Gold Trading & Markets

Gold Trading Guide By Lawrence Pines

Lawrence Pines is a Princeton University graduate with more than 25 years of experience as an equity and foreign exchange options trader for multinational banks and proprietary trading groups. Mr. Pines has traded on the NYSE, CBOE and Pacific Stock Exchange. In 2011, Mr. Pines started his own consulting firm through which he advises law firms and investment professionals on issues related to trading, and derivatives. Lawrence has served as an expert witness in a number of high profile trials in US Federal and international courts.

In this Guide:

Overview

For thousands of years, gold has occupied a unique role in the financial systems of cultures worldwide. Unlike virtually every other commodity, gold has value far beyond its applications in industry. While business sectors including dentistry, electronics and jewelry use gold in their products, there is simply not enough commercial demand to explain the very high price markets assign to the yellow metal. However, the high price is no mystery. Since the beginning of civilization, humankind has viewed gold as a proxy for money and wealth. This reality has made it one of the most fascinating and misunderstood commodities.

Gold and Global Markets

The supply of above-ground gold is limited. Gold deposits are difficult to find, and extracting the metal from gold mines is an expensive and time-consuming endeavor. Analysts estimate that the total supply of gold in the world is around 170,000 tonnes, which if melted in to a cube would measure 21meters on each side. Put another way, if all of this the gold covered Centre Court at Wimbledon, it would rise to 9.8 meters above the ground.

Miners extract gold from the ground on every continent except Antarctica.  The largest producers of gold historically include the following countries:

  1. China
  2. Australia
  3. Russia
  4. United States
  5. Canada
  6. Peru
  7. South Africa
  8. Mexico
  9. Indonesia
  10. Uzbekistan

After it is mined, refiners process gold into bars and sell them. Buyers then transform these gold bars into items such as coins, jewelry and electronic components, or they store the bars and hold them as an investment.

As with supply, gold market demand is also international and includes a variety of different industries and traders. Fast-growing Asian economies including India and China have increased their demand for gold in recent years.

Four groups comprise the major demand components for gold:

  1. Jewelry – This industry fabricates gold into watches, rings, earrings and necklaces among other items. Jewelry manufacturers have been a mainstay of gold demand for centuries.
  2. Technology – Because gold conducts electricity and does not tarnish, many industries use gold in their products. Connectors, switches and relay contacts on cell phones contain gold, for example, as do CPU memory chips and motherboards. Gold is also used in salts to treat arthritis patients and on space vehicles to reflect radiation.
  3. Private Investors – Individuals and investment funds that want protection from inflation and market crises view gold as a way to preserve wealth. Investment demand for gold manifests itself through the purchases of gold bars, coins and funds that invest in the metal.
  4. Central banks and Sovereign Wealth Funds – Most central banks and sovereign wealth funds hold gold reserves. Although none of the major world economies has a formal gold standard, many countries including the US, France, Germany, Italy, Switzerland and China hold substantial gold reserves as a way to instill confidence in their fiat currencies.

The Price of Gold

What Drives The Price of Gold?

According to the World Gold Council, annual volume of gold production has tripled each year since the early 1970s, while the amount of gold purchased each year has quadrupled. The price of gold has risen from $45.75 in 1972, the first year private ownership of gold became legal again, to its levels today.

There are several common factors that typically move the price of gold:

  1. Supply and demand – As with any commodity, the balance between output and market demand determines price levels. When supply levels diminish, prices tend to go up. Factors such as political unrest in countries with large gold mining projects or increases in mining input costs (such as the price of oil) can constrain supply. On the other hand, discoveries of new gold deposits or declines in input costs can increase supply. One factor that consistently affects supply is the price of gold itself. When gold prices increase, mining gold becomes more profitable, so more supply comes on to the market. The opposite happens when prices decline. Similarly, changes in demand from industry, traders, central banks or sovereign wealth funds can move gold prices.
  2. Central bank policies – The actions of central banks can have a big impact on gold prices in two ways. First of all, central banks make decisions to contract or grow the money supply in their countries. These decisions ultimately drive investment demand for gold since fiat currencies (e.g., US dollar and euro) compete with gold as a store of value and a form of money. Secondly, central banks hold large gold reserves. Their decisions to accumulate or sell reserves can move the gold market.
  3. Economic data – Economic data, particularly in the United States, can impact gold prices. Because the US dollar is generally viewed as the world’s reserve currency, weak employment or GDP numbers, for example, often result in a weaker dollar against other currencies. Typically, gold benefits from US dollar weakness as it is a competing form of money.
  4. Demand for financial instruments that invest in gold – Investment instruments such as exchange-traded funds (ETFs) represent an increasingly important segment of gold investing. Most gold ETFs purchase physical gold and store it for their traders although some ETFs invest in gold futures, options or other gold derivative products. Demand for these instruments can impact gold prices.

4 Reasons You Might Invest in Gold

Investors purchase gold for a variety of reasons, but the following are the most common ones:

  1. Hedge Against Inflation and Weak US Dollar – Gold represents a viable way to hedge against weakness in the largest global economy – the United States. Global interdependence means that US economic weakness is likely to spill over into other economies. When faced with such weakness, central banks typically react by lowering interest rates and increasing the money supply. When these remedies fail to spur demand, they can lead to significant inflation and loss of purchasing power. Unlike fiat currencies, gold maintains its purchasing power in periods of inflation.
  2. Hedge Against Global Instability – Gold generally performs well during global crises. Wars, terrorist attacks and pandemics, for example, often produce a flight to safety. Gold generally benefits at the expense of other assets during turbulent times.
  3. Bet on Demand Growth – Investors optimistic about the economic prospects of developing nations such as China and India may see gold investing as a way to profit from this view. Gold has played an important role historically in these countries, and more wealth will likely translate into more demand for gold.
  4. Portfolio Diversification – Many traders view gold as a way to balance their investments. Historically, gold has a lower correlation to many asset classes, which makes it an attractive instrument to diversify.

Should I Invest in Gold?

As with any investment, there are both risks and rewards to investing in gold. Investors should consider gold for its risk mitigation potential. In the case of both economic calamities and geopolitical turmoil, gold may provide portfolio protection. For this reason, traders should consider investing at least a small portion of their assets in gold.

Gold also offers traders a way to cash in on strength in emerging markets. Many emerging economies have experienced long periods of economic and political instability. Citizens in many of these countries have probably experienced devaluations in their local currencies and are less likely to trust fiat currencies. As wealth expands in these economies, so too should demand for gold. Investors who want exposure to growth in emerging economies without investing in local stock and bond markets in these countries should consider gold.

Investing in gold, however, is not without risks. Strength in the US dollar and fiscal hawkishness from central banks may lead to significant price declines for gold. A slowdown in China and India or large sales of gold reserves by central banks could also cause the price to head lower. Finally, traders should consider that gold is a commodity that is subject to the whims of the market. If trader sentiment toward gold sours, the price will head lower.

Never invest more than you can afford to lose.

What Do The Experts Say About Gold?

Investment experts have divided opinions on gold investing.

Legendary trader Warren Buffett holds a longstanding negative opinion of gold.  Buffett argues that gold doesn’t have earnings or pay dividends and is therefore inferior to stocks.

Other experts, such as famed hedge fund manager Jim Rogers, disagree. Rogers has long argued that every trader should hold physical gold coins in their portfolio as a hedge against the collapse of other assets.

Legendary hedge fund manager George Soros has often held positions in gold mining stocks. Soros and hedge fund manager Stanley Druckenmiller see irresponsible actions by the Federal Reserve Bank as a reason to hold gold assets.

How to Invest in Gold

Gold traders and have several ways to invest in the commodity:

Method of InvestingComplexity Rating (1 = easy, 5 = hard)Storage CostsSecurity CostsExpiration DateManagement CostLeverageRegulated
Gold Bullion2YESYESNONONONO
CFDs3NONONONOYESYES
Futures5NONOYESNOYESYES
Options4NONOYESNOYESYES
ETFs3YES*YESNOYESNO**YES
Shares3NONONONOYESYES

*Storage costs are passed on to traders in the form of management fees.

**Some metals ETFs offer exposure to 2x or 3x the movement in gold prices.

Gold Bullion

One way to speculate on the price of gold is to hold physical gold bullion such as bars or coins. While this is the most direct way to invest in gold, investing in bullion requires a secure storage facility. Ultimately, the cost of this storage could make holding physical gold an expensive proposition.

Here are some online gold bullion dealers you might consider:

Gold CFDs

There is a very easy way to invest in gold that is superior in many ways to the previously mentioned alternatives. Through a derivative instrument known as a contract for difference (CFD), traders can speculate on gold prices without actually owning physical gold, mining shares or financial instruments such as ETFs, futures or options.

The value of a CFD is the difference between the price of gold at the time of purchase and the current price. In other words, the value of a CFD increases as the price of gold increases, but falls when gold prices decline.

CFD traders open an account with a regulated broker and deposit funds. The funds serve as margin against the change in the value of the CFD.  Investing in CFDs does not require the trader to pay for gold storage or roll futures contracts forward every month. Traders also don’t have to worry about getting the timing and size of markets move correct in order to profit on their trades.

CFDs are still high-risk financial instruments however and your capital is at risk so you should be an experienced trader or seek out a broker that offers a demo account to allow you to develop your knowledge in advance of risking real money.

Start Trading Gold

Plus500 logo

One of the leading brokers for trading precious metals, like gold, is Plus 500. Here’s why:

  • No Commission on trades (other charges may apply)
  • Free demo account
  • Easy to use (mobile-friendly) platform
  • Industry-leading risk management tools
  • Trade gold and hundreds of other markets
  • Your funds are safe – publicly listed company regulated by the UK’s Financial Conduct Authority and Cyprus’ Securities and Exchange Commission

Start Trading at Plus500.com Important: Your capital is at risk. CFD services are suitable for experienced traders only.

Gold Futures

These gold trading derivative instruments allow traders to speculate on the future price of gold through the purchase of exchange-traded contracts.

Futures markets offer traders a liquid and leveraged way to trade gold. However, leverage can lead to margin calls when prices decline. Also, futures contracts come with definite expiration dates. This requires the trader to either accept delivery of gold or roll the contract forward to the next month. In other words, trading futures requires active and onerous maintenance of positions.

Gold Options

Like futures, options are a leveraged derivative instrument for trading gold. However, options traders must be correct on the timing and the size of the market move to make money on a trade. Options traders may find that they were right about the direction of the gold market and still lost money on their trade.

Gold ETFs

While ETFs may seem like perfect proxy for investing in gold, traders should be aware of their considerable risks and costs. Many ETFs invest in gold futures or options, which have the risks outlined above. As for the ETFs that invest in gold itself, these funds incur same storage and security costs just as individuals do. Ultimately, these costs get passed on to the trader.

Finally, ETFs are financial instruments that trade like stocks. When stock markets decline, ETFs are not immune from the same pressures that drag stocks down. Investors may find that their investment in gold is behaving more like a stock investment.

Here are some leading gold ETFs (based on assets under management):

SPDR Gold TrustiShares Gold TrustETFS Physical Swiss Gold SharesPowerShares DB Gold FundVan Eck Merk Gold Trust

Gold Stocks

Purchasing shares in exploration and mining companies supposedly allows traders to make a leveraged bet on the price of gold. In theory, many of the costs of running a mining company are fixed. Therefore, as the price of gold increases, the additional revenues should flow to the bottom line in the form of profits. Markets assign a multiple to these profits, so in bull markets traders should make more money from owning shares.

The flaw in this argument, however, is that gold prices rarely rise in a vacuum. When the price of gold increases, usually oil and other commodities needed to run a mining company rise as well. In fact, mining shares have rarely if ever outperformed gold prices during bull markets.

Here are a few leading gold explorer and mining stocks:

 Current PriceOverviewListingsFoundedNumber of EmployeesInteresting Fact
Barrick Gold
Largest gold mining company in the World, headquartered in Toronto.Toronto (TSX)
New York (NYSE)
198311,000Originally founded as an oil and gas company.
Newmont Mining
US gold mining company based in Colorado.New York (NYSE)191634,000Newmont is the only gold company in the Standard & Poor's 500 Index
Polyus Gold
Russian gold mining company headquartered in Moscow.London (LSE)
Moscow (MCX)
20064000The largest gold miner in Russia.
AngloGold Ashanti
Johannesburg based global miner and explorer.Johannesburg (JSE)
New York (NYSE)
Sydney (ASX)
200462,000The company has 17 mines in 9 countries.
Newcrest Mining
Australia's leading gold mining company.Sydney (ASX)19661,500Originally a subsidiary of the Newmont Mining Company.

Further Reading