A short history of Futures Trading
Before Futures Trading, any producer of a commodity (e.g. a farmer growing wheat or corn) found themselves at the mercy of a dealer when it came to selling their product. They needed a system in order that a specified amount and quality could be traded between producers and dealers at a specified date in the future.
And that is how Futures Trading began - in 1878 in Chicago to be precise. (Futures Investor)
For example, a dealer would agree to buy 5,000 bushels of a specified quality of wheat from the farmer in June the following year, for a specified price. The farmer knew how much he would be paid in advance, and the dealer knew how much his order would cost.
Until twenty years ago, futures markets consisted of only a few farm products, but now they have been joined by a large number of tradable ‘commodities’.
As well as metals like gold, silver and platinum; livestock like pork and cattle; energies like crude oil and natural gas; foodstuffs like coffee and orange juice; and industrials like timber and cotton, modern futures markets include a wide range of currencies and stocks. (Futures Investor)
All futures contracts are standardized i.e. they hold a specified amount and quality of a commodity. For example, a Pork Bellies futures contract holds 40,000lbs of pork bellies of a certain size and a Crude Oil futures contract holds 1000 barrels of crude oil of a certain quality. A Gold future contract holds 100 troy ounces of 24 carat gold.
Then along came the Speculator Investors
It didn't take long for business-minded people to realise the investment opportunities available in these markets. They didn't have to buy or sell the ACTUAL commodity (wheat, corn or gold, etc.), just the paper-contract that held the commodity. As long as they exited the chain of contracts before the delivery date, the investment would be purely a paper one.
This was the start of futures trading speculation and investment, and today around 97% of futures trading is done by speculators. (Futures Investor)
Gold Futures: a quick summary of why a little knowledge is useful
- Gold futures are hedging tools for commercial producers and users of gold
- Crucially for us, they therefore provide global gold price discovery - a clue as to what the markets and producers believe the price and supply will do in the future
- Gold futures, specifically, offer ongoing trading information, since Gold prices respond quickly to political and economic events (ref: CME Group)
Guessing if Gold (or Silver) will go up or down in the future
One of the key clues Gold Futures gives us is what the market (made up of producers, buyers and speculators) believes about both the price and availability of Gold and Silver in the future and in what length of future. One can buy a futures contract for different lengths of time, for example.
So, the relationship between spot prices (the price now) and Futures Prices is often worth researching.
“The difference between spot prices and futures contract prices is usually significant. The most common relationship between spot prices and futures prices, referred to as a normal market, is one where futures contract prices are increasingly higher over time as compared to the current spot price. The higher futures prices reflect carrying costs such as storage, the additional risk posed by the uncertainty of future supply and demand conditions in the marketplace, and the fact that prices for goods generally tend to increase over time.” (Investopedia)
But this isn’t always as obvious as it first seems. For a deeper read why lower or level future Gold prices are another clue to why it is important to own physical Gold, follow this link to an article I wrote back in 2013 on Gold Backwardation.
Recent Developments in the U.K.’s Gold Futures market
- Just 4 months ago, London’s 250 year old Gold market was forced to reassess the way it does business, due to new regulations.
- Investors can now trade Gold Futures through a London-based futures contract called LME (London Metals Exchange), a move its backers claim will make the world’s largest bullion hub more transparent but pits them against the top precious metal banks.
- Shishmanian, chief executive of the World Gold Council stated, “We are going to see a new era for gold trading in London. It has been a long time coming.” (Financial Times)
- Previous to this seismic shift I didn’t know that, “Approximately three-quarters of global bullion dealing takes place in the City of London.” (Financial Times)
- London’s Gold market has been primarily over-the-counter (OTC), with trades taking place privately between counterparties, rather than on an exchange. (Fast Markets)
- The new London Metals Exchange will give investors a different way to invest. It remains to be seen if this will aid competition and affect the price of Gold and Silver.
So, if you didn’t before, I hope this glossary piece explains what Gold Futures mean. Sadly, there is no exact way to know what the price of Gold and Silver will do in the future. Global and national events shape the market’s fear factor, newly discovered mines can influence short term supply and central bank announcements from overseas can all influence our own Gold and Silver prices.
Having said all that, Gold and Silver remain a historical hedge against financial turmoil and a quiet way to invest in one’s own and one’s family’s future.