Tips for Spread Betting on Gold

Did you know that the letter 'G' in IG Index refers to gold? Indeed Gold was the first speculative product offered by IG Index when financial spread betting first emerged in 1974.
Betting on gold has always been popular due to the metal's inverse correlation with the dollar and equity markets. Gold is also one of the best known ways of playing weakness in the dollar as gold is regarded as a hedge against inflation. This is because a weak dollar is often linked to nervousness in the marketplace, especially about inflation.
Spread betting allows you to gain exposure to gold in sterling. This is important since gold is in itself priced in US$ dollars so even if you're right on the dollar falling in value, buying gold won't solve your problem since your profits will still be lower as they'll be paid to you in a currency that is depreciating. Spread betting solves this because with a spread bet, your holding will be in pounds sterling, from the open to closure of the bet. You deposit pounds in your spread bet account and receive any gains as sterling. Any currency fluctuations are irrelevant so trading gold in this way eliminates the exchange currency risk.

But more than that. Spread betting allows you the possibility to speculate on the future price of the metal without having to accept ownership. Remember gold in itself pays no interest or dividends unlike bonds and equities. In fact it actually costs money to hold it because there are storage and insurance costs to be paid.

One of the advantages of spread betting is that you can go short but remember that this also requires to be contrarian and look beyond the media headlines. In other words when the tabloids finally start highlighting the fact that US dollars are losing lots more purchasing power and 'Joe Sixpack' starts looking at investing in Gold it may be time to consider shorting it...
The other advantage of spread betting on gold instead of buying into an exchange traded fund, for instance, is leverage. In fact most spread betting providers allow a gearing of up to 40 times your stake (20 times if going for a gold futures contract) although this also increases the risk (hence the importance of guaranteed stop losses on trades).
Gold like any other currency is a 24-hour market so you can deal round the clock. Most spread betting firms offer a daily rolling bet on gold as well as a longer-term bet based on the two-month futures contract. Beware that the gold market is highly volatile.
The daily rolling bet allows you to take a short-term view of Gold and will mirror the gold spot price - plus a dealing spread of course. Spread betters can roll the position over into the next day although this will incur a small additional cost (aka financing charge).
Normal closing time for the Spot Gold and Spot Silver markets is 22.00 (London Time). It is important to note that with some providers daily bets expire without spread.
When a Spot metal bet is rolled over, the open bet expires at the official spot settlement price and a new bet is automatically opened for the next trading day at the settlement price plus or minus the provider's rollover spread (say at 0.02% of the price).
A spread bet on a gold futures contract is priced directly from the futures market, with the provider simply wrapping the spread around the quote. As with other commodities and index contracts this will differ from the spot price as it reflects the cost of carry over the remaining time to expiry. It is also important to appreciate that a spread bet on gold futures always expires the month before the futures contract itself settles. Usual margin requirement on a futures gold spread bet ranges from ten to around twenty times the per dollar stake which is about twice the margin required for a daily rolling contract.
The minimum bet size is usually £1 per dollar per ounce and some spread betting providers allow bets in USA dollars as well.
A key point to check is the tick size as providers such as Capital Spreads and City Index will use a tenth of a dollar/troy ounce, while at IG Index this is ten times larger. For instance, at Capital Spreads, gold trades are calculated at 0.1 (i.e. 10 cents move) per US dollar. In simple terms, this means that for every dollar you move, you would either make or lose 10 times your stake. So if you buy £8 worth of points and gold moves up $3 you would make £240 (£8 x 3 x 10).
At IG Index prices are quoted ten times larger. Suppose the current gold price is about $850 (gold is always quoted in US dollars per ounce). IG Index is quoting $880 by the end of September. You decide that it will rise further than this and put up a £100 stake on each point. Your total position is therefore 880 x £100 = £88,000. If at the end of September the gold price is $900 and your position is now worth 900 x £100 = £90,000 equivalent to a £2000 gain. Another way to compute this would be [20 points (i.e 900-880) at £100 each] = £2000 gain. What happened to the dollar is irrelevant. Gold gained 2.27% and you have made a profit of 2.27%.
Given the way that gold is traded it is important to understand your contract exposure; with gold trading at 850 an ounce a bet of £1 per point would represent an effective exposure of £8500 which would typically require an initial margin requirement of around 300. However, in practice you would need more cover as your stop needs to be sufficiently away to allow for the wide daily swings.
The spread for the Rolling Gold Daily is normally 5. This means that a £2 per point bet on Gold would be equivalent of 40 ounces of Gold as you are betting on the $0.10 move. The Gold April Future is currently showing a spread of 8 points.
Contango and Backwardation
The LME has an important peculiarity. The main quoted price for all LME metals is the so called 3-month price, a price for metal to be delivered on a particular date in roughly ninety days time. The 3-month price quoted on, say, 3 July, and the 3-month price quoted on, say, 17 July, a couple of weeks later, are thus prices for different settlement and delivery dates. (This is in contrast to the situation in other commodity futures markets; 'March Cocoa', for example, has the same settlement date whether you trade in December or in February).
This peculiarity has an important practical consequence when you bet on LME metals with a spread betting provider. Say, for example, you 'buy' 3-month copper. A week later the price rises and you decide to take your profit. You cannot close your position simply by 'selling' 3-month copper, because the 3-month date is now a different day. Instead you have to 'sell' copper for the same date for which you 'bought' it. The price for this date is not normally the same as the current 3-month price. It may be lower, if the market is in 'contango' (where the price for future delivery is higher than the spot price), or higher, if the market is in 'backwardation'. When metal is in short supply, backwardations can sometimes be very large. So you should be aware that it is possible to lose money on an LME bet even if the 3-month price has moved in your favour, or make money even if the 3-month price has moved against you.
If this sounds confusing consider contango like the fair value, in that fair value is basically the cost of carry. But, while fair value is more the arithmetic calculation of where the price should be, contango for instance is where it actually is. Let's take an example. The April Gold Future is trading at 922 but the Gold Spot price is at 922.8 so this is an example of backwardation. Normally a future is higher than the underlying spot price, ie Contango. However, the combination of lower US interest rates (so lower funding) and the April Gold contract being close to expiry (27th March so less funding days) has resulted in the backwardation price.
Although the average gold spread better has a much longer term than the average client and gold punters tend to take out bigger positions, spread betting is not really designed as a long term investment medium. Bets can be rolled forward from one expiry date to the next but this comes at a cost so spread betting on gold is best confined to situations where you believe that the short-term price is out of line with events. If taking a longer term view the best way to take a position would be to place a spread bet on the two-month Comex futures contract.
The Comex Gold contracts are traded in the pit from 1.20pm to 6.30pm (UK time) and afterwards they continue trading electronically from 7pm to 1pm the following day with the spread betting hours being about the same (meaning that you can trade Gold almost round-the-clock from Monday to Friday).
Gold is not the only metal available either - you can speculate on gold's poorer sister silver or copper or aluminium, uranium, platinum or palladium. However be wary that copper is hugely volatile (more risky) and it is also difficult to predict the price of aluminium (although aluminium is a very liquid market). It takes substantial energy to produce aluminium so prices tend to be stressed by the cost of energy.
Other ways to gain exposure to Gold include mining funds like BlackRock Gold & General; exchange traded funds such as iShares COMEX Gold Trust, ETFS Gold Bullion Securities (GBSS) or ETFS Physical Gold (PHGP) (this one is actually backed by physical gold in a vault) which track the actual price of gold or silver but trade like a stock on an exchange. One thing to keep in mind with ETFS is that they have built-in management fees so they represent gradually depleting assets - the fees are small in practice but they do add over time. If you had a bearish view you could also use an exchange traded instrument such as ETFS Short Gold (SBUL) to take a short gold position. Of course, you could also buy stocks and shares in gold mining companies and gold mining funds. In an inflationary period it is generally better to hold gold shares versus the physical gold as the gearing provided by gold shares makes the shares winners over the physical. A few gold mining stocks listed on AIM include Avocet Mining, Ariana Resources, Chaarat Resources, GGG Resources, Medusa Mining, European Goldfields, Highland Gold, Nyota Minerals and Shanta Gold. Gold stocks give you a little more leverage than owning the metal itself but this comes with more risk as they have the tendency to promise much more than they deliver. Owning stock in a company exposes you to their business practices, failure or success in finding new gold deposits...etc. In particular, beware of gold mining firms that have hedge positions (meaning they have sold gold in the futures markets, as they will NOT profit if the gold price goes up. Alternatively, if you wish to avoid company specific risk but still want exposure to gold, one ETF to consider would be the Junior Gold Miners ETF (GDXJ), which invests into 60 small-and medium-capitalization companies in the gold or silver mining industry, which tracks the share prices of companies based in the USA, Canada, Australia and the United Kingdom.
It may be wiser to buy the higher cost gold producers over the lower cost producers (no, not a mistake) because there is potentially more money to be made. This is best demonstrated by an example. If it costs a) $200 per ounce to mine and the gold price goes from $900-$1200 then that moves the margin from $700 per ounce to $1000 per ounce, an increase of 42%. If it costs miner b) $600 per ounce and there is a similar move in the gold price, margin moves from $300 to $600, a 100% increase. Scope therefore for a doubling of price. MML is a low cost producer. Vatakula (sp?) is a high cost producer.
Please note that both exchange traded funds and spread betting are primarily a speculatory tool. Exchange traded funds and spread betting are both good ways to speculate on the gold's spot price or to speculate or invest for the short term. However, it is important to understand that when buying a Gold ETF you do not directly own gold and you do not have an automatic right to take possession of your gold. This means that in the event of a 1929 style stock market crash or a global financial meltdown, banks and financial markets may be closed for a period of time and financial markets including exchange traded funds would become illiquid (as recently happened to some Exchange Traded Commodities (ETCs). It is also important to understand that ETF come with counter-party risks as well as liabilities and responsibilities of the market participants such as the auditors and custodians.

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Tips for Spread Betting on Gold