The worsening economic picture, which has decimated retirement savings and home prices, is increasingly forcing concerned people to focus on the question of real money like gold and silver as a store of wealth.  If the U.S. dollar fiat standard crumbles, which is the risk with the way things are going, citizens will want to have a reliable form of money to pay for necessities when the going gets really rough. Consequently people are starting to accumulate gold and silver coins which they usually pick up on a retail basis through rare coin shops or over the internet. 

However, a common problem one encounters is that buying a few coins at a time through a retail outlet means paying a huge mark up which tends to be rather uneconomical.  Imagine what it would cost if you went into a super market to buy one egg.  The practical solution is to buy precious metals on a wholesale basis in order to pay the closest value to the current spot price as possible.  This can be done by opening a futures account and fully collateralizing it with enough cash margin to take delivery of the physical silver or gold from the exchange when the futures contract matures.  

Normally, traders who speculate in futures contracts only put up about 5% to 10% of the full contract value to take a position long or short in the futures market.  This means that the transaction is highly leveraged, not unlike buying a house with 5% to 10% down.  This type of speculation is not recommended for novices or people who are not fully aware of the risks and/or do not have the financial wherewithal to sustain the losses that would occur if the market moves against them.  A speculator with a futures margin account that only requires say 5% to 10% of the full contract value to take a long or short position in the market runs the risk of losing all of the money in that margin account and being forced to replenish the losses with fresh cash, or have the futures position liquidated.  

However, by fully collateralizing the futures margin account with enough cash to cover the full contract value, with the intent of taking delivery of the underlying commodity, it becomes possible to buy precious metals at the wholesale spot price without having to pay a huge retail mark up.

If you don't have enough money individually to do that, try pooling money with other like minded individuals in a commodity pool account. It will enable you to lock in the spot price for bulk orders of silver and gold via the futures market and take delivery directly from the futures exchange. This approach utilizes the futures market as a proxy for locking in the spot price of gold or silver until the futures contract expires. 

Example:  Prices as of March 20, 2009

Contract specifications for gold futures are 100 troy ounces.   

So, $956.20/oz X 100 oz = $95,620.

Contract specifications for silver futures are 5000 troy ounces.

So, $13.83/oz X 5000 oz = $69,150.

The process involves purchasing a futures contract in silver and/or gold today for future delivery. If you hold the contract to expiration, you are contractually obligated to take delivery of 5,000 ounces of silver or 100 ounces of gold from the exchange at the then current spot price. During the time you hold the contract, you will have mark-to-market gains or losses daily in cash that will be added to or subtracted from your futures account.

For example, on Friday March 20 the April gold future closed at $956.20/oz.  If you had bought it at that price you would incur daily gains and/or losses along the way until the contract matures in April.  Assume that the price drops in daily increments to $900/oz by the time the contract matures and you do not sell the contract prior to expiration.  The exchange will invoice you for $90,000 ($900/oz X 100 ounces = $90,000) and will deliver to you 100 troy ounces of gold.  This means that you will have already paid ($5,620) in futures variation margin (losses) to the exchange which in turn has paid the same amount out to the seller on the other side of the contract who made a profit from your loss.  On a net basis when the futures contract expires you will have paid the spot price of gold times 100 ounces or $90,000 + $5,620 in margin losses for a total of $95,620 or a net implied price of $956.20/oz, which is the price you would have locked in when you bought the futures contract.

Of course the price could go up instead of down, and given the accelerated pace of deficit spending with the stimulus package and bank bailouts I reckon there is a better chance of gold going up than down. If the price went up to $1000/oz at contract expiration you would have received $4,380 in futures profits along the way and would be invoiced at contract expiration for $100,000 from the exchange to take delivery. But, your net cost is $100,000 - $4,380 in profit = $95,620 or an implied price of $956.20/oz, excluding commissions which are relatively small. Note that the main point here is not necessarily to profit from buying gold/silver at a low price and then watching the price rise for a profit, (nice as that may be), but to accumulate the physical metal at a wholesale price. 

Regardless of whether the price of gold goes up or down, you have used to the futures market to lock in a price of $956.20/oz, which makes it possible to avoid paying a big retail mark up by purchasing gold / silver wholesale in this fashion.

Ed Rombach

March 2009