How to trade or invest in gold

What is Gold Trading?

Gold trading involves buying and selling gold as a financial asset in the global market. Being a precious metal and store of value, the primary purpose of owning or using gold for investment is to hedge against market fluctuations, inflation, or economic uncertainty. It is also a popular choice among traders seeking to diversify their investment portfolios. However, gold itself is inherently volatile, and trading or investing in it may involve risks, particularly due to global economic conditions, geopolitical events, central bank policies, and supply-demand dynamics. Hence, a thorough analysis of these factors is essential for making informed decisions when dealing with this multi-purpose investment asset.

What is the Gold Market?

The gold market refers to all channels and means through which gold or its derivatives are traded globally across various time zones. This includes physical markets, financial markets for investors and speculators, exchange-traded funds (ETFs), futures markets, and options markets.

Gold is primarily traded over-the-counter (OTC), with London being the global center for OTC trading where market participants trade directly with one another. Although this market is less regulated and more flexible, counterparty risks can be higher.

The London OTC market, the Chicago Mercantile Exchange (CME), and the Shanghai Gold Exchange (SGE) are the three major centers for gold trading, accounting for over 90% of global gold trading volumes. Recently, several important secondary markets have emerged, with Dubai, India, Japan, Singapore, and Hong Kong being some of the most prominent.

Methods of Trading and Investing in Gold

There are several ways to trade or invest in gold, each providing different exposure and mechanisms. Here are the main methods:

Physical Gold Ownership

The most common method of investing in gold is through purchasing physical gold bars or coins. This method requires paying the full value of the gold you wish to own. Typically, gold is 99.5% pure, and bar sizes range from 1/10 ounce to 1 kilogram, with coins available in various shapes and sizes. Keep in mind that additional costs may apply for minting, design, and inscriptions.

Investing in gold jewelry is an alternative but less direct method. Jewelry involves additional costs related to craftsmanship and designer branding, which are not linked to the intrinsic value of gold, and it may also incur taxes as a commodity.

A drawback of physical gold ownership is storage. Many investors choose to store their gold bars or coins in secure deposits or safes, as home storage might not offer adequate security, particularly for smaller pieces that are more susceptible to theft. Another issue is ensuring you deal with a reputable seller to avoid receiving mixed or lower-purity gold.

Investing in Gold as a Financial Asset in Exchanges

Gold's ability to retain value makes it a safe-haven asset during market fluctuations, often used for hedging or direct trading against various currencies, especially the US dollar. Gold is traded under the symbol XAU, and the dollar is the pricing currency, USD. Thus, gold prices generally move inversely to the value of the US dollar, with a stronger dollar typically keeping gold prices low and a weaker dollar raising gold prices due to increased demand as a safe haven. Consequently, gold is often viewed as a hedge against inflation, which rises when prices increase and the dollar weakens.

Buying Gold ETFs

Owning physical gold comes with its drawbacks, including transaction fees, storage costs, and insurance. Investors seeking more liquid and cost-effective entry into the gold market can consider gold-focused mutual funds or ETFs, such as GLD or SPDR Gold Shares, which began in 2004. These shares trade on the New York Stock Exchange and can be bought or sold any time during trading hours, just like stocks. The price of GLD ETFs typically mirrors the price of gold, with a ratio of 1/10. For example, if gold trades at $1250 per ounce, the GLD ETF share price will be around $125.5.

Buying Gold Futures Options

Experienced investors familiar with financial derivatives may consider gold futures options or ETF options. These contracts provide the right, but not the obligation, to buy or sell an asset (gold, in this case) at a specified price within a certain period. Options can be used if you expect gold prices to rise or fall. If your prediction is incorrect, the maximum loss will be the premium paid for the contract. This applies to direct gold trading or ETF options.

Investing in Gold Mining Stocks

Investing in gold mining companies is an alternative to investing in gold itself. Typically, gold mining stocks rise with gold prices, reflecting increased value in the company's gold reserves. However, this is not always the case. The performance of mining stocks can vary based on operational efficiency and management, affecting profitability. Thus, investing in mining stocks adds company-specific risks to gold trading.

Trading Gold with CFDs

Contracts for Difference (CFDs) are popular for gold trading, particularly among retail investors and speculators. CFDs allow speculation on gold prices against the pricing currency (usually USD or sometimes EUR), without owning the underlying asset. Trading CFDs on gold is similar to forex trading, enabling positions in both directions (buy or sell) with leverage and flexibility in contract size. CFDs offer round-the-clock trading compared to ETFs or mining stocks, which have specific trading hours.

How to Calculate Points in Gold CFDs

When trading gold CFDs with leverage, prices are quoted per ounce. For instance, if the price is 1930.11, it means the current price for one ounce of gold is $1930.11. The price moves in cents, so a rise to 1930.15 indicates a $0.04 increase in gold price. In CFD trading, the smallest unit of price movement is a point (PIP), equivalent to one cent in gold pricing.

Example:
If you buy a 1.12-ounce contract of gold at 1930.10, and the price rises to 1931.15:

1. You bought 112 ounces of gold.
2. The price increased by $1.05 (105 points).
3. The point size in the contract is $1.12.
4. Your profit so far = 105 × $1.12 = $117.60.

Remember that trading with leverage involves significant risk and may not suit all investors. Gold price volatility and sensitivity to market changes add further risks. Stay tuned for future articles to learn more about gold analysis and how to manage it.