Gold as investors’ instrument.

InstaForex company suggests you to get acquainted with one of the most stable and effective instruments of capital saving. Nowadays almost every interested person can get an access to the world gold market and invest his funds to this precious metal. Moreover, gold may be not only as dead weight but also percentage deposit. You may use gold in forward transactions, which gave considerable profit. It is very effective to invest in gold in the period of crises, when other investment instruments can not give the same result.

Gold is the oldest and most effective measure of capital and wealth dimension. Other precious metals were used for the same purposes. Generations were replacing each other and gold was as measure equivalent and at one and the same time payment facility and commodity for everybody. System of "gold standard" made a great influence on world economy development in XIX–XX centuries. National borders receded in the face of gold and it served as the main world currency system till 70s XX century, due to this operations with precious metals were under strict control. Mostly all transactions were made on the level of states’ monetary authorities and international financial organizations.

However, as a result of contradictions within the system, qualitative changes took place and currency rates became floating. As consequence, gold’s role was changed; legally it was excluded from the world currency turnover. Liberalization of gold deals began; rights of individuals to physically possession of metals were widened. Market of precious metals was transformed, not only market structure was changed but also its members and spectrum of transactions. Nowadays gold is not more payment facility, however it has not left the system of economic relationship. Today world gold market corresponds combination of internal and international markets, which are slightly subjected to governmental regulation. All this guarantees 24 hours global trading not only by precious metals but also their derivative instruments.

Demand structure at world market of gold may be nominally divided into 3 sectors: hoarding at all levels, industrial and domestic consumption, speculative operations. Offer consists of precious metals, private and government reserves, processing of secondary raw materials (gold) and illegal traffic.

The main resources of offers are gold producers, main buyers who use it for industrial purposes. Both appear at the market irregularly due to different factors. However, we will touch upon lifts and recessions in the market of precious metals later.

Gold markets

International gold markets are located in such cities as Zurich, Hong–Kong, London, New–York, Dubai. High demands are made to a few number of the international market participants. They are usually big banks and specialized companies, which have good reputation and credit standing.

Spectrum of transactions at the international market is rather wide. There are no taxes and custom control. Huge transactions with precious metals are held 24–hours a day, which give extensive clients’ network. All rules are made by market participants.

Internal gold markets are markets of one or several countries mostly focused on local investors. They are divided into free and regulated. Free markets are mostly all European markets, for instance, in Milan, Paris, Amsterdam, Frankfurt–on–Main. Regulated markets are mostly of the Third World countries. In internal markets deals are mostly made with small bars and coins, means of payment – native currency.

Black markets are some markets at Asian continent. Their existence is connected with great government limits on transactions with gold. Black markets live in parallel with closed ones. Closed market is the form of internal markets with radical organization, where gold import and export are forbidden and because of taxes precious metals’ trading is not really profitable.

Participants of gold markets.

Gold–workers

Mostly primary gold enter the market from gold producers. These are small enterprises or big corporations. Companies’ influence on the market depends on the quantity of gold supplies.

Industry

Industrial and jewelery enterprises, as well as companies which deal with refining (clearing of gold).

Stocks

In some countries there are special sections at stocks which are busy particularly with precious metals.

Investors

Investors have different interests at the market and this lead to the investment in different forms. The most popular instrument for investors is contracts for difference (CFD).

Banking sector

National banks are the hugest operators at gold market, they make rules. It should be mentioned, that active sales of reserve gold are not their main goal but they demonstrate interest in active usage of reserves. National banks have big influence on the market climate which became especially noticeable in the 90s of the XX century.

Intermediary and dealers

Professional intermediaries and dealers on the gold markets are specialized companies and commercial banks. They play one of the leading part because almost all the gold firstly goes to their hands.

Physical metal market

The largest amount of operations with physical gold is carrying out in London and Zurich. Firstly predominant part of all gold trading was carried out in London, which was promoted by metal delivery from the Commonwealth Nations (mostly Republic of South Africa). They were attracted by the skilful organization of precious metals trading. Gold transferred from London to continental Europe and from there forward to the Middle East.

Spot market

Current transactions of buying and selling are executed on terms of "spot" with the value date (date of entry/ charging–off of metal and currency) on the second day after the day of settle a deal. International market of current transactions is known as spot market. Standard lot volume on terms of "spot" is 5 thousands of troy ounce (Troy ounce is generally accepted measure of weight of precious metals. Contain 31,1034807 gr.).

Aims of such operations executing are forming of precious metals fund belonging to lending agencies and processing of clients’ requests. Starting point of physical gold price settings detection is the price of the London market, Loco London ("loco" means the place of metal delivery. It is the most important condition for operations with precious metals).

"Swap" operations

This term is frequently used in economic literature. Concerning gold market it can be explained as buying and selling of metal and contrary operations executing at the same time. Such transactions’ volumes are larger than "spot" transactions volume because gold swap does not have such influence on precious metals market like "spot" operations. Standard operation includes 32 thousands ounce (1 ton). It is divided into three types in practice:

Swap by time (financial swap)

It is classical type of swap operations. It is a combination of available and fixed–date opposite transactions: buying (selling) of one and the same metal amount on conditions of "swap" and selling (buying) on conditions of "forward". Date of the closest operation’s execution is named "date of valuation" and further date of operation’s executing is date of swap ending. Agreement can be concluded for any period of time: from 1 day to several months. Usual dates of swap agreement is considered 1, 3, 6 months and 1 year. The essence of operations consists in possibility of conversion gold into currency with keeping the right of buyback gold after swap expiration. Before the contract expiration parties can come to an agreement about prolongation of the contract or eliminate the swap making opposite calculations.

Last time swap operations becomes more popular. First of all benefit from attraction of financial resources is obvious in comparison with US Dollars deposits’ attraction because rates of interest for swaps are lower. Moreover the possibility of smooth gold attraction which can be used for remains of metal accounts managing by banks, for example. In the end, these operations are very popular among central banks. If they want to convert their own gold reserves they can be sure that their activity will not seriously influence on gold market; instead of direct selling on the market gold is moving between contra agents.

Swap by metal quality

In actual practice the situation can appear when market participant needs gold of higher pureness than he has. This wish can be met using swap by metal quality. Such swap provides buying (selling) of one quality metal and against selling (buying) gold of another quality at the same time. At the same time the party which is selling metal of higher quality receives award which depends on deal’s volume and risk connected with substitution of one type of gold for another.

Swap by place

Such swap provides buying (selling) of gold at one place against selling (buying) of it at another place. One of the parties receives award because gold can be more expensive at one place.

Deposit operations

Gold can return interest in case if it is an object of lend because it is financial asset. These operations are executing when it is necessary to attract the metal in the account or enter it there for definite period of time. Gold deposit rates is usually lower than currency rates, which can be explained by high currency liquidity. Standard deposit periods are 1, 2, 3, 6 and 12 months but they can be changed.

Bank attracting precious metals in the network of deposit contracts can use it for making profit during exact period of time, for instance, financing gold–mining or for arbitrage operations, etc. Owners of gold get income from invested gold and avoid expenses for physical metal storage.

Forwards

Except of listed above operations on the world market other operations can be executed: forward deals which provides for real metal delivery at the day that is more than two working days. Making such deal buyer is ensuring himself/herself from gold price increase on the spot market in future. Insurance is secured by make the price which will be mutual settlement executed for fixed. However such deal does not give possibility of usage more auspicious conjuncture.

Forward cannot be canceled. It can be only balanced (close forward position) by buying and selling of stipulated by the deal amount of metal for current price with future selling it for price stipulated by the forward contract. Such transactions are concluded frequently on gold Interbank market. If selling of metal for exact period is necessary seller work it off under conditions of spot and then makes a swap deal: buy metal on conditions of spot and sell it on conditions of forward at the same time.

Transactions with CFD

We were considering physical metal markets’ organization and functioning before. However other part connected with trading with virtual instruments arouses interest.

Among the events that changed the world financial markets not many of them had such influence like CFD introduction. Due 70–s era of unprecedented percentage and currency rates changing aroused need in new financial instruments which could be used for increased risks management. Prosperity of derivative financial instruments industry is connected with its possibility of fast and effective reacting on changing tendencies on the market. Eventually virtual section of the gold market became independent field with huge turnover which were bigger than turnover of physical market turnover in many times.

Another popular form of futures is gold option, introduced in 1976 and widely spread in 1982 after their executing in the USA.

Option is a fixed term contract, which enables the client to buy call option or to sell put option of a certain standard amount of goods by a fixed price on the exact date ( European option ) or during the all specified period of time ( American option ). The writer of the option sells the right to the counterpart to execute the transaction or cancel the deal. The buyer of the option fees for this right to the writer option money. The buyer has the right to exercise an option at a fixed price the price of exercising the option. Therefore, the active part in the transactions with the options is the buyer, because only this person makes decision on fulfillment of conditions of the option contract.

Option transactions are often used for hedging. So, if the investor hedges his/ her risks from increasing in the price of gold, he/ she will be able to buy call option or sell put option; if the investor hedges his/ her risks from lowering of prices, he/ she will be able to sell call option or buy put option.

Compared with other instruments of hedging, the option is attractive, because, besides the fixing prices of fulfillment, in order to protect from adversing changes in market conditions, it gives the opportunity to take an advantage of favorable conditions. In addition, options promote the development of speculative operations. The maximum size of losses of option’s buyer is limited by the paid bonus, the gains are potentially unlimited. Consequently, the situation for the writer of the option is vice verse.

The options can be involved in over the counter market. Such options are called dealer’s options. Their difference is that they are not emitted by an exchange market, but an actual legal personality, whom guarantees the execution of the option. Upon that, dealers’ options can be divided into two groups:

*
Options for selling in the retail market to meet the private speculative demand. Initially, getting such options was associated with increased risk, because in the second half of the 70–s in the USA there were a lot of cases of fraudulent practices with options, because of high market volatility. The reaction of authorities was to put in the new requirements to the organization of trading with dealers’ options. Particularly, it was foreseen to deposit the gold in the custodian bank and the option bonus for the dealer before the execution of the option or after the expiration of validity.

*
Gold trading options. The subjects of the deals are gold mines, industrial customers and major dealers. Deals with such kind of options are different for large volumes and more continued period of validity. The purpose of such options is to smooth the price risk of producers and consumers of metal, in other words, it is not the speculative motive, but the hedging of participants of the process.

Unlike stock options, which are characterized by possible transparency of information, concerning its key measures, dealers options are sold either directly or through a dealer network. Whatever, all the deals with options must be accompanied by a rendering of appropriate accounts, which ensures that the terms of an option contract will be proceeded and to reduce participants’ risks. The volumes of trading by futures and options (paper gold) are frequently exceeded the speed of buying and selling of the yellow metal (the last one amounts only a few percent). At the same time, being the second to the economic meaning of physical gold market, industry of derivatives have recently had a huge impact on the underlying asset price dynamics, because of the superiority of multiple volumes. The participants of stock deals with the gold are interested in the high market volatility, because it makes the opportunities to maximize the profit. These actions of speculators often sharply increase the movement of the market. Hence the fantastic rise of gold price in 1980 and its rapid drop in 1997 – 1999.

Gold price fluctuation

As a rule gold price depends on worldwide economic situation. Moreover gold price was always indicator of effectiveness or unprofitably of alternative investment instruments. Gold depreciated in the period of funds turnover and extensive use of different instruments of capital increase. On the contrary in case of economy stagnation, its rollback or recession, gold seemed to be the most stable and liquid instrument of capital fixation and its future saving. Here analogy can be drawn to currency exchange market and gold can be compared to Swiss frank which is considered as a buffer where volatility can be waited over.

In other words when "bulls" are ruled on the market, consumption is rising and pull all the economic sectors then gold pales into insignificance. But it is temporary....

However not all economic fluctuations have a global worldwide character. For instance, we can take into consideration two crisis situations: one of them happened in Russia in 1988; the second one takes place at the moment and reflects on the whole world community.

In august 1998 Russia was going through the difficult period: state treasury bills depreciation, oil crisis, and following ruble devaluation hit everybody. That time Russians trying to save their capital bought almost all gold in banks and did not regret. Since august 1998 price of one ounce of gold has increased in three times. Even with a glance of 20 % VAT which was taken off that time gold justified investors’ hopes. However that time physical bodies were able to buy gold only in Russian banks. Meanwhile price of one ounce of gold formed on the internal market, and price of gold was higher than on the world market because of limitedness of providers and high demand within Russia. Now there are possibilities for Russians regardless of crisis locality to buy gold on the world open market. It became possible not only because of financial and stock institutes’ development in Russia, but because of huge amount of brokers appearance which provide an opportunity of entrance the international markets.

Concerning current crisis, its picture has fundamental features. It not only runs through the economy structure of different countries but provokes the recession. That is why buying of gold is being considered as one of the safest way of capital saving. Last year gold quotations overcame the level of 1000 USD. Prices of other precious metals are near the maximum prices. For the first time in last 30 years silver approached 21 USD for 1 ounce. Platinum and palladium rose in price till 2273 USD and 582 USD, respectively. However then price of precious metal increased. But this increase did not concern gold. Moreover in spite of decline of production and as a result gold demand among the companies, gold keeps high price due to speculative and capital–saving character.

Other factors have influence upon gold price. For example, US Dollar and oil price. Meanwhile gold value movement is inverse relation with US Dollar and direct relation with oil value dynamic. It is declared that when currency exchange market volatility and US Dollar rate decrease, gold appears to be alternative investment harbor. While the price of one barrel of oil increases gold is the mean of petrodollars accumulation.