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Gold commodity investments, specifically gold futures contracts, offer a unique way to invest in gold. Investors can buy and sell in a transparent, open market, without many of the management fees and costs of holding gold through other vehicles like ETFs. As a result, they actually track gold prices more purely than the ETFs designed to do just that. They offer strategic use of leverage, coupled with excellent liquidity. This culminates in higher potential returns.
Gold Commodity Investments For Leverage
Gold commodity investments offer a unique method of using leverage. This can be remarkably profitable in instances where notable market moves are anticipated. By way of comparison, let’s assume we have $5,000 to invest. We could put $5,000 into gold bullion or and ETF such as GLD. Gold would have to go up a decent amount before the return would be worth thinking much about.
However, by contrast, we could use the same $5,000 to fund a margin account. Accordingly, we can take advantage of the price movement of 100 ounces of gold through COMEX gold futures contracts. To tap the appreciation in the price of gold to the magnitude of 100 ounces, gold would have to be just $50 an ounce, which will likely never, ever happen. There can be north of 25 times the profit potential using futures contracts versus tapping physical bullion in person or through an ETF. Moreover, these days you do not even need to trade full contracts. There are now E-mini gold futures that are much smaller and use less margin.
Gold Commodity Leverage As It Relates To Return
To put things in perspective, let’s look at some hard numbers. Using the once-was number of $1,250 an ounce for gold, $5,000 buys you 4 ounces. If gold goes up $10 per ounce, then your bullion or shares in the bullion-based ETF will bring you about $40. Of course, we’ve not calculated the fees associated with either buying and selling the physical metal, or else the fees of the ETF. On the flip side, where $5,000 controls 100 ounces of silver instead of 2, the same $10 price hike is worth $1,000 to the gold commodity investment using futures. Whereas the gold bullion or the ETF yields 0.8%, the gold futures yield a full 20%!
Gold Commodity Liquidity Is Very High
Gold commodity plays through futures benefit from liquid, efficient markets. There are a large number of people participating in the gold futures market. On top of that, and the huge volume, keep in mind that the vast majority of the futures contracts are traded electronically. To make matters better, all of the transactions are completely transparent. Not only are the transactions made public, but the bid and ask figures are also publicly disclosed in real time. This transparent price discovery not only draws participants, but also in turn adds liquidity. The bid-ask spreads tend to be quite small as well, which is a huge plus.
Gold Commodity And The Tracking Error Of Competing Products
Investments using COMEX futures are excellent at minimizing so-called tracking errors. In essence, this gets at the fact that gold ETF investments come with notable costs and fees that have to do with management of the fund. So, these are in addition to any brokerage transaction fees and redemption type fees. There can also be taxes, in which case futures may be tax beneficial for some investors. Some of these costs are not always transparent, but the consequence is that the ETF will not track the price of gold as accurately as it could.
This may seem insignificant, but a brief elaboration will put things in perspective. It’s important to keep in mind that gold is not an income producing asset. As the ultimate store of value and way to preserve, if not grow, wealth, gold bullion yields no interest. This places a burden on gold ETF funds managers, who end up having to cover the administrative expenses somehow. All of the management fees, marketing fees, and other expenses get paid through the sale of gold.
This presents a contradictory solution to the cost problem, as the very asset being hoarded is the same asset being depleted in the name of fees, and this is a foreign concept to gold commodity contracts. Ironically, the seemingly simple process of liquidating gold for the purpose of covering costs can itself produce transaction costs. So even the solution carries cost inefficiency. Selling gold to pay ETF expenses strips the ETF of the very metal it aims to hold, and necessarily takes away from the value of the fund over time. This, in the nutshell, is the tracking error. After all, the fund was established to “track” the price of gold. Gold commodity investments lack that limitation.
