How to Trade Precious Metals Futures Contracts

It can be very surprising that something that is dug up from the ground can be worth anything in the modern age and economy. However, precious metals have just as much relevancy today as they did in the past. Precious metals of all kinds have maintained their value over time and they continue to be sought-after assets for investors and to facilitate global trade.

You can find artifacts discovered as far back as 4,000 B.C. that showcase just how long precious metals like gold have been seen as a valued resource. There’s evidence a thousand years later that gold mines were found in ancient Egypt which likely began the same effort that exists today to both produce and store wealth.

One of the more important milestones in precious metals becoming viable as a trade commodity can be dated back to 560 B.C. when coins were initially formed. It was in the Greek state known as Lydia where it started. The Roman legion was paid monthly salaries in coins forged out of precious metals. A single coin’s value was around the same as 200 pounds of flour and 30 gallons of cheaper wine.

What’s even more amazing is that the value hasn’t disappointed. A modern worker would likely be just as satisfied with receiving payment in gold. This only goes to show how much staying power precious metals have had throughout the years and it shows the strength of precious metals going into the future. In an economy of such uncertainty, precious metals provide that level of certainty a lot of investors seek.

It shouldn’t be any surprise that precious metals continue to be sought-after and that they play such a pivotal role in the modern economy. After all, there are derivatives traded on exchanges including futures that feature a very liquid precious metals market.

In this article, we will be going over more information about this futures market and why you should care.

Some Background

To gain a better grasp of the futures market for precious metals, you’ll want to have a firm understanding of the background.

In the past, gold coins were traditionally minted with a single weight of one ounce. This is likely the main reason why the value of gold continues to be quoted today on a per-ounce basis. A single gold bar typically weighs 100 ounces. This is also the total amount covered by a single gold futures contract.

Thus, with gold at this moment trading at approximately $1,320 per ounce, it means that the notional value of a single bar of gold and a standard futures contract equally sit at $132,000.

Silver is a precious metal that doesn’t have a market value near gold. It’s significantly lower. However, like gold, it’s quoted by the ounce. Right now, the market price of silver sits at $17 per ounce.

Silver is less valuable than gold. Because of this, the majority of silver futures contracts will be denominated in much larger quantities. For instance, the larger silver futures contract can cover 5,000 ounces. Whereas the smaller contract would only cover 1,000 of them.

This ends up translating to a notional value of $85,000 for a large contract of silver and $17,000 for a small contract of silver assuming it’s sitting at $17 per ounce.

There are plenty of other precious metals including palladium, platinum, and more. However, in this scenario, we are only focusing on the two most actively traded in the market.

Precious Metals Futures Contracts

If you want a more in-depth explanation of futures contracts, we recommend you visit USA futures to learn all the intricate details.

A contract in the precious metals market is a legally binding agreement to take physical delivery of a pre-determined precious metal at a future date for a set price. The overall details of the contract including the quantity, time, quality, and delivery location are standardized by the actual exchanges. Thus, you end up having price as the only variable component of the contract.

A precious metals future contract requires you to take physical delivery of the precious metals you are bidding on after the expiration date. With that being said, a lot of the futures positions taken are fully closed before this date. This eliminates needing to take delivery of the physical metals.

Much like other future products in the marketplace, there are two distinct positions you can take. You can either go long by buying the contract or you can go short by selling the contract. When you buy the contract, you are operating under the obligation that you will have to accept delivery of the physical metal. Whereas, when you go short, you will be obligated to deliver the metals to the respective buyer.

As mentioned previously, the overall specifications of the futures will vary from contract to contract. This is particularly true when you are talking about quantity. You will find that the 100-troy-ounce is typically the most common contract, there are also others including mini contracts that only cover 33.2-troy-ounces.

The most common quantities of silver futures contracts include 5,000 and 1,000 ounces. You’ll want to understand the total quantity involved and the total amount of capital you will need. You also need to ensure you understand the specifics of the contract before establishing any kind of position.

The Different Trading Strategies

As with other futures products, you have different trading strategies you can utilize. Trading precious metals futures can offer the flexibility and diversity that you might want for your portfolio.

A future contract is usually considered an ideal investment vehicle for a lot of investors because they are traded on highly liquid centralized exchanges. This means that you can not only gain additional leverage easily, but you can also benefit from increased liquidity compared to having physical goods. Financial leverage is the ability to effectively trade and manage a higher market value asset and product without having the total capital normally required.

When it comes to the gold futures market, a trader would have the chance to leverage $1 to control as much as $15. However, you need to know both sides of the coin. It also means that you take on much more risk when you take on leverage. Thus, you have higher potential returns, but it comes with higher risk.

From a strategy standpoint, the main use of a precious metals future contract comes down to speculation, hedging, and trading a spread. This is the same as most future trading principles.

When it comes to speculation, it refers to the expression of a directional bias. Meaning, you think it’s going to increase or decrease in value.

When it comes to hedging, you can use futures to lock in the current price for the future.

One of the main things that make precious metals futures so unique is that you can use precious metals to hedge for inflation. A lot of investors have worries that holding fiat currency can expose them to more inflation risk. Whereas, if you invest in precious metals and tangible/finite resources, you can mitigate some of the risks.

By diversifying your holdings in physical goods or futures contracts based on physical assets, you can offset some of the risk associated with inflation.

Thus, it adds another dimension for market participants. This dimension includes having those that are hedging against inflation and those that are hedging against future discoveries or even other holdings.

This is one of the primary reasons why the overall value of precious metals can increase during global economic instability. A lot of investors will be exiting their growth and riskier assets to try to seek safe-haven assets that are much less subjected to price depreciation and inflation.

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