Exchanges get into the futures mode

In Focus/Gold

This throws open an opportunity for big arbitrage trading, the first of its kind in the commodities trading in the futures segment, an official at research, consultancy and information firm 'bullionindia.com' stated.

Gold futures trading is not just providing a trading platform for hedgers, investors and speculators, it is opening up vistas for arbitrageurs.

Though the exchange (MCX) will be formally inaugurated on November 18, it witnessed a trading of 28 trades (one kilogram each) in gold February 2004 futures with an open position of 8 trades on the very first days, which marks a positive outlook for gold futures in the country.

The February gold futures closed at Rs 5756 per 10 gram (99.9 purity). The spot gold price in the Mumbai market was Rs 5765 (99.9 purity). In the silver futures, January 2004 contract witnessed 2 trades (30 kilogram each) with nil open interest. It closed at Rs 7551.

In the castorseed futures 4 trades of one tonne each was traded for February 2004 contract with 2 trades as open interest and it closed at Rs 1529.

MCX followed National Multi Commodity Exchange of India Ltd. (NMCE), which kicked off futures trading in bullion in early October. On the first day, NMCE saw 2978 (10 grams) contracts worth Rs 17.17 crore gold futures being traded in December contract.

The open position was 207 contracts at the closing price of Rs 5761. In the castor seed December futures 20 contracts worth Rs 3.24 lakh and January futures 1428 contract worth Rs 2.27 crore was traded on NMCE.

"India is a large country with diverse investment appetite. And since gold is both money and a commodity it is bought and sold by different people for a wide variety of reasons, ranging from adornment, industrial applications and most importantly as investment in physical form," the website official said.

The dawn of futures trading in the country after almost a gap of 55 years will provide investors an unparallel asset for diversification.

This can help protect the portfolio against fluctuations in the value of any one asset class.

Since gold price is influenced by the economic forces that are different from, and in many cases opposed to, the forces that influence most financial assets, it is an ideal diversifier.

Historically it has maintained its value and has frequently been stable when other assets have been volatile or have struggled to show positive returns.

Gold bears little or no relationship to other mainstream asset classes. It therefore provides investors with a powerful risk management tool, a study by World Gold Council (WGC) states.

Returns on gold tend not to be correlated with returns on equities. Including gold in portfolios would enhance the consistency of performance by reducing overall portfolio volatility, particularly during periods of stress in the financial markets.

Gold futures contracts are firm commitments to make or take delivery of a specified quantity and quality of gold on a prescribed date at an agreed price.

Investors may take or make delivery of the gold underlying the contract on its maturity although, in practice, that is unusual.

The contracts are generally settled or squared off before the expiry of the contract.

The major benefit is that such contracts are traded on margin, that is only a fraction of the value of the contract has to be paid up front.

As a result an investment in a futures contract, whether from the long or the short side, tends to be highly geared to the price of bullion and consequently more volatile.

Futures prices are determined by the market's perception of what the carrying costs ought to be at any time. These costs include the interest cost of borrowing gold plus insurance and storage charges.

Where the future price is greater than the spot price, as is almost invariably the case, the difference is known as the 'contango'.

Very rarely, the future price is lower than the spot price in which case the difference is known as a 'backwardation'.

The cost of a futures contract is determined by the 'initial margin', that is the cash deposit that has to be paid to the broker.

This is only a fraction of the price of the gold underlying the contract thus enabling the investor to control a value of gold that is considerably greater than the cash outlay.

In the event of significant movements in the gold price which could lead to losses the broker will call for additional, or 'variation', margin.

While such leverage can be the key to significant trading profits it can also give rise to losses in the event of an adverse movement in the price of gold.