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All that Glitters is Gold an Silver

By: Adam J. Heist

There is still a huge demand for gold and silver. They represent the traditional means of retaining economic value when financial systems fail or go into hyper-inflation. Gold and silver have gone down quite a bit recently, but are still far above the price level of just three years ago.



Commodities are hoarded and grabbed as representing something real. At least you can have possession of something valuable if you own gold or sliver. Future trading, options and other instances of derivatives trading can muddle the issue. A precious metal futures contract is a legally binding agreement for the delivery of an amount of the metal at a future date. You can take either a long position, to sell or a short position, to buy at that date, at a set price. Most of these contracts are never actually delivered on because the contract is offset before the delivery date. For example, trader Z buys a long contract to sell gold on March 1st, 2007 at $635, in December 2006. He sees the market going down, and on January 1st, he buys a contract to buy gold (short contract) at $630. In this case there is a profit margin, since he’s buying it at a lower price than he is selling it, but never actually delivers physical gold.


The people functioning in this trading market are generally characterized as hedgers or speculators. The hedger buy a position opposite to what their position is in the physical market. Theoretically, the futures market is a useful place for people involved in physical goods to hedge against price fluctuations. In reality, the speculators far outnumber the hedgers, and have taken over in terms of price movements. A hedger could be a jeweler or a central bank involved in buying or selling gold as part of its financial functions. They buy gold for use, but also buy a futures contract if they think the price will either drop or go up. They can elect to offset this contract before the day that it is due, or they can let the contract go to full term and buy or sell the actual gold in the contract. If they buy a contract saying the price of gold will be at a certain price, and the price goes down on the market, they in effect end up paying an insurance fee, by being forced to offset the contract, but if the price actual goes up, they can hold onto the contract and get physical delivery of the gold at a lower price.

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