Trading metals: gold and silver

05/11/2024 Admin 5 min read

Beginner List

Trading oil, gold or silver doesn’t require unloading and offloading huge amounts of physical assets. Let’s look at how futures and options exchanges enable commodity trading on a global scale.

How are metals traded?

There are three main ways to trade metals: on the spot market, via futures and options, or as a forex pair.

When commodity consumers want to purchase goods for immediate delivery, they’ll take to the spot market. Here, the buyer can expect delivery of their chosen assets as soon as their trade is settled. When you see a live price for a commodity listed, it will often be the spot price.

However, most speculators don’t want to take delivery of the commodity they’re trading – it would require a level of infrastructure that most traders don’t have. Instead, they use derivatives called futures and options to buy and sell gold or silver without ever seeing any physical assets.

Futures enable you to trade a contract today in which you commit to buying or selling a set amount of a commodity for a set price on a set day in the future
Options give you the right to buy or sell a set amount of a commodity for a set price before the contract expires

The prices of futures and options will move up or down as the spot price of their market moves up or down. This enables commodity speculators to use them to go long (buying) and short (selling) on assets without ever running the risk of taking delivery. Instead, they trade the future or option before it expires.

Finally, you can trade metals just like you trade a forex pair. XAU/USD, for example, is a pair made up of gold against the USD dollar. It works in the same way as any other currency market – buying means purchasing XAU (gold) by selling USD and gives you a long position. Selling, on the other hand, means buying USD in exchange for gold, and gives you a short position.

Gold and silver pairs are based on the spot prices of each metal, but you don’t take delivery of the underlying market when you trade them.

What drives the prices of gold and silver?

Like any market, gold and silver prices are driven by supply and demand. But the factors on both sides are a little bit different to other commodities.

Gold and silver demand

Gold and silver are both valued for their use in jewellery, but also for their engineering and electrical properties.

Silver has the highest electrical conductivity of any metal, making it a key component in batteries and electronics – meaning demand is expected to rise as industries shift towards green energy. It’s also popular in dentistry and dinnerware because of its anti-bacterial property.

Unlike most other metals, traders also consider gold because it is viewed as the ultimate safe haven, usually weathering market turbulence and retaining its value in periods of economic decline. Silver is viewed similarly, but not quite to the same level as gold.

Historically, one of the most reliable determinants of gold’s price has been the level of real interest rates, or the current interest rate minus inflation.

When real interest rates are low, investment alternatives like cash and bonds tend to provide a low or negative return, pushing investors to seek alternative ways to protect the value of their wealth.

On the other hand, when real interest rates are high, strong returns are possible in cash and bonds, and the appeal of holding a yellow metal with few industrial uses diminishes. One easy way to see a proxy for real interest rates in the United States, the world’s largest economy (according to WorldData.info), is to look at the yield on Treasury Inflation-Protected Securities (TIPS).

Increased demand can push prices up, which is what happened in 2020 when economic uncertainty surrounding the coronavirus pandemic caused market speculators to take a ‘risk-off’ mindset.

Gold and silver supply

Gold and silver’s supply, on the other hand, is driven by the companies all around the world that mine both metals, then refine and sell them.

There is a finite supply of gold available to mine – there won’t be any left for miners by 2070, according to current estimates. This lack of supply, however, is counterbalanced by the fact that gold is very rarely used up – almost all the gold that has ever been used is still around somewhere. Therefore, until supply runs out, the amount of gold available should constantly increase.

Silver, on the other hand, is usually mined as a byproduct of other metals. For example, when copper or lead demand is high, silver supply may rise.