a zero-sum game because every dollar in profit made by one party is a dollar lost by the other party. The chances of losing money with gold futures are greater than the odds of losing money invested in mutual funds or stocks. These latter two investments can grow without anyone taking a hit.
Gold stocks and mutual funds sometimes offer dividends but futures do not. Similar to ETFs, gold futures are not physical things like actual gold mines, coins, or bars — you’re not buying physical ownership of gold, you’re buying an idea — a derivative.
Entering into a futures contract requires that an investor put up a fraction of the contract value, providing a great deal of leverage. For example, investors in S&P 500 futures are only required to put up five percent of the value of the futures contract. In essence, an individual controls $20 worth of market value for every $1 invested.
If the investor makes the wrong call and the price of gold falls below what was agreed upon in the futures contract, the investor loses the cost of the gold futures contract and will need to purchase the underlying gold if the contract is still held upon expiration.
So we’ve talked about gold coins, gold mutual funds, gold ETFs, gold stocks, and gold futures. But any tutorial on the basics of investing in gold would be incomplete without an entire section dedicated to the countless scams and rip-offs that exist in the gold marketing industry. Those are coming next!
Next Part: Junior Gold Stocks