Profits to be Mined on Gold Swings

September 24, 2013 at 13:13

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Love it or loathe it, gold has attracted many investors over the past decade, but in recent months volatile prices and uncertainty have put the metal’s future in question.

When Gordon Brown, as chancellor of the exchequer, decided to sell off a portion of the UK’s gold reserves in 1999, the price stood at about $280 per ounce. Since then the price rose steadily to a peak of more than $1900/oz in 2011 but finally ran out of steam in 2012 and has experienced some sharp price reversals this year. It is currently trading at about $1310/oz.

 However, experts point out that while a fall in the price of gold negatively affects those invested directly in the physical metal, traders can play price falls to their advantage. The question for most investors who tend to use these markets for hedging or speculation is how to make money from fluctuating gold prices.

“Gold, that precious metal, store of value, pillar of financial sanity has certainly dumbfounded traders of late,” says Nick Lewis, head of risk at Capital Spreads.

“When quantitative easing began in 2008, many traders foresaw a Weimar Republic-type hyperinflation taking grip across the developed world. That fear of uncontrolled price rises naturally saw traders pile into gold and up until 2011 their thesis looked good as central banks around the world had adopted the ‘print to prosperity philosophy’, churning out money at unprecedented rates never seen before.”

However, Mr Lewis points out that, as many gold bugs and notable traders have discovered, gold prices have not kept pace with the increase in the money supply. “Since the high in 2011, gold shed almost 39 per cent making another new low in this down trend at the end of June at $1180.4/oz,” he says.

Rising or falling, there are various ways in which investors can gain exposure to the metal. The method of investment will typically depend on the timeframe. Longer-term investors might choose gold funds, mining shares, exchange traded funds and physical gold. Active traders tend to focus on futures, options, spread betting and contracts for difference because of their shorter trading horizons and desire to use leverage to amplify the movement for their trading positions as they seek rapid gains.

As spread betting is a derivative you do not actually own the physical underlying asset but you can profit from rises and falls in the price of gold via a spread bet. Any capital gains you make from financial spread betting are completely free of capital gains and income tax and spread betting is also exempt from UK stamp duty.

Traders tend to like gold because it can be traded at any time of the day, as it is a 24-hour market. Many spread betting firms calculate gold trades at 0.1 basis points per US dollar, which means that for every dollar movement you would either make or lose 10 times your stake. So if you buy £5 worth of points and gold moves up $2 you would make £100 (5 x 2 x 10).

But to make a bet traders need to decide where gold will go next. While most experts say the potential for full-scale conflict in the Middle East is arguably set to be the biggest driver for gold prices in the near term, many people are less sure about the direction of gold prices over the longer term.
Brenda Kelly, technical analyst at IG, says: “It has certainly been a more volatile year than we have been used to recently for gold. There is a feeling that gold has lost some of its allure – maybe not too surprising considering it is still up by around 500 per cent since the beginning of the century. At the moment the risk is that any rallies are likely to be viewed as “dead cat bounces”.

Some say the gains have come about as a result of the recent uncertainty in Syria and the wider Middle East. Joe Rundle, head of trading at ETX Capital, says gold has reclaimed its label as a haven, with clients piling back into the asset as risk aversion due to potential Fed tapering and Middle East uncertainties has become the dominant narrative across global asset classes.

“Gold’s a worthwhile hold when the global economy is in turmoil and you’re worried about where your assets are protected best,” says Mr Rundle. “But with the US economy resurging, the eurozone back in growth mode and the UK economy showing encouraging signs of growth, the global economy is in a much better place than, say, two years ago when uncertainty drove the market and pushed investors running to the safe arms of gold, core government bonds and the US dollar, Japanese yen.”

However, he thinks gold could fall below $1000/oz after the start of tapering and adds that the investment case for the precious metal has been tarnished by the prospects of Fed tapering and the impact it has on financial markets during the process of tapering. He says clients at ETX Capital have closed positions in gold ETFs so the expectation is that there is only one way gold will go during the QE unwind process – down.

Alfonso Esparza, senior currency analyst at OANDA, agrees, saying a strong non-farm payroll number and a quick resolution to potential American involvement in Syria would boost the dollar and “in turn set the stage for the Fed to begin tapering this month, negatively impacting gold prices”.
This widespread negative sentiment is summed up nicely by Steve Ruffley, chief market strategist at CFD provider InterTrader, who says: “The speculators have already made their money from gold. There is just simply not enough fear or greed in the markets for gold to head back to $1900/oz.”