Whether it’s behaving like a bull or a bear, the gold market offers high liquidity and excellent opportunities to profit in nearly all environments due to its unique position within the world’s economic and political systems. While many folks choose to own the metal outright, speculating through the futures, equity, and options markets offers incredible leverage with measured risk.
Market participants often fail to take full advantage of gold price fluctuations because they haven’t learned the unique characteristics of world gold markets or the hidden pitfalls that can rob profits. In addition, not all investment vehicles are created equally: Some gold instruments are more likely to produce consistent bottom-line results than others.
Trading the yellow metal isn’t hard to learn, but the activity requires skill sets unique to this commodity. Novices should tread lightly, but seasoned investors will benefit by incorporating these four strategic steps into their daily trading routines, experimenting until the intricacies of these complex markets become secondhand.
- If you want to start trading gold or add it to your long-term investment portfolio, we provide four easy steps to get started.
- First, understand the fundamentals that drive the price of gold, get a long-term perspective on gold price action, and then get a handle on some market psychology.
- Once all that is done, choose the best way to acquire gold—either directly in physical form or indirectly through futures or a gold exchange-traded fund (ETF) or mutual fund.
1. What Moves Gold?
As one of the oldest currencies on the planet, gold has embedded itself deeply into the psyche of the financial world. Nearly everyone has an opinion about the yellow metal, but gold itself reacts only to a limited number of price catalysts. Each of these forces splits down the middle in a polarity that affects sentiment, volume, and trend intensity:
- Inflation and deflation
- Greed and fear
- Supply and demand
Market players face elevated risk if they trade gold in reaction to one of these polarities when in fact it’s another one controlling price action. For example, say a sell-off hits world financial markets, and gold takes off in a strong rally. Many traders assume that fear is moving the yellow metal and jump in, believing that the emotional crowd will blindly carry the price higher. However, inflation may have actually triggered the stock market’s decline, attracting a more technical crowd that will sell against the gold rally aggressively.
Combinations of these forces are always in play in world markets, establishing long-term themes that track equally long uptrends and downtrends. For example, the Federal Open Market Committee (FOMC) economic stimulus, started in 2008, initially had little effect on gold because market players were focused on high fear levels coming out of the 2008 economic collapse. However, this quantitative easing encouraged deflation, setting up the gold market and other commodity groups for a major reversal.
That turnaround didn’t happen immediately because a reflation bid was under way, with depressed financial and commodity-based assets spiraling back toward historical means. Gold finally topped out and turned lower in 2011 after reflation was completed and central banks intensified their quantitative easing policies. The Cboe Volatility Index (VIX) eased to lower levels at the same time, signaling that fear was no longer a significant market mover.
2. Understand the Crowd
Gold attracts numerous crowds with diverse and often opposing interests. Gold bugs stand at the top of the heap, collecting physical bullion and allocating an outsized portion of family assets to gold equities, options, and futures. These are long-term players, rarely dissuaded by downtrends, who eventually shake out less ideological players. In addition, retail participants comprise nearly the entire population of gold bugs, with few funds devoted entirely to the long side of the precious metal.
Gold bugs add enormous liquidity while keeping a floor under futures and gold stocks because they provide a continuous supply of buying interest at lower prices. They also serve the contrary purpose of providing efficient entry for short sellers, especially in emotional markets when one of the three primary forces polarizes in favor of strong buying pressure.
In addition, gold attracts enormous hedging activity by institutional investors who buy and sell in combination with currencies and bonds in bilateral strategies known as risk-on and risk-off. Funds create baskets of instruments matching growth (risk-on) and safety (risk-off), trading these combinations through lightning-fast algorithms.
3. Read the Long-Term Chart
Take time to learn the gold chart inside and out, starting with a long-term history that goes back at least 100 years. In addition to carving out trends that persisted for decades, the metal has also trickled lower for incredibly long periods, denying profits to gold bugs. From a strategic standpoint, this analysis identifies price levels that need to be watched if and when the yellow metal returns to test them.
Gold’s recent history shows little movement until the 1970s, when, following the removal of the gold standard for the dollar, it took off in a long uptrend, underpinned by rising inflation due to skyrocketing crude oil prices. After topping out at $2,420 an ounce in February 1980, it turned lower near $800 in the mid-1980s, in reaction to restrictive Federal Reserve monetary policy.
The subsequent downtrend lasted into the late 1990s, when gold entered the historic uptrend that culminated in the February 2012 top of $2,235 an ounce. Gold prices then began a steady decline that lasted for several years, bottoming out around $1,330 in November 2015. The metal traded sideways for a few years before beginning to climb again, breaking through the $2,000 milestone again during the COVID-19 pandemic in 2020.
More recently, although inflation jumped to elevated levels in 2022, the price of gold ticked downward for most of the year, returning to lows around $1,630 in October. With inflation remaining persistent despite the Fed’s attempts to rein in price increases and market participants concerned about a looming recession, gold prices began to recover toward the end of 2022. As of January 2023, the metal trades at more than $1,900 per ounce.
4. Choose Your Venue
Liquidity follows gold trends, increasing when gold is moving sharply higher or lower and decreasing during relatively quiet periods. This oscillation affects the futures markets to a greater degree than it does equity markets, due to much lower average participation rates. New products offered by Chicago’s CME Group in recent years haven’t improved this equation substantially.
CME offers three primary gold futures: the 100-ounce contract, a 50-ounce mini contract, and a 10-ounce micro contract, added in October 2010. While the micro contract’s volume was over 6.6 million in 2021, the other contracts were not as widely traded, with volume of over 26,000 for the mini and 1.2 million for the largest.
This thin participation doesn’t affect long-dated futures held for months but has a strong impact on trade execution in short-term positions, forcing higher costs through slippage.
SPDR Gold Shares (GLD) shows the greatest participation in all types of market environments, with exceptionally tight spreads that can drop to one penny. Average daily volume stood at 5.4 million shares per day in January 2023, offering easy access at any time of day. The Cboe Gold ETF Volatility Index tracks options on GLD, offering another liquid alternative with active participation keeping spreads at low levels.
The VanEck Gold Miners ETF (GDX) grinds through greater daily percentage movement than GLD but carries a higher risk because correlation with the yellow metal can vary greatly from day to day. Large mining companies hedge aggressively against price fluctuations, lowering the impact of spot and futures prices, while operations may hold significant assets in other natural resources, including silver and iron.
What is the best way to invest in gold?
The best investment vehicle for gaining exposure to gold depends on your specific goals. Investors can purchase the precious metal directly in physical form, such as bullion or coins, although there may be costs associated with storing and insuring physical gold. It’s also possible to invest in gold through the futures and options markets. Many investors turn to mutual funds and exchange-traded funds (ETFs) such as SPDR Gold Shares (GLD). Finally, shares of mining companies offer another type of exposure to gold, although the correlation between mining stock prices and the performance of gold may vary.
What affects the price of gold?
While gold is known for maintaining its value over the long term, there are several factors that affect its short-term price performance. Supply and demand, as well as investor behavior, can have an impact on the price of the metal. On the supply side, changes in production levels by mining companies can affect how much gold is available on the market. In terms of demand, in addition to jewelry and technological uses, purchases by central banks that use gold as reserves are an important contributor. Demand for gold by investors is also critical, and since the metal is used as a hedge against inflation and intertwined with the value of the dollar, these considerations also affect gold demand. Traders hoping to capitalize on price movements in the precious-metals market should be aware of all these factors.
What are gold futures and options?
A gold futures contract is a legally binding agreement for delivery of the metal at an agreed-upon price in the future. Meanwhile, a gold options contract secures the right—but not the obligation—to buy or sell the metal at a specific price before the contract’s expiration date. Compared with trading physical gold, these derivatives allow for increased leverage, making it possible to earn greater returns on a smaller amount of capital invested. However, this also means increased risk. Given the potential for significant losses, gold futures and options are best suited for experienced traders.
The Bottom Line
Trade the gold market profitably in four steps. First, learn how three polarities impact the majority of gold buying and selling decisions. Second, familiarize yourself with the diverse crowds that focus on gold trading, hedging, and ownership. Third, take time to analyze the long- and short-term gold charts, with an eye on key price levels that may come into play. Finally, choose your venue for risk taking, focused on high liquidity and easy trade execution.