Trading metals: Gold and silver

Trading oil, gold, or silver does not require handling large amounts of physical stock. Let’s explore how futures and options exchanges facilitate global commodity trading.

1. How is metal trading conducted?

2. What drives the prices of gold and silver?

How is metal trading conducted?

There are three primary methods for trading metals: via the spot market, through futures and options, or as forex pairs.

Spot market

The spot market is for those seeking immediate delivery of purchased assets. Transactions are settled based on the current price, known as the spot price, and the buyer receives their assets as soon as the trade is finalized.

Futures and options

Most speculators do not aim to physically acquire the commodities they trade, as this would require significant infrastructure. Instead, they use derivatives like futures and options, enabling them to trade gold and silver without physical ownership of the assets.

• Futures: These are contracts where a trader agrees to buy or sell a specified quantity of a commodity at a predetermined price on a future date.

• Options: These provide the right (but not the obligation) to buy or sell a commodity at a set price before the contract expires.

Futures and options prices fluctuate based on movements in the spot market. These tools allow traders to profit from rising (long position) or falling (short position) commodity prices without needing physical delivery, as contracts are usually sold before expiration.

Forex pairs

Metals can also be traded as forex pairs. For example, the XAU/USD pair represents gold against the US dollar. This works similarly to currency trading:

• Buying creates a long position, where you purchase XAU (gold) by selling USD.

• Selling creates a short position, where you purchase USD by selling gold.

Gold and silver pairs are derived from their spot prices, but no physical ownership occurs during trading.

What drives the prices of gold and silver?

Like other markets, gold and silver prices are influenced by supply and demand, but the factors affecting them differ from most other commodities.

Demand for gold and silver

Silver:

Silver boasts the highest electrical conductivity of any metal, making it essential for batteries and electronics. Demand for silver is rising, especially in industries focused on green energy. Additionally, silver is popular in dentistry and tableware due to its antibacterial properties.

Gold:

Gold is often viewed as a "safe haven" asset, maintaining its value during economic downturns and market turbulence. While silver shares a similar status, it is not considered as reliable as gold.

Real interest rates

Low real interest rates:

When real interest rates (nominal rate minus inflation) are low, investments like cash and bonds offer minimal or negative returns. This prompts investors to seek alternative assets like gold to protect their wealth.

High real interest rates:

Conversely, high real interest rates make cash and bonds more attractive, reducing demand for gold, which has limited industrial use.

A simple way to monitor real interest rates in the US is by observing yields from Treasury Inflation-Protected Securities (TIPS), which are safeguarded against inflation.

Increased demand

During periods of economic uncertainty—such as the COVID-19 pandemic in 2020—investors gravitate toward safer assets. The increased demand for gold during this time led to a significant rise in its price, as market speculators sought to mitigate risks.

Gold and the US dollar

One of the most debated topics among gold traders is the relationship between gold and the US dollar. Since gold is priced in USD, it is often assumed that the two assets are inversely correlated—meaning when the dollar strengthens, gold prices fall, and vice versa.

However, this simplified view of the correlation is not always accurate. During periods of financial stress, both assets may rise simultaneously. Such situations occur during times of economic uncertainty when traders perceive both gold and the US dollar as safe havens, driving up demand for both assets.

Supply of gold and silver

Gold and silver supplies are determined by global companies that mine, refine, and sell these metals.

Gold:

The available supply of gold is limited. Current estimates suggest that all mineable gold could be exhausted by 2070. However, this potential scarcity is offset by the fact that gold is rarely consumed. Almost all gold ever mined still exists in usable form. As a result, the total available supply of gold should continue to grow until mining ceases completely.

Silver:

Silver is often mined as a byproduct of other metals, such as copper or lead. Therefore, its supply can increase when demand for these base metals is high.