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The Cost of Physical Gold vs. Futures
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The Cost of Physical Gold vs. Futures
Written by Keith Weiner (Click For Original)
Suppose you plan to buy gold, hold it 10 years, and sell it at the end. Is it more cost-effective to buy physical metal, store it, and sell it at the end? Or are you better off buying futures?
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It’s easy to calculate the cost of physical metal. If you buy at $4 over spot, that’s about 35 basis points (bps). You will also pay for storage an insurance, say 30 bps per year. In 10 years, you sell it at the spot price. Your total cost is about 3.3%. If you started with enough to dollars to buy 400oz of gold, then at the end you would have dollars equal to about 386.8oz at the then-current price of gold.
Futures contracts are more complicated. When you buy, there is almost no premium (10 or 20 cents). However, there is a commission of around $0.25 an ounce. So initially, you get more gold.
See the graph above, zoomed in to show the small difference in cost between the two approaches to holding gold for 10 years and then selling it.
However, the cost of holding the position is greater. This is because the price of longer-dated contracts is higher—called contango. Contango represents the majority of your cost if you hold for a long period of time like 10 years.
There’s a simple reason why contango is normal in the gold market. Contrary to popular belief, the typical seller of a gold contract is not betting on a falling gold price. He is an arbitrageur. He is earning a small spread between the price of gold in the spot market and the price in the futures market. He simultaneously buys metal and sells a contract, storing the gold in the meantime. This is called carrying gold. The cost of carry is mostly interest expense. So generally, the price of a future should be above the price of spot by the amount of this interest.
Not too long ago, the contango in gold was about 80 bps. It’s now about 25 bps (which suggests the market has become tight, but that’s a whole separate discussion). This is your cost to hold futures contracts.
For example, a gold contract for Dec 2016 delivery is a little over a year until maturity. Instead of paying spot—say $1,135—you will pay about $4 over spot.
Unfortunately, when December 2016 comes around, you will have to sell the contract and buy another one that’s farther out—called rolling the contract. Rolling costs you another commission.
Also, that premium you paid will have wasted away. When it comes time to sell, you will be lucky to get the spot price. That’s because in our new normal world, gold futures tend to go into backwardation as they approach expiration. Backwardation, the opposite of contango, is when a futures contract trades below the spot price. Selling a backwardated contract costs you more—about 80 cents for the December 2015 contract right now.
Currently, you’re looking at a loss of about $5 when you roll a contract forward one year. To hold futures for 10 years, you have to do this 9 times. Assuming the costs remain the same (they won’t), you will have about a 4.4% loss by the end. To exit your position, you simply sell the last contract but don’t buy the next year.
You end up with a total dollar amount worth about 382.6oz of gold. Remember from above, with gold bars, it’s about 386.8oz. It’s pretty close at the moment, though futures come out behind. And this is with futures being a lot cheaper than normal (due to the tightness I mentioned above). If the market corrects this condition, the cost of using futures could go a lot higher.
There are more complex ways to play with futures. If you’re sophisticated and have a bit of luck, you could end holding your gold exposure at zero or even make a profit. However, this approach is not for most people.
There is one other advantage to physical metal over futures. Futures have counterparty risk. You are extending credit. For a short time frame, I wouldn’t worry about it too much. However for a 10-year period, there is a risk that gold could go into permanent backwardation . In that case, futures contracts could become worthless.
Please email with any questions about this article or precious metals HERE
Author - Keith Weiner is CEO of Monetary Metals, a precious metals fund company in Scottsdale, Arizona. He is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. He is founder of DiamondWare, a software company sold to Nortel in 2008, and he currently serves as president of the Gold Standard Institute USA.
Weiner attended university at Rensselaer Polytechnic Institute, and earned his PhD at the New Austrian School of Economics. He blogs about gold and the dollar, and his articles appear on Zero Hedge, Kitco, and other leading sites. As a leading authority and advocate for rational monetary policy, he has appeared on financial television, The Peter Schiff Show and as a speaker at FreedomFest. He lives with his wife near Phoenix, Arizona.
Sprott Money - Established in February 2008, Sprott Money Ltd. is a leading precious metals wholesale, institutional and retail dealer selling gold, silver and platinum bars, coins and wafers online and over the phone.
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Paper gold - whether futures or not - puts your money in the hands of the bad guys. Can they be trusted to redeem the notes when you want? Holding the actual metal is also fraught with risk. An ounce of lead in the right place can always get you a ton of gold. A difficult decision.
Venezuela has gold they could dig out of the ground to create money.......it is all a game! All global gold and silver, shovel ready projects are on hold currently pending environmental permits..........
When they opened up King Tut's Tomb they found papyrus contracts for a million pieces of gold and silver, the excited archaeologists all split them up and took off for parts unknown with their newfound wealth..
Not.
Promissory paper will be worthless sooner or later.
But it is oh so helpful in suppressing the price of the physical metal such that the rabble do not become alarmed...... so far.
I have spent a lot of time on spreadsheets and analysis etc on this very topic... and i have come to one simple conclusion... if you dont hold physical gold "carry" you are toast!! It matters not whether you own Tonnes, Kilo's or Grams of the stuff.. so long as you physically have possession.
Personally I help ordinary people try accumulate a few grams per month by using the Karatbars International model.. it works and it's both tremendously satisfying knowing you and your friends/clients/customers hold the bullion, and tremendously lucrative.
www.teamramgold.com/about-us use your knowledge to help those less enlightened
That you make a lot of money from people buying what you are advertising has NOTHING to do with anything, correct?
Tail wagging the dog.
It would be more interesting to analyse the effect huge futures have on the underlying asset.
At what point do the gold futures have more importance on the price than the underlying asset. I think that we are there and have been for a while.
The storage and insurance costs for gold at the bottom of a lake are minimal and .GOV will never find it.
-Venezuela May Sell 3 million Ounces of Gold
http://www.armstrongeconomics.com/archives/38505
"And as Pirrong points out, the central bank can pay for that gold...meaning that it can simply print the money to boost those reserves."
What a nasty game we're playing
Yeah well the Chinese can suck up those 3 million incredible ounces in about 2 weeks.
Paper Gold/Silver defeats the real purpose of owning Gold/Silver, because paper has 3rd party risk. Its complete B.S. Its only good for trading, which you can do with stocks. The idea "Paper" gold is even considered or used is an indication of how far from reality the markets really are. Anything that is not a 1:1 ratio with gold should be illegal. period. There is no point other than manipulation.
The worst of all is that even physical gold runs the risk of becoming "paper gold" if the Federal State is about to be bankrupt . In post-1929 deep crisis, President Roosevelt edicted the Citizens' Gold Confiscation Act (April 5th, 1933 ) , suddenly forbidding the owning of physical gold by the citizens, threatened of sanctions (jail and enormous fines) . The Americans had to give their physical gold to the State and received paper certificates instead . Roosevelt's CGCA is still valid in similar circumstances but everybody seems to forget History .
Funny how governments come and go like dust in the wind, but gold remains the same - shiny, incorruptable, constant, and valued.
That law was largely ignored by a good number of people. The Gov't did not go door to door looking for gold.
"largely" ignored by a "good number" ----- wha-huh does that mean?
Here's an article that tries to suggest something similar but ends up indicating the opposite - http://philipndiehl.com/2014/04/29/did-fdr-confiscate-americans-gold-in-...
In other words gold was seized, though most volunatrily turned it in. Of course, these people were 'compensated' with ever more to be inflated dollars (credit tokens) at about 21$ per oz, and then gov declared gold to be 35$ oz. but kept redeeming at the market price...... sigh. An oz of gold now buys, what, about 1000 of those little credit tokens, and the goods and services that such could trade for?
If you hold your gold in your own house or in a hole somewhere or some other location where gov officials can not with reasonable ease find it, then yes, you are probably right, the gov won't go get it. But if you try to move it, or (silly) put it in a bank and then try to withdraw it, or attempt to pay with it in other than completely private transactions, then, confiscation under such an executive order is likely.
Merci pour le lien http://philipndiehl.com/2014/04/29/did-fdr-confiscate-americans-gold-in-...
The flood of refugees will become the UN peacekeepers and they'll go door to door confiscating gold and guns.
Try to see less movies.
Paper gold is a serious alternative to owning an actual thing of value?
Who the fuck are they kidding?
(Except 99 percent of us)
Paper gold is a step ahead of a crypto currency, and I intend to create one of those for Zero Hedge fans...
I wonder if Sprott Money could help me create a gold fractional reserve for a Crypto Currency, and act as custodian and Trust working independently to ensure the Crypto Currency Coins could be redeemed for gold or cash, by any of the coin's holders, even if the entire coin team quit or otherwise left?
i will blog more about this here later, I think. http://zhc0.com
(insert non-GMO popcorn eating smiley here)
Sure. I have a brige in Brooklyn and some waterfront vacation property for sale as well.
All you will end up with is greed oriented digital fractional reserve banking in the end, and a bunch of bag holders getting fucked - that - is human nature.
Why ? There is no fractional reserve, no bank, no regulatory oversight, no assets, and no reality - just some electrons wiggling around making empty promises.
If it is not physical, in your hands, you don't own it.
Go, all of you, go, and worship at the digital Shit Coin altar.
See you on the other side of the trade.
15horses1donkey is a fucking Fonestar genius.
He gets 15 horses out of the deal - you get - one ass.