Turning Gold Futures into Gold

The whole rigmarole explained. Only for those investors who want to turn Gold Futures into metal...

GOLD REMAINS more than 10% off its peak in US Dollars, write the editors of the Big Gold newsletter from Casey Research.

Yet at the same time, Spot Gold is cruising at or near all-time highs against a host of other currencies, including the Swiss Franc, British Pound, Canadian Dollar, Australian Dollar and Indian Rupee.

That disparity means buyers around the world are prepared to pay much more for gold, relative to their own currencies, than is reflected in the Dollar Gold Price right now.

Demand for Gold Coins in particular is running so high that there were severe shortages in 2008. Dealers' shelves emptied, mints either rationed their output or stopped producing entirely, and premiums over the spot price rose dramatically. All of which implies that the metal's bull market is far from over. Yet taking advantage of the trend becomes problematic if you can't get what you want.

Sure, you can buy as much paper gold as you like, through the SPDR Gold Trust ETF (NYSE.GLD). It is bullion "backed" and will be sensitive to an advancing price. But what if you simply want physical metal and want it in quantity – say, a hundred ounces?

Well, you could buy 100 coins. If you could find them. Or you could buy a single 100-ounce bar.

Take heed: if you are buying in 100-ounce, 400-ounce or 1-kilo sizes, you want a Good Delivery bar, one that carries a hallmark from a recognized refiner. And buy only from a source you have a good reason to trust. The gold trade has been replete with con artists since ancient metalworkers began hammering on the shiny stuff and found they could increase their profit margins by adding in a little silver, copper, or even lead. With 100 ounces going for upwards of $85,000, caution is in order.

Once you're ready to commit to a 100-ounce buy, the next logical question is: Is there any way to avoid the big premiums and acquire what you want at spot? The answer, fortunately, is yes.

[Ed.Note: To skip the following 1,271 words...buying from one gram up to many hundred of spot-market ounces at live prices...and skipping the risk of Gold Futures entirely...click through to BullionVault here...]

You can, if you wish, elect to play with the big boys and get your 100-ounce bar on the Comex exchange in New York, where the bullion banks and giant funds do their trading using Gold Futures and options contracts.

The Comex is primarily a "paper market", with speculators going long or short on contracts for future delivery. Pretty much 99.9% of those contracts get settled in cash, rather than with gold deliveries, and they are closed out before the delivery date arrives, with participants pocketing profits or taking their lumps as the price moves.

Very little physical gold changes hands through Comex trading. But some does, because every participant who goes long has the right to pay in full and insist on actual delivery. And every participant who goes short has the right to deliver the goods and get paid. Those trades represent the other 0.1% of the contracts.

If you're tempted to use Gold Futures, it's worth getting a little more acquainted with the topic first. Log on to the Comex gold section and have a look around.

Pay close attention to the Current Session Overview. It gives you a real-time picture of trading, with the various delivery months displayed, along with the price per ounce being bid. (With gold, contracts on the months further out nearly always have higher prices, a situation known in the commodities trade as "contango". This is because gold costs you to own it, and so the longer you leave it with somebody else, the more he'll need to raise from you in storage and other costs. The opposite situation, when near-term prices exceed those down the road, is called "backwardation", and for gold it's extremely rare.)

If you decide to proceed with the idea of buying on the Comex, you have to open an account with a Gold Futures broker. To do that, you'll need to answer some questions about your financial status and then make a deposit. We spoke with an agent at Lind-Waldock in Chicago, one of the oldest and most active futures brokers, to learn about their requirements.

First, at Lind-Waldock, you must have a yearly income and net worth of at least $25,000 and $50,000, respectively. (Anyone who can afford a hundred ounces of gold will surely qualify.) Then you must deposit a minimum of $5,000 with the broker. Finally, you choose from among several levels of service, which affects the amount of commission you'll pay.

Once the futures account is in place, you're set to go.

Let's say the bid price three months out is $850/oz., and you like gold at that price. You call your broker and place an order at $850, for one gold contract (which represents a single 100-oz. bar of Good Delivery metal in New York). As with bidding on a stock, you may not get what you want if the market is heading up and runs away from your price. The alternative is to place a market order, trusting that it gets filled at close to your target price, but that can be risky in a fast-moving market.

Let's assume you get your contract and lock up what you'll pay for the gold, most of which will be due at "expiration date", the last day that contract trades on the market. What next? There are two possibilities.

• You can just deposit the full cost of the gold, sit back, and enjoy the wait for your prize;
• Or you can deposit the minimum amount required (the minimum "margin"), which varies and is set at the exchange's discretion.

For a single gold contract at the moment, margin is some $5,800...about 7% of the contract's value.

That's how the speculators play the market, putting up as little front money as possible and never looking to take physical Gold Bullion in future. For you, margin won't be a problem if the price of gold rises, since the broker will be crediting a matching amount of cash to your account on a daily basis. But you have to be careful if the price of gold falls, because the broker will then charge your account for a matching amount of money day by day – and to keep the balance from going below the minimum margin requirement, he'll send you a margin call, insisting that you deposit more cash.

If you fail to meet a margin call, the broker will enter a sale order for you, and you'll be out of the market with a loss.

Changes in the value of a futures contract, with their attendant shifting cash requirements, are of critical importance to traders who are simply playing with paper. Since you're only interested in acquiring a physical Gold Bar, the fluctuations shouldn't affect you. Just make sure you have enough money in your account that you're not inadvertently sold out.

Then, on the settlement date, your account will be charged for an amount equal to the settlement price multiplied by the exact weight of the particular bar that's been assigned to you (a "100-oz." Comex good delivery bar can actually vary in weight between 95 and 105 ounces). This is when everything gets squared up.

If you keep your position open until delivery, the Comex will hand your broker a warehouse receipt with the details of your specific bar (hallmark, serial number, and weight to one-thousandth of an ounce). The broker can either hold the receipt in your account or mail it to you. (If you take possession of a warehouse receipt, be aware that it's an irreplaceable bearer instrument. Don't lose it!)

Your bar will be sitting in the vault of one of the four designated Comex depositories, all of which are in or near New York City. If you want to bring the bar home, you'll have to pick it up at the depository or arrange for third-party delivery. If you intend to hold it until gold reaches a certain price and then sell, your best bet is probably to leave the bar in the Comex depository and leave the receipt with your broker.

We called Scotia Mocatta, which operates one of the Comex-designated vaults, and were quoted a storage fee of $15/month per bar. If, however, you want the bar in your hands, you'll have to pay a $150 delivery fee to get the bar released by the depository. Then you're responsible for retrieving it, which could be a problem.

Unless you want to put the bar in your suitcase and fly home with it, you'll have to have it delivered. You can't ship a gold bar via the US mail, FedEx or UPS. You have to hire an armored car service, such as Brinks. Shipping costs depend, of course, on how far your gold will travel from the City.

VIA MAT International (USA) gave us a ballpark figure of $150 to transport one Gold Bar from New York to California – a heckuva lot cheaper than airfare, and you get to keep your shoes on.

One final note: Armored carriers won't deliver to a house address. You would have to arrange to receive the shipment at a business, which could be an additional worry if neither you nor a trusted friend owns one. Or you could have it delivered to your bank and slide it into a safe deposit box, provided you don't mind the bank's employees knowing what you're doing.

If you leave your gold bar in the Comex depository, in contrast, it will be easier to sell, running once more through the Gold Futures market. You just go through the above procedure in reverse, going short a contract instead of buying one.

However, if you take physical delivery and later wish to sell through the Comex (or through a private dealer), you will need to have the bar "assayed" once more. A prospective buyer of such a costly item must be certain that it was genuine to begin with, and that it hasn't been tampered with while in your possession. This is how the Spot Gold market retains its efficiency, cutting out all doubt over "integrity" and maintaining that Good Delivery status inside approved vaults.

The Comex provides a list of approved assayers on its website. The one we contacted, Ledoux and Co., quoted us $300 per bar for the service.