3

At the time of writing:

  • According to Kitco, the spot price for gold is about $1240 per ounce.

  • According to CME Group, futures contracts are above that price for many months ahead.

Why couldn't I buy an ounce of gold at the current spot price of $1240 and sell a futures contract for August 2014 at $1256, hold it until it expires, and guarantee myself a 16 dollar profit?

Am I missing something here? Why don't more people do this?

  • 1
    Have you looked to see the contract size for the future you would sell? These things are priced per oz, but trade in quantities far higher. – JoeTaxpayer Jul 5 '13 at 10:49
  • Right, I believe each contract is equivalent to 100 Troy Ounces, so that's how much I'd have by at market value. I'm very new to all of this. – Jon Jul 5 '13 at 10:54
  • Have you considered commissions as well? – John Bensin Jul 5 '13 at 16:21
9

You're missing the cost-of-carry aspect:

The cost of carry or carrying charge is the cost of storing a physical commodity, such as grain or metals, over a period of time. The carrying charge includes insurance, storage and interest on the invested funds as well as other incidental costs. In interest rate futures markets, it refers to the differential between the yield on a cash instrument and the cost of the funds necessary to buy the instrument.

So in a nutshell, you'd have to store the gold (safely), invest your money now, i.e. you're missing out on interests the money could have earned until the futures delivery date. Well and on top of that you need to get the gold shipped to London or wherever the agreed delivery place is.

Edit:
Forgot to mention that of course there are arbitrageurs that make sure the futures and spot market prices don't diverge.

So the idea isn't that bad as I might have made it sound but being in the arbitrage business myself I should disclaim that profits are small and arbitraging is highly automated, so before you spot a $1 profit somewhere between any two contracts, you can be quite sure it's been taken by an arbitrageur already.

  • +1 - Plus you are risking all that for a measly 1.3% return over 13 months. – Victor Jul 5 '13 at 7:00
  • Since I've posted this Gold spot price has dropped to 1233 but the futures for August 2014 are still at 1256, has the future market not responded to the change just yet? – Jon Jul 5 '13 at 9:50
  • It has, the current quotes are 1242.40 for 4 v 1 @ 1242.60, there has been no trade though, if that's what you mean. – hroptatyr Jul 5 '13 at 9:56
  • 1
    Buying a future today is just a promise, no money or goods are exchanged until maturity (well apart from daily settlement cash flows). You have to get your wallet out in 13 months, so you can invest your cash somewhere else, e.g. put it into a savings account and earn interest. The spot buyer has got to pay today, their money is exchanged immediately for gold and hence won't get them any interest. – hroptatyr Jul 5 '13 at 10:02
  • 1
    Re the interest, yes that's exactly correct. You'd use the one you can realise. Because after all, if you want to decide if there is an arbitrage you'd consider alternative investments you could have done instead. On the same note, not everyone's insurance or shipping costs are the same, so you'd throw the actual costs for you into the equation. – hroptatyr Jul 5 '13 at 10:14
1

As proposed:

Buy 100 oz of gold at $1240 spot = -$124,000

Sell 1 Aug 2014 Future for $1256 = $125,600

Profit $1,600

Alternative Risk-Free Investment:

1 year CD @ 1% would earn $1240 on $124,000 investment. Rate from ads on www.bankrate.com

"Real" Profit All you are really being paid for this trade is the difference between the profit $1,600 and the opportunity for $1240 in risk free earnings. That's only $360 or around 0.3%/year.

Pitfalls of trying to do this:

  1. Many retail futures brokers are set up for speculative traders and do not want to deal with customers selling contracts against delivery, or buying for delivery.

  2. If you are a trader you have to keep margin money on deposit. This can be a T-note at some brokerages, but currently T-notes pay almost 0%.

  3. If the price of gold rises and you are short a future in gold, then you need to deposit more margin money. If gold went back up to $1500/oz, that could be $24,400. If you need to borrow this money, the interest will eat into a very slim profit margin over the risk free rate.

  4. Since you can't deliver, the trades have to be reversed. Although futures trades have cheap commissions ~$5/trade, the bid/ask spread, even at 1 grid, is not so minimal. Also there is often noisy jitter in the price. The spot market in physical gold may have a higher bid/ask spread.

  5. You might be able to eliminate some of these issues by trading as a hedger or for delivery. Good luck finding a broker to let you do this... but the issue here for gold is that you'd need to trade in depository receipts for gold that is acceptable for delivery, instead of trading physical gold. To deliver physical gold it would likely have to be tested and certified, which costs money. By the time you've researched this, you'll either discover some more costs associated with it or could have spent your time making more money elsewhere.

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