Gold is the most recognized precious metal and serves a purpose well beyond its role as fine jewelry. Prior to the 1971 gold was a global benchmark as the worlds currency, as the Bretton Woods agreement required that many developed countries adhere to a fixed exchange rate where their curries were tied to gold prices. Gold continues to trade actively in the global capital markets, allowing traders to speculate on the direction of gold prices. There are numerous way individuals can invest in gold, including purchasing physical gold, trading it in the retail over the counter market, as well as using futures contracts and exchange traded funds.
In 1944, The Bretton Woods system was introduced generating financial relationships between the United States, Western Europe, Japan, Australia and Canada. The Bretton-Woods Agreement focus was the obligation of member nations to peg their currencies to gold prices. Additionally, central banks adopted monetary policy that was geared toward making sure their currency fluctuation was minimal.
In the summer of 1971, the United States terminated its participation in the Bretton Woods agreement, allowing the US dollar to float against all currencies. President Richard Nixon shocked the global financial community with this action, which eventually allowed allow major currencies to become free floating.
Gold began to trade activity in the 1980’s as futures prices were introduced, making gold a more liquid tradable product. The futures market sparked an active over the counter market which allows producers to hedge future gold exposure. In the past 10-years, gold trading volume has exploded with the introduction of retail foreign exchange trading and exchange traded funds.
How to Trade Gold
Gold is activity traded in many arenas, including institutional over the counter (OTC) trading, retail trading, bullion trading, futures trading and ETF trading. Generally large financial institutions, hedge funds and gold producers participate in trading in the over the counter market. Players in this arena are generally interested in trading forward contracts on gold which allows them to hold positions for multiple days, weeks, months or even years.
Gold trades like a currency pair, in that its quoted against the US dollar. When you purchase or short gold for a period longer than 2-days (spot market), you either pay away interest or receive interest depending on whether gold interest rates are higher or lower than U.S. interest rates. For example, if you purchase gold in the OTC market, and gold interest rates are lower than U.S. interest rates, you will pay the difference for every day you hold your position.
Gold futures trading is very liquid allowing traders to enter and exit throughout the day, 24-hours a day, 5-days a week. Gold futures allow you to speculate on gold prices based on a future delivery date as some point in the future. Gold futures provide leverage, which allows you to borrow money to enhance your position size. This means that a money that you use to purchase or short gold can be increased with borrowed capital. Futures trade on an exchange and are generally regulated by the government of their domicile.
Gold also trades actively in the forex broker market. Forex brokers offer gold as a tradable instrument using an over the counter method where you are speculating on the direction of a specific gold benchmark. Forex brokers generally offer significant leveraging, in some cases up to 200;1. This means for every dollar that you use to purchase gold, you can borrow $200 to purchase more gold. You should perform due diligence before you place your money with a forex broker. While there are many forex brokers that are tightly regulated, there are some that are loosely regulated which could generate some concern.
Gold ETFs are also excellent ways to speculate on the direction of gold. Gold ETFs are trusts that hold gold products such as futures and OTC products. Gold ETFs are regulated by government entities and are a secure was to invent in gold.
Lastly, you can always purchase gold bullion. You can purchase physical gold and hold it in a safe or at your home. The most secure way is to hold it at a bank or depository. Here your gold can be held separately or commingled. When it is held in a commingled account you are purchasing top notch certified gold that is interchangeable.
From the mid-1990s to 2012, gold experienced a historic rise, but since 2014, prices have remained rangebound capped near 1,375, and floored near 1,050. All diversified portfolios should own some gold, as while it is not longer than global currency benchmark, it is still viewed as a safe-haven asset.