Knowing the terms

For an average person, the world of trade and markets can seem daunting, with unknown terms thrown around on a regular basis. The first step for any keen investor, be it an amateur or a professional is to know what they are getting into, to test the waters before they take a swim (in a way). Gold is no easy commodity to own, with prices digging deep into your wallet, but the returns are often worth the investment. Two commonly used terms when it comes to gold are spot gold and futures gold. So what does one imply when they use these terms? A simple definition can help you understand the finer nuances of trading in gold.

Spot Gold – As the term implies, spot gold refers to trade in which gold is purchased immediately, i.e. on the spot. The price is determined immediately and both the product and cash are interchanged almost instantly.

Futures Gold – Futures Gold refers to trade in which a transaction is executed on a particular date but the product delivery will take place only in the future, at an agreed upon day. Typically it means that you pay for the gold now, but will be able to take delivery only in the future.

Spot Gold and Futures Gold Rates

Gold has been at the forefront of trade for centuries, with countries and armies waging wars in the past to find and own this metal. Today, gold continues to enamour the world, forming an integral part of our investment portfolios, regardless of its cost. A number of factors go into determining gold rates, with demand and supply, international trends, currency changes, etc. being some of them.

The value of spot gold changes on a daily basis, according to the market. Typically, spot gold rates are cheaper than gold futures rates since there is no extrapolation involved when one purchases spot gold. What they see is what they get, with no market predictions. Rates for gold futures, on the other hand are costlier on account of storage charges till the delivery date and any additional expenses a supplier can incur.

Example: Mr. Krishna has a keen interest in gold and decides to purchase 10 grams each from the Spot market and futures market. The price for 1 gram gold at present is Rs 5,500 and he pays Rs 55,000 for 10 grams in spot trade and takes delivery for it. He also agrees to pay Rs 5,700 per gram for gold futures, the delivery for which will be taken after four months. He signs a contract a week later, paying Rs 57,000 for these 10 grams. After 4 months the cost of gold is Rs 6,000 per gram, thereby providing a profit of Rs 3,000 on his futures purchase.

Differences between Spot and Futures Gold