Gold Derivatives Essay

801 words - 4 pages

Gold Derivatives
Gold has been a very important element to mankind since before recorded history. It has many uses including currency, jewelry, and art. It is unique because it is very malleable, resists corrosion, and is an excellent conductor of electricity. For these reasons, gold demand has increased concurrently with population growth throughout history. Gold investments have their place in every portfolio, whether they are used to hedge against inflation, speculate, or just to diversify among different assets.
Many investors choose gold, because our dollar, as a fiat currency, is very unstable by nature. I think G. Edward Griffin put it best when he wrote, “Fiat Money is paper money ...view middle of the document...

S. Government.” The same credit rating that was downgraded in August of 2011. Due to these reasons, many investors choose to diversify their portfolios among many different assets denominated in multiple currencies, as well as commodities, one of which is probably gold.
One unique aspect about the gold forward and futures market is that it is basically in permanent contango. Contango is defined by investopedia as, “A situation where the futures or forward price of a commodity is higher than the expected spot price.” In most cases, this is due to the fact that if an investor, hedger, or speculator were to buy gold bullion today, they would have to pay storage and carry fees. But since with futures and forwards one doesn’t actually take delivery of the gold unless they hold the contract until expiration, this leaves the gold market in a permanent contango.
Gold derivatives started gaining popularity in the 1980s. The U.S. left the gold standard in 1971, and all of a sudden the government had this huge stockpile of gold that was not earning any return. They decided that needed to be changed. In order to earn their keep, these gold reserves were eventually lent out. The presence of this lending provided much greater liquidity in the gold market. So essentially, central banks became the source of the much-needed liquidity that was crucial to the development of the gold derivatives market.
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