When it comes to managing risk, gold has been a tried-and-true insurance policy for the bulk of human history. For producers, speculators, and buy-and-hold investors, gold is an asset rarely ignored.
Perhaps gold’s strongest attribute is its versatility. Aside from being held in the physical form, it is readily tradable via standardized futures and options contracts. If you’re looking for a way of limiting your exposure to risks far and wide, the world’s ultimate safe-haven asset may be a suitable alternative.
Hedging Risk with Gold
Gold and gold-based assets are frequently sought by investors seeking protection from both sectoral and systemic risks. This is accomplished through the implementation of a vast array of hedging strategies, each specifically designed to compliment a unique portfolio or business operation.
Here are a few of the more common ways that traders and investors utilize gold as a financial safe-haven:
- Physical: Stockpiling golden bars, jewelry, or coins for emergency bartering power is a time-honored practice.
- Corporate stocks: Capital investment in mining or refining companies is a common way of capitalizing on periodic gold appreciation. This is similar to other commodity stock buying strategies in that the value of the company is likely to rise in concert with the underlying commodity.
- ETFs: Exchange Traded Funds (ETFs) offer traders a mode of engaging the gold markets through a professionally managed and liquid security.
- Futures: Gold futures contracts furnish participants with an opportunity to address the asset’s value at a forthcoming point in time. Gold futures may be used to lock in profits from both bearish and bullish value fluctuations, or to take physical delivery of the metal.
- Options: Similar to futures, options contracts allow traders to realize gains from accurate projections regarding gold’s value at some future point in time. In addition, advanced strategies such as straddles and strangles offer exclusive opportunities.
Although each of these listed assets benefit from the positive attributes of gold, they do so in very different ways. For example, a portfolio that incorporates mining stocks or bullion ETFs is designed to benefit from positive gains in the assets themselves, not necessarily from a bump in gold pricing. This is an important distinction to make, because each portfolio requires varying degrees of gold exposure in order to optimize a hedge’s strategic functionality.
Hedging with Gold: Futures and Options vs. Hard Assets
In comparison to holding bullion, buying stock, or trading ETF products, futures and options offer several unique advantages to traders. Here are a few of the largest:
- Flexibility: One of the premier benefits of futures and options contracts is their inherent flexibility. A trader can realize profits from both long or short positions, opening the door to a variety of hedging strategies.
- Liquidity: Futures and options are readily convertible to cash on a near 24/5 basis. This is not the case for physical bullion, stocks, or ETF products. Waiting periods, trade restrictions, and even the availability of a certified gold dealer are all considerations that must be made when dealing in these assets.
- Leverage: In comparison to futures and options, the availability of leverage is limited in the other gold assets. Often, a greater capital allocation is required to achieve the same hedging objectives.
- Price correlation: Stocks and ETFs are traded on exchanges independent of gold, thus their values do not track with 100% accuracy. While there are discrepancies between spot and derivatives markets, gold is the underlying asset and dictator of value for futures and options contracts.
- Low fees: Commissions and fees are relatively low with futures and options. ETFs feature a management expense ratio, physical gold buyers often charge a service fee, and stock commissions can be extensive.
It’s difficult to rival the flexibility, liquidity, and cost effectiveness of hedging with gold futures or options. When executed within the context of a comprehensive trading plan, these products can be invaluable to active traders or long-term investors interested in hedging unwarranted risk.
Getting Started with Gold
Precious metals are unique assets ― values depend upon many factors, including current geopolitics, international finance, and global scarcity. Simply put, staying on top of the gold market is a full-time job.
If you’re in the process of developing your own golden hedging plan, the advice of an expert can help. For more information on how to actively manage your portfolio’s risk exposure with gold futures and options, talk with an industry professional at Daniels Trading today.