Gold Spot Vs Future


Gold spot price

Spot prices are the current most accurate prices for gold. Gold is acquired “on the spot” at this price. The spot price is similar to a stock price quote which identifies the current price of one share of a publicly listed stock at any given time. Spot prices are constantly changing numbers, updated every second like a moment in a movie. The “price of gold” refers to the spot price when someone refers to it.

Spot gold prices are usually expressed in grams or kilograms. Most of the time, gold spot prices are quoted as per troy ounce, which weighs 31.1035 grams, not 28.3495 grams as in the common ounce or avoirdupois ounce. 

The spot price of gold will never be available, however. This is due to the fact that gold dealers charge a markup on all transactions involving gold, just like all other retailers. Buyers benefit from this by paying more than the current spot price. It is therefore wise for investors and gold enthusiasts to use the spot gold price as a guideline to how much gold they might expect to pay in the near future, but not how much gold they will actually receive when they buy. Spot pricing is usually only available by buying “paper gold” or “digital gold” or another financial derivative, which are typically priced at spot but obviously aren’t real gold.

Gold spot market operations work similarly to any other public exchange, with bids and asks representing different levels of willingness to pay. At the bid level, buyers are willing to pay the highest price for gold, and at the ask level they are willing to sell it for the lowest price. 

Generally, the bid/ask spread is a relatively narrow price difference between buyers’ bids and sellers’ ask prices. However, when demand or supply are extremely high, this gap can be very large, resulting in higher buyer and seller premiums as market liquidity dries up. 


What is the source of spot price?

London Gold Pool members calculate the spot price twice daily in an event known as the London Spot Fix. Among these institutions — which manage bullion markets in London — are the ones that denominate gold prices in different currencies, including the U.S. dollar, British pound, and euro. They publish the spot gold price daily on their website. 

As well as mining, refining, shipping, handling, and dealer margins, the spot price also takes into account the futures contract with the highest volume, known as the front month.


Gold Futures Prices

The gold futures contract is a contract in which buyers lock in a price FOR a delivery at a specific future date, much like other commodities futures contracts. A futures price may be compared to a stock quote if the spot price reflects a stock’s current share price and future potential value.

Commodity futures are mostly financial bets. In the hope that the CONTRACT VALUE will rise, traders might buy soybean futures or West Texas Intermediate crude oil futures. Then they can sell the contract and pocket their profit. Commodity futures contracts are rarely bought with the expectation of receiving 16 tons of non-fat dry milk powder or 15,000 bushels of hard red winter wheat. It is possible to take PHYSICAL DELIVERY of your precious metals when the contract closes, however…

Gold’s price is affected by many factors when it is purchased on the futures market. Convenience yield is the result of combining these factors from buying and holding physical gold. Convenience yields are influenced by a number of factors, such as:

  • Taking delivery of gold after the futures contract expires
  • Cost of transportation from seller to buyer of physical goods
  • Costs associated with insuring gold until delivery
  • Gold is stored before it is delivered to the buyer at a cost of carry

Due to their time-based nature, futures contracts take into account the estimates of supply and demand over the contract’s life. To provide a price for gold based on these conditions in today’s futures market, the price for gold takes into consideration all of these additional time-based factors (and their uncertainties).


What is its origin?

CME exchange futures prices of gold are influenced by gold market traders. Gold futures prices will be affected by ANY factor that impacts gold trader’s purchasing habits, such as currency devaluation, macroeconomic factors, and so forth. Gold futures prices vary depending on both the duration and size of futures contracts.


Futures and margins for gold

MARGIN or LEVERAGE is used by futures traders to increase their buying power. A margin is an upfront payment to the seller that is required from a buyer of a futures contract. Both buyers and sellers are typically protected by margin payments made through trusted third parties.

It works like this…

Consider a scenario where you are interested in investing $1,000 in a gold future. The margin requirement for the futures contract is only 10%. If you invested $1,000, you could obtain $10,000 worth of gold futures. By investing the same capital in the spot market, you would have earned $100 for every $1000 investment, but for every $10,000 futures contract you would have earned $1,000 ($10,000 futures contract 10% gain). Using margin to invest in futures might sound foolproof, but the downside risk is much greater. 

A 10% decline in gold prices would put you at risk of losing your entire $1,000 investment (unless you add to your margin), while you’d only lose $100 in the spot market ($1,000 investment – 10%). Gold prices are measured in U.S. dollars per ounce.


Futures and Spot Prices Interact

Despite constant fluctuations, spot and futures prices are strongly correlated. It is the difference in price between these two that is known as the basis. The spot price of gold heavily influences the futures price. Using Euler’s number (E) as a mathematical constant, we can calculate the price of gold for the futures market:

Futures price = (Spot price + storage and other costs) Euler’s number^(risk-free rate time to maturity)

Gold futures prices are based on the spot price of gold, along with any expenses incurred, multiplied by a constant variable based on the risk-free interest rate and duration of the contracts. 

In retrospect, this makes sense. In order to determine the optimal price for gold in a FUTURES contract, these time and expense factors must be taken into account TODAY.

It is often the case that the futures price of gold is higher than the spot price of gold as futures contracts take into account more costs than the spot market; however, this is not always the case. If future expected supply and demand are such that gold will be less desirable in the months ahead, the futures price could dip BELOW the spot price of gold. 

As you can see, the spot price and the futures price of gold are highly correlated, forever tied to one another. The spot price gives the most current price of gold at this very moment, while the futures price denotes the price of gold based on a given futures contract where buyer and seller transfer gold in the future. Gold traders use both of these prices to determine how they believe the price of gold may change down the road.


Price difference between spot and future




Neither instrument has different margin requirements, but that’s all that differs. The spot gold markets can be traded with 10,000 units, which is the minimum lot size to open a position on. A gold futures contract can be traded with a minimum of one lot, or 1000 units. It is the spread that determines the price of gold in the spot market instead of a commission in gold futures.

A major difference between gold futures and spot markets is the inability to hold overnight positions beyond the current contract month’s last day, typically the third Friday of that month. This implies a need for traders to close their positions for the current month and to initiate new positions in the subsequent month. Be aware that this will incur a $15 commission when you trade the subsequent contract month.

You can hold overnight positions in the spot gold markets for as long as your strategy dictates. While traders do not pay commissions when trading spot gold futures, they must pay the spread. Overnight positions attract overnight negative swaps. The spread for a standard lot of spot gold is $30 at a 0.3 pip fixed spread.

The floating spread of 0.1 – 0.2 ticks in gold futures translates to a spread mark-up of $10 – $20. This mark-up is in addition to the standard $15 commission.

So, which market should you trade? We have taken a look at the costs of day trading and swing trading gold futures and spot gold markets, as summarized in the table below.



It is clear from the above table that intraday trading in gold futures offers lower costs. You pay $15 for ‘fees’ when trading gold futures.

Hence, spot gold is less expensive for day traders (positions held throughout the day). Of course, variable spreads have to be taken into consideration, which can vary from 0.1 to 0.2 pips.

Example:

Gold (Futures and Spot) Scalping example

  • Spot gold, sold 1 lot at 1921.31, exit at 1921.72 (0.41) or -$41.00. No commissions involved
  • Gold futures, sold 1 lot at 1932.10, exit at 1932.80 (0.70) or -$70.00 – $15 commission for a total of -$81.00.


In the gold swing trading position example, you’ll notice overnight swaps accrue costs over a five-day period, including seven days due to a triple rollover on Wednesdays.

However, the gold futures position incurs an upfront cost of $15, provided you’re trading within the contract’s reasonable timeframe.

Remember, it’s also important to position your take profit and stop levels at least 200 points or $2 away from the market price when trading gold futures.

It is recommended to place limit and stop orders 100 points apart from the market price when trading spot gold.


Conclusion

Spot Gold trade and Futures Gold trade are fundamentally different ways of investing in the yellow metal. Armed with a basic understanding of gold investment, you are poised to venture further. The same central principles apply to other commodities as well.


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