After a few days of the RBI issuing Sovereign Gold Bonds on behalf of the government, August Gold Futures hit an all-time high of ₹48,871 ($646.66) per 10 grams in India. Moreover, Gold Futures touched $1800 per ounce in the US – highest since October 2012 – in the backdrop of less than 1% interest rate and fear of increasing Covid-19 cases. So what do gold futures means? Should you invest in gold? Let’s find out.
Crux of the Matter
To understand futures, options, and forwards, first, we will need to understand what does derivative mean? A derivative is an instrument whose value is derived from the value of one or more underlying asset, that can be commodities, precious metals, currency, bonds, stocks, stocks indices, etc. Four most common examples of derivative instruments are Forwards, Futures, Options, and Swaps.
A forward contract is a customized contract between two parties, where settlement takes place on a specific date in the future at a price agreed today. The contract has to be settled by delivery of the asset on the expiration date. In case the party wishes to reverse the contract, it has to compulsorily go to the same counterparty.
Futures are exchange-traded contracts to sell or buy financial instruments or physical commodities for future delivery at an agreed price. There is an agreement to buy or sell a specified quantity of financial instrument commodity in a designated future month at a price agreed upon by the buyer and seller. Here we are concerned with Gold Futures. Gold Futures of August means a Futures contract for buying or selling Gold that expires in August. In India, a Futures contract expires on the last Thursday of the expiry month – in our case last Thursday of August.
An Options contract is similar to futures but the buyer does not have an obligation to perform. Options seller, however, has the obligation to sell if the Option buyer exercises the Option.
What Is A Long Position?
Let’s say you want to buy sugar 3 months from now. 1 kg of sugar costs ₹50 today. But after 3 months, the price is expected to rise to ₹60. Now you make a contract, fixing the price of the sugar at ₹50 that you will buy three months from now. This contract of buying an asset or security at a future date is called taking a long position.
What Is A Short Position?
Let’s say you own a sugar processing industry and want to sell sugar 3 months from now. 1 kg of sugar costs ₹50 today, but after 3 months, the price is expected to fall to ₹40. Now you make a contract, fixing the price of the sugar at ₹50 that you will sell three months from now. This contract of selling an asset or security at a future date is called taking a short position.
Gold A Safe Haven?
The current price for Gold in India (as on 2nd July 2020) is ₹46,540. A higher price of August Futures and an increasing price suggests that investors think that the price of gold will increase in August owing to it being a safe bet in times of uncertainty.
Gold has always been considered good for investment. But there was one anomaly: In 1979 the global gold price increased by 120% and next year it railed some more than 29%. But the gold price took an ugly turn in 1981. In 1981 gold lost 32% and didn’t recover till 2006. In 2006 it retained the price of $594/ounce. This sudden drop happened at that time dollar price went high resulting in the downfall in the prices of the gold.
However, investors are currently trodding safely on the stock market because of fears of rising cases of Covid-19, and even interest rates in most countries have fallen – interest rate in the US is below 1%. Well, if this does not make Gold a safe haven, what does!
- A safe haven is an investment that is expected to retain or increase in value during times of market turbulence. Safe havens are sought by investors to limit their exposure to losses in the event of market downturns.
- The Giving Pledge is a campaign to encourage extremely wealthy people to contribute a majority of their wealth to philanthropic causes. Most of the signatories of the pledge are billionaires, and their pledges total over $1 trillion. Warren Buffett founded The Giving Pledge in 2009 with Bill Gates.
- The carat is a fractional measure of purity for gold alloys, in parts fine per 24 parts whole. In 309 CE, Roman Emperor Constantine I began to mint a new gold coin solidus that was 1⁄72 of a libra (Roman pound) of gold equal to a mass of 24 siliquae, where each siliqua (or carat) was 1⁄1728 of a libra. This is believed to be the origin of the value of the carat (or karat).