Trading Gold

SO EVERYONE’S TALKING ABOUT GOLD – WHAT IS IT ALL ABOUT?

Human beings have long valued and treasured gold for its inherent lustre and malleability. In fact, gold has been used in human commerce since the societies of the ancient Middle East over 2,500 years ago, making it the oldest form of money still recognised today. Gold’s long track record as a store of value despite wars, natural disasters, and the rise and fall of great empires means that it is generally seen as the ultimate “safe haven” asset.

Therefore, it’s not surprising that interest in owning and trading in gold has skyrocketed in recent years with the onset of the Great Financial Crisis in 2008. Gold prices have risen in sympathy, hitting an all-time high above $1900 in late 2011. In this brief guide we will discuss the major forces that drive gold prices, along with some of the common methods for trading gold and a brief overview of possible trading techniques.

The Mechanics of Gold Trading

Physical gold is valuable because it represents many of the qualities of ideal money. It is scarce, durable, portable, uniform across the world, and widely accepted—in part due to its long history of being widely accepted. However, in the current digital world, few traders actually take physical possession of gold bullion. Instead, most traders focus on trading the current “spot” gold price, which is based on the price of the most active futures contract on the COMEX (Commodity Exchange) in New York. For all intents and purposes, you can trade gold as you would any other trading instrument at a spread betting provider like Ayondo.

Two of the most common ways to trade the price of gold are through CFDs or spread betting. Both of these products offer leverage, meaning that traders can control £1,000 of gold with less than £1,000 of margin. Leverage can offer great potential for profit if the market moves in your favour, but it can also lead to a large, rapid loss if the market moves against you. Therefore, it is essential to practice good risk management and place a stop loss with every trade.

Factors that influence its Price

Gold is one of the most difficult financial assets to value. As we alluded to above, gold is similar to a currency, such as the U.S. dollar or the euro, in many ways; unlike these more commonly traded currencies, though, gold is not supported by an underlying economy of workers, companies, and infrastructure. In other ways, gold is more similar to a commodity like oil or corn because it comes from the ground and has standardised physical characteristics. Unlike other commodities, however, gold often fluctuates independent of its industrial supply and demand.

One of the most reliable historical determinants of gold’s price is the level of real interest rates, or the interest rate less inflation. If you think about it, this relationship is relatively straightforward. When real interest rates are low, investment alternatives like cash and bonds tend to provide a low or negative return, pushing investors to seek alternative ways to protect the value of their wealth. On the other hand, when real interest rates are high, strong returns are possible in cash and bonds and the appeal of holding a yellow metal with few industrial uses diminishes. One easy way to see a proxy for real interest rates in the United States, the world’s largest economy, is to look at the yield on Treasury Inflation Protected Securities (TIPS).

Gold Trading Strategies

As with any trading instrument, there is no one “best” way to trade gold. Many traders from other markets have found that the technical trading strategies they employ on other instruments can easily be adapted to the gold market, especially given gold’s tendency to form durable trends. That said, longer-term traders could go a step further by using a filter based on the level of real interest rates discussed above.

The below chart shows the relationship between gold prices and the yield on TIPS, a proxy for real interest rates in the United States. The inverse correlation is obvious, but it looks like the recent gold rally accelerated further as real yields dropped below 1% in early 2009. A longer-term look at the relationship would reveal that gold prices generally fell in the late 1990s, for instance, which were characterised by real yields above the 1% threshold.

Gold Price vs Tips Yield since 2008

Therefore, longer-term traders may want to consider only buy trade opportunities if real yields are below 1%, a level which has historically been supportive of gold prices. Conversely, if real yields rise above 2%, traders may want to focus only on sell trades. The ability to use a filter based on real interest rates is one of the unique features that long-term traders can use to gain an edge when trading gold, but the trading strategies and opportunities in trading the world’s oldest “currency” are truly limitless.

Spread Bet Gold

Spread betting on gold has long been profitable for many commodity traders. It was in fact IG Index who came up with the concept of financial spread betting to allow speculation on the price of gold way back in 1974.

An example gold spread bet:

• Generally 1 point (tick/pip) is considered $0.10 when trading gold (gold is quoted in dollars per troy ounce, but you can bet per point movement in your own currency).
• Given the current climate, you believe the price of gold is in no hurry to come down, and decide to open a bet by going long (buying).
• After looking at the options of a rolling daily spread bet, an April contract or a June contract, you decide to open a position based on a June contract.
• You can of course exit the bet anytime by selling (closing your position) , you do not have to see it out until the end of June.
• IG Index quote a price of $878.70 – $879.30. You decide to buy, so you take the buy price of $879.30 at $3 a point. The spread is 6 points, and it’s only until it moves by more than this amount that you are in profit. Effectively, whenever you open a spread you’ll always be at a loss until it moves in your favour by at least the amount of the spread.
• Gold goes up steadily, and at $930.70 quoted as the sell price, you decide to take your profit and close your bet ahead of its June expiry date.
• Your profit is calculated at: $930.70-$879.30 = $51.4 increase. $51.4 = 514 point movement * £3 = £1,542 profit (although gold is quoted in dollars, you can bet in your chosen currency per point movement).

Trading Gold with Ayondo

If you’re interested in trading gold, you can use a provider like Ayondo. Gold futures and spot gold are available for both CFDs and spread betting, with spreads as low as 0.3 pips.