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Sidestepping Risk In Gold Futures
Want to trade the gold market but reduce your exposure to its sharp downturns?
The brightest trading commodity is still the yellow metal. With its uncanny ability to achieve historic pricing records, gold’s demand remains strong. After decades of selling, central banks, most notably in Asia, are diversifying their foreign reserves by purchasing millions of tons of gold once more. If the fundamentals driving this investment remain attractive, the prospect of rising prices would increase; nevertheless, despite waves of explosive buying, many investors seem to be reluctant to take a position in the precious metal because they do not want to get caught in one of its unpredictable and ruinous meltdowns.
Can you buy gold but still remain relatively risk-free? This article is for those market participants who want to do it all, who want to trade the gold futures contract (GC) but reduce their exposure to one of its painful downturns. How often do these corrections occur? Despite this contract’s uplifting performance going back 513 trading days, the probability of experiencing a loss of $10 or more per contract in a single day was about three in every 13 trading days.
Not having a position at all when there is a $10-plus correction is best, but that’s not realistic. A more attainable objective is to gain a better understanding of what causes these steep losses.
Setting the stage
Let’s examine the impact that a $10-plus daily loss has on the trading days immediately after a large loss. With a 100 multiplier, a $20 loss would result in a $2,000 setback for each contract.
This study begins after the $17.40 decline on March 4, 2008, and runs until March 17, 2010. During these 513 trading days, the continuous GC contract, which uses the nearby expiration date, had an increase of $157.90. (The historical daily pricing for this continuous contract [GC #F] comes from downloading the numbers at esignal.com.)
As of March 4, 2008, the GC contract stood at $966.30. Since then, it had a brief run to $1,000 but sank to $681 (October 24, 2008). A few weeks after the equities market began its bullish run, this contract took the spotlight as the price of the yellow metal made its way to an intraday price of $1,227.50 (December 3, 2009), finally sliding to a closing price of $1,124.20 on the last day of this study.
Figure 1: reading frequency cycles. The vertical spikes display the distribution of every GC correction over $10. By the spring of 2009, the frequency of these setbacks became less regular as the price of gold rallied.