1985 - Robert Beale - Trading in Gold Futures

TRADING IN
GOLD FUTURES
Robert Beale
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rne Angus L. Macoonalcl UDrary

St. F. X. University
Antigonish, Nova Scotia
Woodhead-Faulkner • • Cambridge
Nichols Publishing Company • New York
Preface
Since time immemorial gold has fascinated man, because of its

beauty, rarity and the high value placed on it. Therefore there
have always existed ready markets where gold could be bought
or sold. Some of these 'markets' have been no more than a
private arrangement between one individual and another, but in
many centres organised markets have grown up. Futures mar-
kets in gold are a relatively recent phenomenon, and perhaps the
most modern manifestation of man's need and desire to trade
gold. The most important of today's futures markets in gold
trace their origin only to 31st December 1974, the date on
which residents of the United States were permitted to purchase
gold for the first time since January 1934. This event allowed
the concept of futures trading, which, for other commodities,
had a considerable history in the United States, to be extended
to include gold. Gold futures trading has become remarkably
popular in the ten years since this beginning. This book seeks
to explain how the gold futures markets operate and the reasons
for their huge success in the United States. In attempting to do
so, it addresses the identity and psychology of gold traders, their
motives for trading, as well as the means by which they trade
on futures markets. While the most active of gold futures
markets today are established in the United States, the first one
was founded not there, but in Winnipeg, Canada, in 1970. Since
then the success of the US markets has encouraged imitations in
a number of other countries. Today there are nine futures
markets on which gold is traded. All of these will be discussed.
vi Preface
Though they differ in detail, they have many features in

common, and all seek to attract the business of every conceiv-
able type of buyer and seller of gold.
An accusation often made against futures markets in general,
and those where gold is traded in particular, is that they
encourage speculation. While there is undoubtedly a strong
element of truth in this proposition, it is also, like most
generalisations, unfair. Speculators, of course, seek to make
money for themselves, but for many other participants in gold
futures, the motives are different. In many cases such partici-
pants are aiming to protect themselves against damage to their
business caused by adverse or volatile movements in the price of
gold. If speculators do today tend to dominate the markets,
their actions and activity often present opportunities to other
participants, which, without the speculative element, would
never have existed. If it is true, as is frequently stated, that
speculators have a low record of success, then such împortuni-
ties are extensive indeed. In the United States, private indi-
viduals as well as professional operators participate in futures
trading, so that the workings of these markets are increasingly
widely understood there. In other countries, the concept and
shape of futures markets are less well comprehended. This book
is addressed to those who have an interest in gold or gold
trading, but whose knowledge of futures markets is rudimentary
or non-existent. It is hoped that the book will expand their
knowledge, and at the same time convey a greater understand-
ing of the interaction of futures markets with other markets for
gold.
This is not intended to be a general book on the subject of
gold; many such have already been published over the years,
and a number are very good. Nevertheless, many references to
other markets and to other aspects of gold must perforce be
made in this book, and it is hoped that these will encourage the
reader to increase his general knowledge by further reading.
Better still, he may be persuaded to join the steadily increasing
band of participants on gold futures markets, and learn at first
hand of the opportunities they provide, as well as their dangers.
R.B.
Contents
Preface v
1. Gold: who needs markets? 1
2. US futures markets 15
3. Who needs gold futures? 23
4. Comex 27
5. Other American markets 49
6. From frozen wastes to tropical beaches 58
7. Who uses futures? 77
8. Great or unusual gain 95
9. Options 106
10. The future 110
Appendices
A. A word of advice to potential speculators 118
B. Commodity Exchange Inc. official list of approved
refiners and brands 121
Index 125
1
Gold: who needs
markets?
Throughout the 5,000 years of recorded history, gold has been

important to all mankind. The reasons for this importance to men
and women have been various and have altered from time to time;
nevertheless, it has been almost universally prized, so that it is said
that there is no language amongst the estimated 2,700 spoken in the
world, and no known tongue of the past, that does not have a word
for 'gold'. If we recognise that many of these languages are spoken
in regions where gold is not, and never has been, found in its natural
form, this fact speaks loudly of gold's widespread permeation of
human consciousness, and of the markets which must have existed
throughout history to ensure such extensive acceptance. Of all
metals found naturally, it is the best known and generally the most
prized; prized as much for its colour and its workability as for its
rarity.
Many a prospector has been entranced by the yellowish glint in
the gravel panned from a river bed, which tells him that he may have
stumbled on a fortune. By the craftsman, gold is prized for a number
of unique properties. Most malleable and ductile of all metals, it can
be beaten to incredible thinness (less than 1/25,000th of an inch), so
thin that daylight can pass through it, or drawn into a wire so
delicate that it resembles a spider's web. There are many examples
of the goldsmith's art in the world's museums, which stand
testament to the artistry and workmanship developed in areas as
geographically (although perhaps not racially) far apart as
pre-Columbian South America and ancient Egypt; and that is to
ignore the skill of European craftsmen both in Celtic times and in
2 Trading in gold futures
the great tradition which began at the time of the Renaissance; nor
do the ancient civilisation of Babylon, Persia, India, China and
Japan fail to provide further examples. It has been estimated that by
the end of 1983 of the approximately 92,000 tonnes of gold
produced since the beginning of time, perhaps 30,000 tonnes still
exist in the form of artefacts or jewellery. Another of gold's special
qualities is that it is a good conductor of electricity. As such, it has a
wide range of industrial applications, and particularly has played its
part in the development of the electronics industry over the past 25
years. Then again, it is widely used in dentistry to rebuild worn or
decayed teeth in an efficient and attractive fashion.
Yet, perhaps more than for any other reason, gold has been
prized as money or as a store of value. The days when gold
commonly circulated as coinage have passed, but even today it is
widely held in the vaults of Central Banks and official institutions as
an important component of national reserves. In a number of
countries the proportion of gold held in reserves is greater than that
of any currency, and over 38,000 tonnes are held in this way.
A similar quantity (including gold in jewellery) is held by private
individuals, not as immediate money, but as a store of value, or an
investment to protect them against inflation, political and economic
upheaval and even against ultimate disasters of world war or
famine.
It follows from the above that there are many motives for
producing, using or holding gold, and we can discern the need for
gold markets, and the characters who may be participants in these
markets throughout the world.
First there are miners who today may be individual prospectors
or huge corporations. Both need efficient markets where they can
secure the best possible price for their production. On the other side
are buyers; goldsmiths and jewellery manufacturers, processors of
gold for industry, official institutions and private individuals. A
detailed description of the market for physical gold is beyond the
scope of this book, but, for those interested in the further study of
them, the excellent The New World of Gold by Timothy Green
(Weidenfeld &c Nicolson, London, 1982) may be recommended.
Even without further study, however, one thing is clear. Each of
the market participants described above is interested in physical
gold. The miner wishes to sell gold he has in his possession and
deliver it to buyers in return for cash. Most of the buyers on the
other hand wish to take possession of gold, either to change its form
or to put in a safe place for future use. So at the beginning one sees
Gold: who needs markets? 3
the requirement for a market which facilitates the exchange of gold

for cash and arranges prompt and efficient delivery.
Yet this is not what futures markets are designed to do. On gold
futures markets the proportion of the total volume traded which is
eventually delivered physically is invariably less than 5 per cent. In
1980, a year of great speculative activity and high prices, only 1.6
per cent of the volume traded on the New York Commodity
Exchange was actually delivered, and delivery, in most cases,
involved the exchange of paper representing gold, rather than gold
itself.
This is the great paradox associated with gold. Today it is the
metal which many people seek to possess and keep close to
themselves or in a safe place, yet at the same time it attracts a huge
interest in markets where the buyers and sellers of gold will never
see what they are trading, and probably do not wish to. The simple
answer to this conundrum is that a new type of gold buyer or trader
has arisen, whose needs were not fully met by the existing markets.
The details of the operations of physical gold markets will not
concern us here, though it is worthwhile spending a little time
describing the main features and history of the best established, the
London Gold Market (LGM). The five present members of this
market take part in the world-famous 'fixing', which occurs twice
daily at 10.30 a.m. and 3.00 p.m. London time. A short history of
this market .will be sufficient to show that the LGM is first and
foremost a market for the delivery of physical gold. Indeed, in the
brochure published by the Market describing its activities there is
but scant mention of forward trading; moreover, even today,
although the price fixed for 'spot' or prompt delivery is rapidly
transmitted round the world by the newswires, there is no official
forward quotation on the LGM. Each forward deal is a private
arrangement between an LGM member and his customer.
The five members, of whom the youngest, Samuel Montagu &
Co. Limited, was founded in 1853, and the oldest, Mocatta &
Goldsmid Ltd, traces its earliest transaction to 1676, first came
together for a gold fixing in September 1919 at the offices of N. M.
Rothschild & Sons (now N. M. Rothschild & Sons Limited). The
date is significant. Before the beginning of the First World War in
1914, the gold standard had been adopted by most leading
industrialised countries, and many others; In essence, a full gold
standard meant that the money in circulation in a country was
related to, and limited by, the stock of gold held by that country in
its reserves. Imports and exports of gold were unrestricted. The
coinage in many countries was mainly gold, although silver was

widely used for smaller denominations. In the United Kingdom the
issue of notes was permitted, although limited in extent.
It was the widespread suspension of the gold standard at the
beginning of the First World War which set the scene for the gold
markets of today. In the United Kingdom the price of gold in terms
of sterling had been stable, except during the Napoleonic Wars, for
almost 200 years. The Bank of England bought at £3 17s. 9d.
(£3.8875) per standard ounce, and sold at £3 17s. \0Vid. Only
during the First World War did it withdraw as a seller, so that
production from the Transvaal was added to its reserves. After the
end of the war, in the United Kingdom the official price of gold
remained as before, but a private market was allowed to establish
itself and to quote prices based on supply and demand. The supply
was in fact limited to newly mined gold, as it had been pressure from
producers in the British Empire to obtain a fair price which resulted
in the new market becoming established. At first the London'traders
bought from and sold to each other on an individual basis,
transmitting their bids and offers by messenger. On 12th September
1919 this informal system was replaced by a daily meeting at which
they traded gold together, buying or selling according to the orders
received from their customers. At this first meeting a price of £4 18s.
8<i. (£4.9333) per ounce was established. As the quotation was now
based on the fine ounce, this represented a premium of some 16 per
cent over the official price.
The new market soon flourished, and the premium over the
official price moved up steadily as sterling weakened, until February
1920, when it was 50 per cent. This occurred despite considerable
offerings in the market which absorbed not only the new
production from the Transvaal gold mines, but also significant
selling from the reserves of the Soviet Union, which was
re-establishing its financial position after the Revolution. In
addition to the weakness of sterling, the strength of the demand for
gold at that time can be set against the inflationary background of
the period, as the European nations tried to regain their economic
strength and bring back full employment. Perhaps this was the first
example in the modern era of gold being purchased as a hedge
against inflation. The spiralling inflation which occurred in the
Weimar Republic during the 1920s has been well documented. The
German investor who had access to gold at that time was well
served by it.
Notwithstanding the re-adoption of a limited gold standard (the
gold bullion standard) by the United Kingdom in 1925, when the

official price ruled again for six years, gold had become attractive to
those who believed in sound money and were worried about
inflation.
The seven years from the end of the First World War until the
adoption of the gold bullion standard in 1925 was a period when
newly mined gold did not necessarily find its way into the major
countries' official reserves. Thus it will be seen that during those
years the conditions in the LGM paralleled those which occurred
after 1968, to which we will return later.
After the United Kingdom finally came off the gold standard in
1931, the scene was again set for a moving gold price, at least
against sterling, which until that time was still the major currency
used for international trade. The US dollar had, however, become
progressively more important, and its importance was to grow still
further. Until March 1933 the United States remained on the gold
standard, but after his election President Roosevelt imposed a ban
on the hoarding and export of gold. In January 1934 the United
States revalued gold against the dollar from the equivalent of
$20.67 per ounce to $35, a measure designed to help pull the
economy out of the depression. Gold thus acquired another feature
and reputation, that of a good investment in times of economic
recession. With gold fixed at a new level against the US dollar, the
market in London became mainly a play on exchange rates, as
currencies floated freely.
On the outbreak of the Second World War in 1939, the London
Gold Market was closed, and did not officially reopen until 1952,
although the individual members of the market conducted a limited
business during the interim. In July 1944 the Bretton Woods
agreement between the world's most important industrial and
trading nations established gold as the linchpin of a new monetary
system. Thenceforward, all major currencies would have an official
parity against the US dollar, and the US dollar would have a value
fixed in terms of gold. The dollar was equivalent to 0.888672 grams
of gold, or, to put it another way, the gold price remained fixed at
$35 per ounce, as it had been since 1934.
This establishment of a fixed dollar/gold parity made good
economic sense at the time, because the value of the gold held in US
reserves valued at $35 per ounce by far exceeded the claims of other
countries on the United States.
We have seen, therefore, the evolution of gold in the first half of
the twentieth century from currency under a full gold exchange
standard, to a metal prized as a hedge against inflation and currency

weakness, as a countercyclical investment, and finally returning to
the centre of the monetary system in a modified form. Of course, the
setting of a parity with the world's strongest currency from 1944
produced another attractive ingredient to gold's modern psychol-
ogy. Anyone who possessed gold at that time knew that he could
always realise his asset at a price in local currency near to the
equivalent price in dollars. In other words, he had an asset fixed in
terms of the world's strongest currency, and thus protection against
the devaluation of his own country's money.
There are stories of holders of gold, even with small quantities,
who escaped the effects of rampant and uncontrolled inflation and
monetary collapse, most notably that in Hungary at the end of the
Second World War. I have been told, too, of the personal experience
of Europeans interned by the Japanese in the Far East, who when
freed found themselves able to obtain the necessities of life — food
and transport — at a time when both were in short supply ^simply
because they had managed to retain possession of a couple of small
bars.
This rapid, and no doubt incomplete, summary of the many
facets of gold gives us a clue to its attractions. It is at bottom a store
of value having a well-deserved reputation as a protection against
most forms of economic disaster. It will be clear that for gold to
fulfil most of these roles physical possession is required, or at least
easy availability in a safe place. This was indeed the assumption on
which the premier gold market of the world, the London Gold
Market, worked. Its operations were premissed largely on the
physical availability of gold, and amongst the services which the
members offered, and still offer today, is that of capacious vault
facilities.
So long as gold remained at the centre of the monetary system
established by Bretton Woods in 1944, its position was protected by
regulations in force in many countries either preventing the
ownership of gold or at least limiting external transactions. The
operations of the London Gold Market from its reopening in 1952
until March 1968 were in many cases concerned with finding ways
of legally moving gold from one centre, where it was freely
available, to another where it was in limited supply and therefore
commanded a higher price.
Of course, the London Gold Market performed other functions
as well during this period. It provided an outlet for new production
and sales by the Soviet Union, and at the same time satisfied the
requirements of customers who required gold for manufacture. It

also serviced the needs of countries who wished to acquire or
dispose of gold in settlement of their international trade obli-
gations. Its ability to do all this efficiently was considerably en-
hanced by the role of the Bank of England, which acted as agent for
the South African Reserve Bank for sales of newly mined gold, and
from 1961 was manager of the Gold Pool established by the world's
wealthiest nations to ensure that, as far as possible, new gold
production flowed into their reserves; all with the object of assisting
the financing of the rapidly increasing volume of world trade.
As the 1960s progressed, the parity of the US dollar in terms of
gold was increasingly threatened; the claims of other countries on
the United States rose rapidly, and soon exceeded the value of the
US reserves, which were almost entirely held in gold. From time to
time, sizeable speculative purchases of gold were made in the belief
that the gold/dollar parity would have to be altered in favour of
gold. Most of such 'bulges' in demand were short-lived, and were
satisfied by running down the reserves of the Gold Pool; once the
short-term requirements had been met and speculation subsided,
sellers would predominate as the recent purchasers vied with the
producers to sell to the only significant buyer — the Gold Pool.
The Gold Pool could vary its price, selling not at exactly $35 per
ounce, but at up to $35.20; the 20 cents per ounce premium
reflected mainly the cost of shipping gold from the United States to
London, an action which was only necessary when the reserves of
the Gold Pool were depleted and fresh supplies from the United
States were required. Once speculative demands receded, the Bank
of England would try to bring the price below $35.20, and
repurchase at lower levels. These tactics were successful until
March 1968, when the size of private demand for gold reached a
level never seen before during the years of the Gold Pool. In a matter
of days huge losses to the reserves were sustained. On 14th March
the Gold Pool countries decided that enough was enough, and the
London Gold Market was closed. The following day, the Gold Pool
countries agreed in Washington that they would no longer
intervene in the private market for gold. Between nations, the price
of gold would remain, in theory at least, at $35 per ounce, but other
buyers would have to meet their needs from a free market supplied
by new production and from private holdings. In this new market
prices were, of course, at liberty to rise or fall according to supply
and demand from day to day. The closure of the London Gold
Market was maintained by official decree for two weeks, a fact that
placed it at a considerable disadvantage to other markets. The three

largest Swiss banks, Swiss Bank Corporation, Union Bank of
Switzerland and Swiss Credit Bank, immediately started quoting a
pool price for gold, agreed between them. More importantly, they
approached the South African Reserve Bank with offers of
assistance with the financing and marketing of South African gold,
the single most important source of supply. Having successfully
obtained access to this, they embarked on a significant worldwide
publicity programme, aggressively selling physical gold to con-
sumers and hoarders wherever they could.
The London Gold Market members, having lost their access to
new South African gold to the Swiss pool in Zurich, traded as best
they could when they were permitted to reopen on 31st March.
With an eye towards the US market, they introduced a second daily
fixing at 3.00 p.m. London time. In 1968 the US market was limited
in scope; US citizens were not permitted to own gold — only
bona-fide consumers could obtain authorisation to purchase, and
the quantities they could purchase were controlled. The establish-
ment of the afternoon fixing was, however, to stand the London
market in good stead in years to come.
With Central Banks no longer controlling prices, price move-
ments became more volatile as supply and demand fluctuated from
day to day, but both the London and Zurich markets operated
much as before, with the emphasis on physical transactions. Both
markets quoted officially only a price for spot delivery, although
forward business became more prevalent than before.
Despite increased speculative activity, prices did not run away
from the previous $35 per ounce level. On 17th March 1968 the
opening price of the Swiss Pool was $42-45 per ounce, but
profit-taking from previous buyers soon eased prices below $40,
and they remained below $45 until January 1972.
In the early 1970s there developed considerable pressure on the
US dollar in foreign exchange markets. In the previous decade there
had been upward revaluations of other currencies, particularly the
Deutsche Mark, against the dollar, but now the dollar began to
weaken against all other major currencies; the foreign exchange
market was in considerable turmoil during 1971, as several
currencies were either revalued against the dollar or allowed to
float. On the free market gold was widely purchased by investors
worried about the uncertainties, while on the official market the
United States became progressively more unwilling to convert the
dollar holdings of foreign Central Banks into gold. On 15th August
that year, dollar convertibility into gold at $35 per ounce was
formally suspended by the United States, while a reform of the
international monetary system was sought. By 17th December new
parities against the dollar for the principal currencies were
established, and the US Administration agreed to request Congress
to permit a revaluation of gold from $35 to $38 per ounce. At this
time, the price in the free market was $43. When the official
revaluation to $38 was finally enacted on 8th May 1972, the free
market levels had risen to $52.
The realignment of currencies had brought only temporary relief
to foreign exchange markets, and during the first half of 1972 the
dollar came under renewed pressure. In part this was met by resort
to increased inward exchange controls, which encouraged further
buying of gold as the strong currencies became harder to obtain.
Official intervention in foreign exchange rates ceased from time
to time when the dollar came under particular pressure, but in the
second half of 1972 the dollar staged something of a recovery. By
March 1973, however, the pressure had become intolerable, and
fixed exchange rates were finally abandoned in favour of floating.
The dollar was devalued by a further 10 per cent by reference to the
IMF Special Drawing Right (SDR), taking its parity against gold to
$42.22. As a result of so many uncertainties, the price of gold in the
free market had risen as high as $70 in 1972 and $127 in 1973.
From this peak the market fell back on fears that some countries
might sell gold on the free market, for which permission was
granted on 13th November 1973.
The purpose of relating briefly the history of the gold and
exchange markets and the development of prices between 1968 and
1973 is to give an indication of the changes which both underwent.
Clearly in the changed conditions of the gold market the
requirements of customers needed to be met in different ways. More
importantly, a new range of customers came to the market. These
were in one way or another of a speculative inclination; not always
perhaps true speculators, but sometimes investors, who had long
believed in the potential for profit inherent in holding gold. Faced
with much greater volatility of price, they increased the volume of
their transactions, selling temporarily when the price seemed to
them exaggeratedly high, and seeking to add to their holdings when
the market appeared low. At the same time, the larger price
movements from day to day or week to week attracted true
speculators, both individuals and professional traders. Many a
commercial bank with an established foreign exchange department
saw great opportunities in the new era of floating exchange rates.

From trading in these new-style currency markets, it was but a small
step to the new-style precious metals markets, particularly gold. For
these and others, whose financial resources to trade in gold in
addition to currencies were limited, there came a demand to deal on
a forward basis. They did not wish to commit large sums to the
outright spot purchase of gold, but preferred to buy and sell for
delivery in the future. This was a service readily provided by
members of the London Gold Market and their colleagues in the
Zurich pool, as well as by other traders around the world in a
number of local markets.
If the spot price of gold in the free market was $50 per ounce, and
US dollar interest rates in the Eurodollar market 6 per cent per
annum, then the price of gold for delivery in one year's time would
be about $53 per ounce (spot price of $50 + (spot price x 6%)).
Thus a contract for delivery in three months' time could be
purchased for a premium over the spot price of no more lhan 75
cents per ounce — an attractive proposition when spot prices not
infrequently moved by several dollars in a week.
Of course, it was not a free ride. For counterparties of the very
highest credit rating, the London dealers might permit a forward
contract without any margin, but for most customers they would
insist on the immediate payment of a percentage of the value of the
forward contract. This percentage might be as high as 50 per cent of
the value for those of lesser standing. Furthermore, if the market's
direction went against the position of the customer, he would be
required to put up further sums of money to meet his losses if he
wished to maintain the position. The sum of money placed with the
dealer in the first instance is known as 'original margin', and
subsequent moneys placed with the dealer to meet adverse price
movements as 'variation margin'. Notwithstanding these, in many
cases, rather stringent conditions imposed by dealers, the facilities
for forward trading proved popular with the new generation of gold
market participants, because of the opportunities which the greater
movement of prices now offered.
It was not only speculative traders who found them attractive;
anyone with a regular business of buying or selling physical gold
needed some protection against the dangers of unpredictable price
movements. We will return to them later on.
Towards the end of 1973 a new factor began to affect gold prices.
Throughout that year, the nations which made up the Organisation
of Petroleum Exporting Countries (OPEC) inexorably raised their
oil prices, and in December tripled them so that in a year they had
climbed from $2 to $10 per barrel. The industrialised countries
were heavily dependent on OPEC for most of their oil supplies and
no alternative source of supply was immediately available. Oil was
widely used to power their industrial installations, as well as to
provide heating in homes, offices, shops and factories. Because of its
relative cheapness, oil had grown in popularity as a form of energy
at the expense of other traditional methods, such as coal and gas.
The realisation that OPEC had control of a large section of energy
prices came as a bombshell, and immediately raised the spectre of
inflation. This was soon reflected in the price of gold, so long
considered the ultimate asset to protect the investor against rising
prices. Within two and a half months, the price of gold doubled
from $90 to $180 per ounce. This movement was helped by the
belief that citizens of the United States would soon be permitted to
buy gold. Although rumours of this announcement had been
circulating in the market for some time, its effect on the gold market
had earlier been moderated by fears that Central Banks, now free to
sell gold on the free market, would depress the price by their sales,
the potential supply from this source being of huge proportions. In
the event, such official institutions were no more likely to sell their
most prized asset cheaply than other holders. Rather, private
demand from investors concerned about inflation rapidly out-
stripped available supplies from mine production and other sources.
Like all such movements, however, the rise from $90 to $180 per
ounce occurred too quickly, and once it became clear that the
potential for further rises was reduced, holders attempted to take
profits on at least part of their holdings. Those buyers who had
missed out on the rise adopted a more cautious attitude, waiting for
the price to fall; which it did, under the pressure of profiit-taking, as
low as $129 in July.
Before long, however, renewed buying moved prices upward
once more. The rise culminated on 30th December 1974 at $197.50
per ounce at the London Gold Market's morning fixing session, in
anticipation of a surge of buying from US citizens when American
markets opened on the following day. Needless to say, Americans
were not fooled into buying; they thought, quite rightly, that other
markets had 'seen them coming'. The size of US demand was big
enough to absorb only a fraction of the gold overhanging the
market. The market fell back, and it was more than three and a half
years before the price of $197.50 was surpassed.
We have seen, then, some of the changes which affected the
established market for gold in the period running up to the

beginning of gold futures markets in the United States. We have also
seen how the popularity of forward contracts increased as the price
of gold became more variable. In 1974, also, there occurred another
event which was to speed the changes to the established market. In
that year, the Government of Hong Kong decided that the import
and export of gold to and from the Crown Colony should be made
free. Until then the import of gold had been subject to licence, and
licences were only granted to industrial users, who were permitted
to import gold in a form suitable for the end-use for which it was
destined. Often this was 14-carat sheet for the jewellery industry.
Alongside this controlled market, and within Hong Kong, there was
a local Chinese gold exchange — the Chinese Gold and Silver
Exchange Society or 'Kam Ngan' ('gold—silver'). This market is
highly respected and well established; it traces its origins to 1910.
Its members had important contacts in a number of major cities of
the Far East, whose Chinese societies were in one way orânother
cut off from the free market in gold, yet desperately wished to trade
it. Syndicates from Bangkok or Manila as well as groups originating
from particular areas of China, but now living in Hong Kong,
operated on the Kam Ngan, but, if they needed to deliver gold to or
from the market, they had often had to make the arrangements
clandestinely. The liberalisation of gold imports to Hong Kong
made it possible for the non-Chinese to join in. Now European
dealers could buy gold in, say, London, ship it to Hong Kong, and
deliver it on to the Kam Ngan. Of course, the conditions must be
right; the premium available in Hong Kong must be sufficient to
cover the cost of airfreight and insurance from London, the cost of
conversion into the five-tael 99 per cent fine bars which are required
on the Kam Ngan, and still leave a margin to cover the Hong Kong
Government's small import tax, and the dealer's profit.
Delivery on the Kam Ngan is handled in such a way that the
whole operation is quite simple. The European dealer makes a firm
commitment to buy spot gold in London, for which he can obtain
delivery in two working days. On the delivery date in London, he
makes arrangements to transport the gold to Hong Kong where the
400-ounce (12.5-kilogram) standard bars of 99.5 per cent fineness
will be melted down and reconstituted as five-tael bars 99 per cent
fine, acceptable to the Kam Ngan. Let us be generous and say that
the whole operation takes only one week. If the arbitrage dealer is to
avoid a risk on the price movement of gold, he must sell on the Kam
Ngan at the same time as he purchases in London. This requirement
was at first difficult, because the two markets operate in different

time zones, whose opening hours barely overlap. Ideally, the
arbitrageur must find a dealer who will make him a price for gold
'loco London' (i.e. for delivery in London) at a time when the Kam
Ngan is open for business. Soon this service was provided by the
London Gold Market members who founded subsidiary or
associated companies in Hong Kong to quote loco London prices as
a parallel market to the Kam Ngan, during the hours when the latter
was open. Once this parallel market was available, arbitrage
became easy, because when making his simultaneous sale through a
broker on the Chinese Exchange, the arbitrageur knew that he did
not have to deliver promptly. The Kam Ngan had, and still has, a
daily interest settlement at which each unsettled purchase and sale
contract is carried forward to the next day. If buyers do not wish to
take up gold offered for delivery by sellers, they will be penalised in
the rate of interest applied to that day's carry forward. Likewise, if
sellers are unable to deliver when buyers want gold, they will be
charged for the privilege of delaying. The arbitrageur selling into
the Kam Ngan knows, therefore, that he need not deliver until his
gold brought from Europe is available in the correct form, but he
runs the risk of being penalised by the rate of interest applied to the
daily carry forward of his contract on the Kam Ngan. If the profit
margin on his deal is sufficient, this is a risk he is able and willing to
take for a few days.
If, on the other hand, prices on the Kam Ngan go too low, a
reverse transaction may be undertaken by the arbitrageur. Under
these circumstances, he needs the facility to go short in the London
Market. He buys on the Kam Ngan, and simultaneously sells gold in
London, where, as yet, he has no gold to deliver. He requires time,
first to obtain the gold he has purchased in Hong Kong, then to make
arrangements to fly it to London, and further to organise its refining
to London Gold Market standards, and finally to deliver to his
London buyer. This operation might take up to two weeks, perhaps
longer if the gold refineries in the United Kingdom have too much
work. To overcome the problem of an unknown delivery date, the
arbitrageur could, of course, sell forward in London, but such a
contract would commit him to delivering on a date fixed at the time
of the contract. He can guess the date approximately, but not
exactly, so that he may be left with an expensive adjustment to
make in order to get his forward contract exactly to meet the date of
actual delivery.
In order to overcome this problem, London dealers offered a new
type of facility to arbitrage traders. This is known as the 'account/

account' or 'deferred settlement' facility. The arbitrageur opens two
accounts with the London dealer: the first denominated in unallo-
cated ounces of gold, the second in US dollars. In exchange for
an agreed fee, and subject to giving the London dealer control over
both accounts, the arbitrageur is permitted to overdraw on either of
the accounts, provided that the other account is in credit to an
equivalent value. In other words, if he buys gold from the dealer, his
gold account is credited with the amount of gold purchased, and his
dollar account is debited with the dollar countervalue of the agreed
contract price. Details of the operation of such an account are given
in Chapter 6.
One further complication not mentioned so far is that gold prices
on the Kam Ngan are quoted in Hong Kong dollars per tael, and the
unit of dealing on that exchange is 100 taels. The arbitrageur
therefore runs the risk of movements in the exchange rate between
the Hong Kong dollar and the US dollar, which he miJst»cover in
order to avoid losses which might easily exceed the profit on his
arbitrage operation. He must also match as far as possible the
weight of gold in taels in Hong Kong with that in ounces in London.
Mention of a deferred settlement facility is made here to show
one of the innovations put into place by one of the established gold
markets at about the time that futures markets commenced in the
United States. Of course, the uses to which a deferred settlement
account can be put are not limited to the business of arbitrage with
the local exchange in Hong Kong, although the desire to undertake
such business there seems to have been the initial reason for their
development. As time went by, professional traders used such
facilities for arbitrage between loco London gold and the United
States futures market, as well, too, as to take outright long or short
positions without the need for full settlement. For the London
dealers who grant such facilities, the deferred settlement facility
provides an additional source of fee income.
While the London Gold Market met the challenge of changing
conditions by developing new products at the end of 1974, it did
not provide anything exactly equivalent to the new futures markets
in the United States. As the popularity of these markets became
apparent, many other dealing centres, including London, started
their own futures markets, in an attempt to reserve for themselves a
part of the new activity. To this theme we will return in a later
chapter.
2
US futures markets
In the first chapter we saw how the established gold markets of

London, and later Zurich, were very largely based on spot or
physical transactions, and why. The buyers and sellers whom those
markets principally served wished either to sell or to acquire
physical metal. Even after 1968 the development of forward market
dealings, and later the deferred settlement facility, though these
exhibited features similar to US futures markets, in reality always
related back to spot transactions. As already recorded, the London
Gold Market to this day has no official price for forward trades.
In the United States, the background to the introduction of gold
futures is very different. Futures markets in other commodities have
a long history. It may be said that they have their origins in the type
of people who were attracted to the United States in the early days
of its independent development, and responded to the needs of such
people. For most immigrants, the United States represented a
country of great opportunity, offering a chance to participate in the
richness of its natural resources and land. Those who went there
from Europe were in the main persons of pioneering spirit, prepared
to leave behind them the inequalities of lifestyle, land tenure and
opportunity, in return for the chance of becoming wealthy or
acquiring a higher status in a young country. In doing so, they
recognised that they were taking a risk, but were only too willing to
do so, because they saw little prospect of bettering themselves in
Europe. Many were from the land, and went to get larger holdings.
The size and diversity of the United States offered the prospects of
growing many different crops, but the climate in most areas can be
harsh, and they soon learned that their harvests were subject to a
great number of uncertainties. Late frosts or snowfalls in spring,
heavy rain or drought in summer and hurricanes or tornadoes could
all affect success. In uniformly good years, the abundance of crops
could drive down prices for grain, while shortages, either local or
widespread, could cause a boom. Faced with such uncertainties,
there grew up a demand for futures markets for agricultural
commodities. Chicago became an important centre in the Mid-
West for the processing of many products, both agricultural and
pastoral, and it is therefore not surprising that markets soon
became established there for the various commodities, the earliest
being that for agricultural produce set up in the Chicago Board of
Trade in 1848.
What these markets offered was essentially the facility to hedge
without the necessity of delivery. In other words, if a farmer knew
that the price of wheat for delivery in a few months time*vas high
enough to cover all his costs of production and transport, and leave
him a good margin of profit, he could sell on the futures market. If
prices subsequently came down, he could congratulate himself on
obtaining a price better than he would have realised if he had waited
until his crop was harvested and ready for the market. If, on the
other hand, prices continued to rise, he would complain of his
misfortune, but yet be satisfied that he had locked in a good margin
for himself. He had reduced the uncertainty and passed the risk on
to someone else. Of course, he might find tbat in the event the yield
of his harvest was less than anticipated. In this case, he would have
to buy back the excess quantity he had sold, but he always had the
opportunity of doing this, even though he could not be sure that he
would be able to do so at an advantageous price. More probably, he
would not in the first place hedge the whole of his estimated crop; he
would rather lock in his profit only on a proportion, and continue to
carry the risk himself on the rest.
Likewise, a wheat merchant could make contracts to supply end-
users and protect himself against changes in price before delivery of
the wheat by buying on the futures market, again assuring himself
of a profit margin on part or all of his commitments. The farmer and
the merchant were not and are not the only participants in such
futures markets. Because commodities such as wheat are subject to
the vagaries of the weather and the availability of transport,
movements in price may become quite large as the prospects for any
given harvest change. As soon as such price movements are suf-
US futures markets 17
ficient to attract the speculator, such an individual will come to the

market in the hope of picking up a profit.
The scene for a futures market in wheat having been set, it may be
appropriate to consider the workings of such a market in more
detail. Wheat may seem very different from gold, but the futures
markets of both have many similarities of organisation. A futures
market (or futures exchange) is one where a number of members
come together to trade in a commodity. In a commodity such as
wheat, the members will probably consist mainly of grain mer-
chants who buy from farmers on the one hand and sell to end-users
on the other. Some merchants specialise in collecting orders from
farmers, while others are more active with industrial processors.
Large farmers may be members in their own name, while some
processing companies will also seek membership because the cost of
the commodity is by far the largest proportion of their total costs.
As the market develops, new members may be attracted who have
no direct involvement in the grain business, but who see opportuni-
ties to buy and sell, or perhaps to benefit from the differentials in
price between one commodity and another. Lastly, a number of the
members will be the so-called 'commission houses', who specialise
in collecting orders in many different commodities from indi-
viduals, be they farmers, processors or speculators.
The members set aside a room or floor for the purpose of trading.
Today such 'trading floors' are very much purpose built. The large
exchanges, such as the Chicago Board of Trade, deal in a number of
different commodities; for each there is a separate trading floor,
with a 'pit' around which members, or authorised traders who may
not be full members, stand when they wish to trade. Around the pit
are banks of telephones, by means of which orders to buy and sell
are transmitted from the outside world. In active market condi-
tions, the member or authorised trader cannot leave the pit to
receive or report the execution of orders. Clerks (also authorised by
the exchange) take down in writing the orders from the telephone
and hand them to the trader. Staff employed by the exchange, who
are not themselves members, record the trading as it occurs, and
transmit the prices traded to a large indicator board situated on the
trading floor. Nowadays these price signals are also broadcast to
the world by news services, who 'buy the signal' and send it
electronically to a multitude of television screens and ticker-tapes
placed in the offices of their subscribers throughout the world.
Such a complex operation requires rules. These are usually
established by the members themselves, although in recent years
most large exchanges have come to employ a full-time staff who are
responsible for marketing the exchange's products and considering
all matters relating to the rules. Increasingly, they must take
account of legal matters and the requirements of the Commodity
Futures Trading Commission (CFTC) the body established by the
US Government to regulate trading in commodities.
In essence, the rules relating to trading on futures markets may be
divided into three parts. First, the 'contract rules', which define the
quantity and quality of each commodity traded and the delivery
dates. Secondly, the rules for the conduct of trading itself, many of
which are designed to encourage fair trading and to prevent
malpractices. Lastly, there are the rules concerning the clearing
house, an essential feature of futures markets.
Initially, each trade will be concluded between a member who has
a buying order and another who is a seller. A number of members,
but not all, are 'clearing' members of the exchange. The clearing
members as a group make up the 'clearing house'. The*clearing
house takes over from a non-clearing member the responsibility for
the contract. (Outside the United States the functions of the clearing
house may be assumed by an outside independent body.) By the end
of the trading day, all trades must be 'given up' to a clearing
member, who in return for a fee registers trades with the clearing
house, which guarantees performance of the contract. So once the
trade is executed, agreed and registered with the clearing house, the
two members who originally traded together no longer have
responsibility to each other for its performance. Their individual
responsibility is to the clearing house, through their chosen clearing
member. The latter is responsible to the clearing house for the
collection of margin, both original and variation, from his
customers; in other words, for ensuring that the customer is in a
position to meet his commitments under the contract.
The system generally used on US futures markets is to set a low
level of original margin, normally between 2 and 5 per cent of the
value of a contract in normal market conditions, but higher for
speculative accounts. If price volatility becomes very marked in the
commodity concerned, original margin may be increased substan-
tially. At the end of each trading day (and occasionally more
frequently if price movements are pronounced in one direction)
each outstanding contract is revalued at the settlement price of the
day, and each person holding a contract either receives the dif-
ference between the price at which he dealt and the day's settlement
price, if he has a profit, or pays in the difference, if he has a loss. All
variation margin is payable or receivable in cash, whereas on some

futures exchanges some participants may deposit original margin in
other acceptable forms, such as US Treasury Bills.
The market in agricultural commodities quickly became
established, and volume on the exchanges grew rapidly. Because of
the importance of such commodities for the nourishment and
wealth of the nation, they soon attracted the attention of, and were
subject to regulation by, the US Department of Agriculture. In other
commodities, too, a futures market soon developed as production
of such important raw materials as copper grew rapidly. There was
generally a ready market for such commodities in the United States,
whose population and, therefore, consumption increased as a result
of the large immigrations which occurred between 1870 and 1920.
The United States prospered greatly as a result of the First World
War, and the boom continued, as is well known, into the 1920s.
Nevertheless, supply and demand were often not evenly balanced,
so that futures markets in metals, as well as agricultural commodi-
ties, were established to assist in evening out the imbalances.
Gold did not feature among these futures markets for two
reasons. First, despite the big discoveries in California from the late
1840s, and in the Yukon towards the end of the nineteenth century,
it was never in excessive supply in the United States. More import-
antly, it was part of the currency and circulated as coinage. Until
1900 the United States was on a bimetallic standard, that is gold
and silver coinage were in circulation side by side, and both were a
standard of value, the ratio between the two being officially fixed.
The ratio varied from country to country; in the United States it was
changed from 1:15 to 1:16 in 1834, but it always proved difficult to
maintain the ratio in the face of changes in the level of production of
the two metals. This was particularly the case after 1870, when gold
production temporarily decreased, while that of silver increased
rapidly. After considerable controversy the United States adopted a
gold standard in 1900. The substance of the gold standard was that
the price of gold was fixed, and that gold coins formed the whole of
the currency in circulation. In practice, notes redeemable in gold
usually also circulated. Because the value of the dollar was fixed by
law in terms of gold, which could be freely imported or exported,
there was no requirement for a futures market.
The United States prospered under the gold standard, and the
high level of economic activity persisted through the First World
War to the 1920s. The arrival of the Depression was, however, to
affect the general demand for commodities, and eventually had an
effect on gold, if in a different way. To take first the demand for raw
materials. Once the demand for the consumer goods which these
raw materials served was suddenly cut, excess supply became a
problem. Copper mines, whose metal was required for a number of
products from automobiles to telephone equipment, quite suddenly
found that their product was needed in much smaller quantities, not
only because the demand for the end-products was sharply reduced,
but also because its users were forced to cut back the level of stocks
they held for normal business; excess supplies could not be readily
exported, as the Depression spread rapidly to other industrialised
countries. The futures markets also suffered, and it is no accident
that the Commodity Exchange Inc., New York (Comex), today the
leading futures exchange for gold in the world, traces its origins to
1st January 1933, when a reorganisation of several exchanges,
including the National Metal Exchange founded 50 years-earlier,
occurred. After over three years of depression, few could see any
% %
change, and a new market was needed.
As far as gold was concerned, the price remained unchanged at
the equivalent of $20.67 per ounce until later in 1933. As part of his
Government's 'New Deal' to pull the United States out of the
Depression, President Roosevelt decided to increase the value of
gold. In March 1933 a ban on the export and the hoarding of gold
was introduced. Later the same year the US Administration began
to push the price slowly up, but, finding that this had no measurable
effect on boosting the economy, they resorted to a major price
increase in January 1934, when gold was revalued to $35.00 per
ounce.
The ban on ownership was to last, as already stated, for 41 years,
until 31st December 1974, thus effectively preventing any forma-
tion of a futures market until that time. At approximately the same
time, however, in August 1934 to be precise, measures were put into
effect to nationalise silver in the United States. This was eventually
to result in a strong interest in precious metals, when a silver
contract on Comex was re-established in 1963. Like other pro-
ducers of raw materials, the US silver mines were hit by the
Depression. The price of that metal had dropped from about 150
cents per ounce in 1920 to under 50 cents in 1931. As the United
States was still minting silver coins, and there was substantial
seigneurage (the difference between the nominal value of the coins
and the cost of their manufacture) available, the US Government
decided to purchase silver from domestic mines at a price originally
fixed at 50 cents per ounce. For some years this was above the free
market price of the metal, and the quantity produced by US mines

exceeded the rate of minting. As a result, the US Treasury acquired a
very substantial stockpile. After the Second World War the world
price moved above 50 cents per ounce, eventually reaching 100
cents in 1961, when the US Treasury free stocks were virtually
exhausted. This increase in price reintroduced a requirement for
hedging, as the development of prices became less certain.
The new silver contract of Comex dates from 1963, by which
time the price of silver had reached $1,293 per ounce, the level at
which the amount of silver contained in the US coinage was equal to
the nominal value of the coins. In order therefore to ensure that the
coinage remained in circulation, the US Treasury was forced to sell
silver to all-comers in the market. In fact, the minting of 90 per cent
silver coins ceased in 1965, and they were gradually replaced by
coins containing only 40 per cent silver, but it was several years
before the existing coins were withdrawn. The stocks of silver
which the US Treasury had built up in the 1930s and 1940s were
substantial, but demands from the market, particularly as a result of
the growth in photography, were also large. It became clear that the
stocks held by the US Treasury would be exhausted before long.
Speculation against this possibility increased rapidly, and soon the
demands from the market became overwhelming. On 12th May
1967 the US Treasury suddenly announced that it would no longer
supply all requirements, although for a time it continued to provide
silver to US domestic customers at the price of $1,293 per ounce.
On the free market, prices shot up rapidly, as international con-
sumers, investors and speculators vied with each other for the
diminished supplies now available. Total consumption for minting
and industrial purposes outstripped new mine production by a
considerable margin, although there were very large additional
supplies in the hands of the public and in industrial stocks. The
public held large quantities of 90 per cent silver coin, which began
to disappear from circulation as its intrinsic value surpassed its
nominal value.
These developments were ideal for the rapid increase in volume
on Comex, the only futures market offering a silver contract at the
time. On the one hand consumers and speculators wanted to buy
silver for future delivery. On the other, dealers and members of the
public were willing sellers at the higher prices. Those dealers who
had been clever enough to buy silver coin at the lower price levels
needed to hedge their holdings during the time required for refining
silver into bar form. A number of schemes were developed to
acquire 90 per cent silver coins still in circulation, even at the new
higher prices ruling. These, too, caused a requirement for hedging.
From 1966 to 1969, during which year silver prices reached almost
$2.50 per ounce, the annual volume on Comex increased from
9,329 lots of 10,000 ounces each to 544,804. In November 1969 a
silver contract was introduced on the Chicago Board of Trade, the
world's largest futures exchange.
While there were strong reasons for the rapid growth of interest
in silver per se, it should be remembered that US citizens were
prevented from owning gold, which, after March 1968, had
become more widely sought as a hedge against the value of the
dollar and as a protection against the possibility of inflation. To a
large extent, silver was purchased as a substitute for gold, in the
belief that it had the same monetary connotations as gold, and had,
in addition, the support of a large and growingindustrial consump-
tion. In the early 1970s, the attention paid to precious metals
continued to increase, as currency instability and inflationary fears
gripped the public. While these concerns were in the United States
most notably directed towards silver, the growth of futures markets
generally was setting the scene for the introduction of gold.
3
Who needs gold
futures?
In the preceding chapters we have contrasted the attitude towards

gold widespread in Europe and the Far East, with the history of
futures markets in the United States. While there are features
common to the two, in particular the desire for protection against
uncertainty, there are also manifest differences. Many Europeans
have seen their countries overrun during two World Wars, during
which time the concept of worldly possessions has for many
evaporated, and the issue of survival on the best possible terms has
become uppermost. In agricultural communities, both in Europe
and in many parts of the Orient, the vagaries of crops have often
required the building of reserves in good times in a form which may
easily be liquidated when times turn bad. Gold has been an ideal
investment under both circumstances, being easily recognisable,
commanding a fair price throughout the world, and being easily
transportable in small quantities. Furthermore, it has the long
tradition of being associated with wealth, thus acquiring a social
cachet. In the few countries which have suffered rampant inflation
within living memory, it has shown the ability to maintain its value,
in spite of its main defect compared with other forms of investment,
that it does not pay interest or dividends.
Against this strongly developed tradition has been set a brief
history of the people of the United States, who have been presented
as endowed with a pioneering spirit, willing to take risks to better
themselves, and therefore having little interest in the traditional
European defensive values ascribed to gold. They are, moreover,
generally well versed in the markets of the capitalist system,
accustomed to investment in stock markets and prepared to risk

their money in many and varied schemes, not least the futures
markets for commodities.
What the 1970s have done is to bring together these divergent
attitudes, at least in a small way, by combining them in gold futures
markets. This was made possible by inflation, or, more correctly,
the expectation of it. Before the oil crisis of late 1973, such fears
were stimulated by the weakness of the US dollar, after a long
period of strength which resulted not only from the United States'
position as a large producer of food and raw materials, but also
from the dollar's central position in the world's monetary system
after 1944. As the United States' trade performance deteriorated,
and an outflow of capital occurred in the 1960s, the strength of the
currency was called into question. Notwithstanding the rather
small reliance of the United States on international trade, when US
citizens, whether corporations or individuals, saw other currencies
strengthening at the expense of their own, they increased their
investments abroad. The resulting outflow of dollars (there being
no exchange controls) fed on itself, as foreigners, previously look-
ing upon the United States as the safest haven for their own money,
also searched elsewhere. The capital inflows which other countries
such as West Germany, Japan and Switzerland could accept were
limited by the size of their economies, and often attempts were
made to discourage such inflows.
The official devaluations of the dollar in 1972 and 1973 did little
to alleviate matters. Once the dollar began its fall from grace, an
increasing number of investors sought to protect themselves from
further decline. The predominance of the dollar as the currency in
which international trade, particularly that of commodities, had
been denominated had earlier been a source of strength, but now
became a further cause of its weakness. In an attempt to restore
their declining revenue, and recognising that the industrialised
nations were at their mercy, the OPEC countries' decision to triple
oil prices in December 1973 caused a major interest in gold to
develop. This one event, more than any other, turned the attention
of the world towards the probability of inflation, not just in the
United States but throughout the world. Indeed, the first reaction
was that the United States, being less dependent on imported oil
than other industrialised countries, would suffer less, and the dollar
therefore staged a temporary recovery. Nevertheless, the threat of
worldwide inflation was real. The only alternative would have
been for a major deflation to be induced by governments, but such
Who needs gold futures? 25
was not expected because it would not be popular with their

electorates. As it was, the increased cost of oil for heating homes
and for running motor cars would affect the average family's
budget and reduce its spending power. Some governments did
introduce emergency schemes for saving energy, especially when
Arab OPEC countries imposed an embargo on the supply of oil to
the United States and Holland, and a shortage of supply became a
reality.
We have already seen that events late in 1973 caused investors
and speculators to turn to gold, that traditional haven in times of
turmoil. As yet, citizens of the United States could not legally join
those of other countries who bought gold, but nevertheless the
'American' effect on the market was starting to make itself felt in
early 1974. Behind gold's rise there were not only concerns about
the effect of the energy crisis, but rumours that OPEC countries
might demand payment for oil in gold, and that EEC countries
might use gold in intra-Community settlements at market-related
prices. Perhaps more substantive was the poor performance of the
world's stock markets, which made investment in securities unat-
tractive. But behind it all was the impending arrival of US gold
ownership. Later in 1974 the news was not all good, and in
particular the threat of sales by countries in balance of payments
difficulties loomed large. The likelihood that US citizens would be
able to own gold came a step nearer on 29th May, when it was
announced that the US Senate had passed an Amendment to a Bill
which would permit this; but by the time this was finally confirmed
on 4th July, the market had dropped by 20 per cent, mainly because,
with the withdrawal of the banking licence of the German
Bankhaus Herstatt in Cologne, it was rumoured that liquidation of
their substantial long positions in gold would be necessary. In under
four weeks the gold price had fallen from $160 to $129 per ounce.
The market was to make up this loss and more before US ownership
occurred at the end of the year. This volatility in a metal for so long
the backbone of the world's monetary system was curious, and in
many quarters unexpected, but it certainly made gold a prime
candidate for a futures contract.
These are the fundamental changes which gold underwent in the
years leading up to the establishment of gold futures markets in the
United States. No longer under the control of the Central Banks, it
gained a price volatility which made it comparable to the commodi-
ties already traded on futures exchanges - agricultural commodi-
ties, copper and silver — at a time when the financial world was
adjusting to the new conditions of the 1970s, including floating

exchange rates and less stable interest rates.
The actual moment of the long-awaited US ownership was
disappointing. The Americans showed little desire to buy gold
whose price had been pushed up to record high levels. From
$197.50 quoted in London on 30th December 1974, the market fell
back to $170 on 7th January 1975. For one thing, the US Treasury
had decided to auction 2,000,000 ounces (62 tonnes) of gold to
meet anticipated demand from its own citizens. The market's
malaise was, however, more deeply rooted than this, and the
volume of business on the established European markets dropped
away, while on the US futures markets it was slow to develop. The
need for a futures market in gold had been made clear, but, in the
new market's infancy, the spark necessary to create activity was
missing.
^ %
4
Comex
Now that we have traced the history in this century of the principal
markets for gold and that of the futures markets in the United
States, the time has come to move on to the organisation of gold
futures markets there.
On 31st December 1974 ('impact day') four futures exchanges
had gold contracts ready for trading — the Commodity Exchange
Inc., New York (Comex), the Chicago Board of Trade, the Interna-
tional Monetary Market of the Chicago Mercantile Exchange and
the Mid America Exchange, also in Chicago. All these markets are
still in business today; Comex will be considered in this chapter and
the others in Chapter 5. The New York Mercantile Exchange also
introduced a one-kilogram contract on impact day, added a 400-
ounce contract in 1977, but discontinued both contracts when no
activity was recorded in 1981.
Reference to Comex has already been made. Although it had,
prior to 1974, tried contracts in commodities such as propane, and
has subsequently introduced several contracts in financial instru-
ments, its main activities and success have been in metals. Before the
introduction of gold, copper and silver were its mainstay, but in
recent years gold has surpassed both in terms of volume traded.
Most observers believed that, if gold futures were to be successful at
all in the United States, then Comex would be an important market,
being situated in the United States' leading financial centre. This
belief has certainly been proved right by events. Nevertheless, in
early days activity was slow to develop, but even in the first full year
of trading, 1975, the total volume of 100-ounce contracts turned
over was 393,517, equivalent to 1,224 tonnes of gold, or 110 per

cent of the supply in that year. As Comex is now by far the most
active of the US gold futures markets, it seems only appropriate to
devote more attention to it than to the others, which share many
features in common with it.
The twin towers of the World Trade Center in downtown New
York are a spectacular and well-known landmark to New Yorkers
and visitors from all parts of the United States and other countries
of the world. They may no longer be the tallest buildings in the
world, but their dominating presence makes it easy to pick them out
from the crowded skyline. On a clear day they can easily be seen
from the windows of an aeroplane landing at New York's John F.
Kennedy Airport. No less spectacular are they when entered from
the ground floor. In rush hours, thousands of people jostle each
other as they make their way to or from work, passing through huge
shopping precincts, all enclosed.
The two buildings house no less than 50,000 people-dyring the
working day. Not least amongst them are the employees of Comex
and those who trade there on the floor. On the eighth floor of Four
World Trade Center is the huge trading floor known as the
Commodities Exchange Center shared by Comex with three other
New York commodity exchanges.
During the busy periods, over 1,000 people may be on the floor at
once, packed around the rings at which each different commodity is
traded. It is truly an unbelievable experience to visit this place, and
to recognise how huge a turnover in many different commodities is
generated. To the untutored ear and eye it is more like bedlam, as
hundreds and hundreds of people scream at each other prices,
orders and executions of orders. Close to each ring are group lines
of telephone booths — the traders' means of communication with
the outside world. Manning these phones are the clerks who receive
the orders from the customers and pass them to the authorised
traders. Clerks are not permitted to trade, but they frequently leave
the phone booths to hand a slip to a trader standing by the ring. On
these slips are written orders to buy and sell. Many have developed
coded hand signals used mainly to transmit prices, and perhaps, on
occasion, orders.
Also present on the floor are officials of the Exchange, respon-
sible for keeping track of prices traded and inputting these prices to
the Exchange's computerised signal system, which flashes the prices
on to an enormous price board covering the whole wall of one side
of the trading floor, from where it can be seen from every corner.
Com ex 29
These signals are sold to the leading newswire services, which

transmit them through their system of computers and by satellite to
television screens in every corner of the globe. Despite the tech-
nology which sends these prices so quickly across the world, no
system has yet been devised to give a truly instantaneous trans-
mission, as a result of which, in times of hectic trading, the prices
available through the news service companies may often be a
minute or so behind actuality. For this reason, many large dealers
outside the Exchange are linked up to the phone booths by direct
telephone, and the clerks monotonously call the latest quotations
over the phone throughout the trading session. In many a dealing
room in New York City, the clerk's voice on a loudspeaker intones
'60 at 80, 60 at 80, 70 bid, 70 to 90 now, figure bid, 2.00 bid at
20 ...'. These abbreviations convey to practised dealers the precise
price levels of the market. Suppose that there are buyers of gold
February delivery at $375.20 per ounce and sellers at $375.40. This
will come across as '[375.] 20 bid at 40 [asked]'. Even in today's fast-
moving markets, the 'big figure' is frequently left out. If the market
moves up to $375.60 bid and $376.00 offered, this will be '60 bid at
00'. If buyers come in at $376.00, you will hear '00 bid' or '600 bid'.
Confusion can arise when a large buying order hits the market and
drives the price up by $1.00 per ounce or more. For a moment, those
outside the Exchange may lose track of the real price (as indeed may
some on the floor). There are even occasions when different prices
trade on different sides of the ring simultaneously, notwithstanding
the basic assumption that sellers will sell to the highest bidder and
buyers seek the lowest offer. In this environment, the quick-witted
survive longest, and get the largest share of the business. Oppor-
tunities are there to be taken, but no one is successful every time.
The Comex gold contract is typical of most gold futures contracts
around the world, so that a detailed description is given here.
Delivery months
The delivery months quoted are the spot month, plus the next 11
'active' months. Active months are the following: February, April,
June, August, October and December; the calendar month two
months after the spot month may also be quoted, even if not an
active month. For example, those delivery months for which a
quotation was available in March 1984 were March, April, May,
June, August, October and December 1984, plus February, April,
June, August, October and December 1985. The date of delivery is
at the seller's option.
Contract size
The size of one contract or 'lot' is 100 ounces, having a value in
March 1984 of some $40,000.
Daily limit
The minimum fluctuation in price is ten cents per ounce, and the
maximum permissible daily movement from the previous day's
closing price level (up or down) is $25.00 per ounce. The spot
month is, however, not subject to the limit on daily price move-
ments. As an example, on Tuesday 13th March 1984, the closing
(or settlement) price for the March 1984 contract was $398.50 per
ounce, while that for April 1984 was $400.40 per ounce. This
meant that on the following day the April 1984 contract could not
be quoted lower than $375.40 per ounce, nor higher than $425.40.
(In fact, the market conditions on 14th March were relatively calm,
and the extreme range of prices on that day for the "Ajtoril 1984
contract were $395.00 to $402.90 per ounce.) If it had been the case
that the market on 14th March had fallen to $375.40 for April 1984
delivery and there had been unfulfilled offers of gold at that price,
then, because no further downward movement would be permitted,
trading would effectively be suspended in the future months for the
remainder of the day, although, as stated, dealing could have
continued in the spot month (March 1984 in this example). In
practice, it is usually possible, if a daily 'limit move' occurs, to
transact one's business in the spot months, and then switch it to the
future month. A switch is the simultaneous purchase of one cur-
rently quoted month, and sale of another month.
The daily limit move may be adjusted in the light of market
conditions from time to time. In March 1984 the limit of $25 per
day would automatically have been increased to $50 per ounce after
two days of $25 moves in the same direction. However, it may be
altered at any time after consultation and agreement between the
Comex authorities and the clearing house.
Original margin
The daily limit in force at any time usually has some relation to the
minimum original margin requirements. In mid March 1984 the
original margin required from speculative accounts was $1,300 per
lot for outright positions, that is positions either all 'long' or all
'short'. Lower margins are agreed for switch positions, i.e. where
long positions in one contract month are set against short positions
Comex 31
in another month. Special margins may be required for open

positions in the spot month.
Based on the price of approximately $400 per ounce on 13th
March 1984, the daily limit move was equal to about 6.25 per cent
of the contract value, while the minimum original margin for
speculative accounts was equal to 3.25 per cent of the contract
value. Non-speculative accounts (known as 'bona-fide hedging
accounts') may benefit from a lower original margin. At 14th
March 1984 the minimum original margin requirements for such
accounts was $1,000 per lot.
By way of comparison, the closing price for silver for March 1984
delivery on Comex on 13th March 1984 was $9.76 per ounce,
while the initial daily limit was $0.50 per ounce, equivalent to 5.12
per cent of the contract value. Although this figure was lower than
that for gold, the minimum original margin requirement, at $3,200
per contract (or 6.55 per cent of the contract value) for speculative
accounts, was higher. One reason for this was that there was
perceived to be more speculative activity in silver than in gold.
During the five months from 1st October 1983 to 29th February
1984, the daily limit movement occurred eight times in silver, but
not at all in gold. Another reason for the higher original margin in
silver was the somewhat greater value of one lot (9.76 x 5,000
ounces, i.e. $48,800 compared with $40,000 for one lot of gold).
Over the whole of 1983, prices in the March 1984 silver contract
varied between a high of $16.24 and a low of $8.75 per ounce, a
movement of $7.49, or 46 per cent from the highest price. In gold,
the range in the April 1984 contract over the same period was from
$565.20 to $388.40, a movement of $176.80 or 31 per cent from
the highest level.
While the setting of the level of original margin is based on the
recent historic price volatility of the contract, and the amount of
speculative activity, the clearing house may require the level of
original margin to be raised in case of a sudden increase in activity
or volatility, and such new requirements may be applied to existing
contracts as well as new ones. At the height of the speculative boom
in silver in January 1980, the original margin requirement for silver
in the spot month was $75,000 per contract, equivalent at the time
to almost 30 per cent of the value of one contract. This apparently
draconian requirement proved fully justified when the market soon
collapsed, and silver declined by the maximum daily limit on 20
successive business days from 6th March to 3rd April that year.
The clearing house

It would be suitable at this juncture to give more details of the
Comex clearing house. In March 1984 there were some 140
'clearing' members. Clearing members must be corporations or
partnerships and must have a minimum capital of $1 million. The
clearing members jointly make up the clearing house and guarantee
the performance of each of the contracts quoted on the Exchange.
The rules relating to liability in the event of the default of a clearing
member are quite complex, but, in essence, the remaining clearing
members have to take up their share of the defaulting member's
liability. Thus, any person trading on Comex has the combined
strength of the clearing members standing behind the contract in
this mutual guarantee. The clearing members of Comex include
such illustrious names as Merrill Lynch, E. F. Hutton, Prudential-
Bache and Shearson/American Express, but it should be borne in
mind that many of these large firms have formed separate subsidi-
ary companies to undertake their responsibilities as clearing mem-
bers of Comex or other futures exchanges, so that the full financial
strength of each parent corporation does not automatically back
the contracts.
Although the financial health of the Comex clearing house was
put under severe strain during the boom and subsequent collapse of
silver prices in 1979/80, it survived to tell the tale. The lesson
learned at that time was the danger which exists when too great a
concentration of the open position is in too few hands, even if those
holding a large position, either short or long, succeed in dominating
the market for a considerable period of time. For this reason,
nowadays the positions of a certain size are scrutinised both by the
exchange concerned and by the Commodity Futures Trading Com-
mission. Details of this monitoring are considered later.
Variation margin
The danger of a concentration of positions arises from the system
known as variation margin. In effect, this means that each operator
on the market is entitled to receive his profits and must pay up his
losses every day. It will be recalled that the minimum original
margin on gold contracts stood at $1,300 per contract for speculat-
ive accounts in March 1984. The clearing member of Comex is
responsible for collecting this margin from his customer. If he has
any doubt about the customer's creditworthiness, the clearing
member may well require an original margin higher (in some cases,
Comex 33
much higher) than the minimum fixed by the Exchange. Whatever

arrangements he may choose to make above the minimum level of
original margin, there are no exceptions in respect of variation
margin, which works as follows.
Taking the same days as examples, we have gold for April 1984
delivery with a closing price of $400.40 per ounce on 13th March
1984. Assume that there is one operator, 'A', with a long position of
ten lots, and another, 'B', with a short position of the same amount,
and that they hold these positions on 13th March, and maintain
them on the next business day. On that day the market closed at
$395.80 per ounce for April 1984 delivery. As compared with the
previous closing price, A has a loss of $4.60 per ounce, while B has
the same profit; on ten lots, or 1,000 ounces, the loss for A, or profit
for B, amounts to $4,600. A is required to pay up $4,600 immedi-
ately, while B is entitled to receive his profit of the same amount.
The exact arrangements which each clearing member makes with
his client may vary considerably. In practice, many individual
customers will keep spare cash with their clearing member to meet
possible calls for variation margin in case the market moves against
them. On the other hand, if a customer has a profitable position, he
may elect to leave the profit in his account with the clearing
member. Furthermore, he may use his profits as original margin,
and add to his position. Clearing brokers do not pay interest on
margin deposited by customers, so that larger operators usually
wish to withdraw profits from their account with the clearing
broker in order to avoid loss of interest. In many cases, professional
operators may be arbitraging between Comex and another market.
If therefore they have a profitable position on Comex and a losing
position elsewhere, they may need to withdraw their variation
margin profits on Comex so as to meet calls for margin from other
markets. It will be obvious that the effect of the variation margin
system is that both profits and losses are payable immediately,
which in practice means with good value on the following business
day. Therefore, to withdraw profits as they arise and place the funds
in an interest-bearing account can significantly reduce the cost of
trading. On the other hand, adverse variation margin may add to
that cost considerably.
Delivery
It is often said that futures markets are not really designed to
facilitate delivery of the commodities traded, and it is certainly true
on the major gold futures exchanges that most contracts are closed
out before the delivery date. In 1982 the total volume of gold
contracts traded on Comex was 12,289,448, while deliveries were
only 113,154 contracts, or less than 1 per cent. In 1983 the figures
were 10,382,805 and 116,467 or 1.12 per cent. Nevertheless, an
efficient mechanism exists for delivery if required. Sellers may
deliver gold meeting certain precise requirements into warehouses
approved by the Exchange. The requirements to be met include the
weight of bars and the fineness of the gold, which must not be less
than 0.995. Furthermore, only the bars of certain gold refiners are
accepted. Details of these are given in Appendix B. As bars rarely
weigh exactly 100 ounces, an adjustment will be made to the exact
weight delivered, and it should be noted that this adjustment is
made at the settlement price of gold ruling at the time of delivery of
the contract, not at the price at which the purchase or sale was
originally made. ^ _
On Comex, delivery of a 100-ounce lot may be made either in
bars having a fine weight of approximately 100 ounces^±5 per
cent) or in three one-kilogram bars. Though these weigh exactly one
kilogram, their fine weight varies according to the fineness of the
gold contained in them. If this fineness is the minimum acceptable,
the weight of three bars is 95.970 ounces. To be eligible for delivery,
all bars must be deposited in warehouses approved by Comex.
In practice, most deliveries do not involve a movement of the
physical gold. When gold is delivered to the approved warehouse,
the warehouse will check the weight of the bars, and issue a receipt
to the depositor. This 'warehouse receipt' specifies the identifica-
tion numbers and weight of the bars, and their fineness, which is
generally supported by an assay certificate. The warehouse receipt
is made out in the name of the depositor, but may be endorsed by
him. Once so endorsed, it becomes effectively a 'bearer' document-
that is that the warehouse will redeliver the gold represented by the
receipt to the holder from time to time, subject to suitable identifica-
tion and other security procedures.
When futures contracts come to delivery, settlement is made by
transfer of the warehouse receipt. Let us suppose that a dealer is
short of futures contracts and wishes to deliver against his short
position. When the delivery month is reached, he will present the
warehouse receipt to his clearing broker and instruct him to tender
the receipt to the clearing house. This is done by issuing a tender
notice. On receipt of this notice, the clearing house will allocate the
delivery to another clearing member having a long position. This
second clearing member will in turn allocate tenders he receives to
Comex 35
his customers holding long positions, normally on the basis that the
customer who has held the long position for the longest period of
time is allocated first. The actual delivery is effected by the first
clearing member settling direct with the clearing house, that is by
delivering the warehouse receipt in return for a cheque in payment
('delivery against payment'). The price used for such payments is
not, of course, the original contract price, but the settlement price
ruling at the time of delivery. Once the clearing house has the
warehouse receipts it on-delivers them to the second clearing
member in return for a payment. It is also possible for the two
clearing members to settle direct with each other.
Comex members
As at the end of 1984, Comex had approximately 650 full members.
Every full membership is in the name of an individual, but two
members may confer 'corporate (or partnership) privileges' on a
firm. In the days before negotiated commissions came in in 1978,
members of Comex benefited from a reduced rate of commission on
business which they transacted on the market. Today, the level of
commission paid by members and non-members depends on the
amount of business they can introduce, and their bargaining power.
At the end of 1984, there were approximately 500 members
regularly trading on the floor (excluding financial instrument
permit holders). Some of these work for large corporations special-
ising in commodity brokerage. These are mainly firms which are
also stockbrokers, such as Merrill Lynch, Shearson/American
Express, Prudential-Bache Securities, E. F. Hutton and Drexel
Burnham Lambert. Collectively they are known as 'commission
houses' and are considered to be the main conduit for bringing
speculative business to the market. Other firms who employ their
own floor traders include large dealers in physical bullion, such as
Philipp Brothers, Republic National Bank and J. Aron & Co. Such
companies are known as 'trade houses'. The business of such
companies is mainly the hedging of physical positions of their own,
acquired because they make two-way prices in bullion to a variety
of customers, who are either producers, consumers, or large dealers
outside the United States. Such bullion dealers may also be engaging
in place arbitrage transactions - the purchase of gold in other
markets against a corresponding sale on Comex, or vice versa.
The floor traders employed by these companies only transact
business on behalf of their companies, but there are present on the
floor many traders whose speciality is executing orders on behalf of
Comex members who are themselves not represented on the floor,

or on behalf of non-members. These are known as floor brokers,
and may be individuals or firms who employ a number of
authorised floor traders. Then there are floor-trading members who
operate for their own account and risk, taking long or short
positions according to their view of the likely development of
prices. These are known as local traders or 'locals'. Amongst these,
some only take positions for short periods during the trading day,
but others are prepared to back their judgement by holding posi-
tions for considerable periods of time, although they may also trade
in and out many times during the day. Many of the individuals who
trade in this fashion are wealthy and prepared to take large
positions; 100 to 200 lots of gold are commonplace, with 500 lots
by no means unknown; with such a position, they are risking
$500,000 on a $10 per ounce price swing. The locals are generally
thought to provide the essential liquidity to the market, which
attracts other business. Without them, it is true, a heavy yjflux of
buying or selling orders from outside the Exchange would often
cause still wilder swings in price than those which frequently occur.
On the other hand, if a large local decides to cover in or change his
position on an unwilling market, he may well cause a large move-
ment in price which is by normal considerations unjustified. As
local traders are in business to make money for themselves, they
naturally tend to congregate in the pit where the commodities witb
greatest turnover and price volatility are traded. Comex gold has
been consistently the most active metal since 1980, so that the most
important and active local traders are usually to be found at the
gold pit. During 1983 and 1984, however, silver was frequently
more volatile than gold, and the volume of silver business increased
sharply to record levels, surpassing even the period of exceptional
speculative activity in 1980, and at times approached that of gold.
While this development may have deflected some local interest
away from the gold pit, the total turnover for gold during 1984 was
9,115,504 contracts, while that for silver was 6,842,351. The
respective figures in 1983 were 10,382,805 and 6,432,982.
Switches
The previous section has given some indication of the different roles
undertaken by authorised traders on the floor of Comex, but it is by
no means exhaustive. While the major part of the business transac-
ted on the floor consists of outright purchases or sales, there is also a
considerable volume of business in 'switches'. Switches, also known
Comex 37
in the United States as 'spreads', are the simultaneous purchase of

gold for delivery in one month and sale of the same quantity for a
different month. Some floor brokers and locals specialise in switch
trading, either executing such orders for outside dealers (brokers)
or taking positions for their own account (locals). From outside the
trading floor, switch orders originate for a variety of reasons.
Speculators who are long of gold for one month rarely wish to go to
the trouble and expense involved in taking delivery. Suppose a
speculator has bought gold for the April delivery month, and has
held the position until the end of March, but still believes that the
price is going to rise. Before the first notice day for April, he will
wish to carry his position forward to a later month in order to avoid
taking delivery, which would require him to put up the full cost of
the gold. He will probably instruct his broker to sell his April
contract and simultaneously purchase the same number of lots for
June delivery. On a rising or bullish market, the volume of such
business may be considerable, and as a result the price of April gold
will tend to be depressed, while that for June tends to rise relative to
other months. If this difference between the two prices widens too
far, well-financed dealers may decide to do the opposite transaction
— a purchase of April and a sale of June at prices which will allow
them to take delivery of the April gold, borrow the required money
and redeliver the gold in June at a price which will cover the cost of
finance and leave them a profit margin. Such transactions are
known as 'cash and carry' operations.
Distortions between the price of two future months may also lead
to similar transactions. If the cost of finance from, say, April to
December is 10 per cent per annum, while the difference between
the price of gold for April delivery and December delivery is
equivalent to 11 per cent per annum, an operator such as a bank
may seek to lock in that differential of 1 per cent per annum, by
simultaneously buying the April and selling the December contract,
while at the same time borrowing the funds. It may reasonably be
asked why such an opportunity should arise. One reason might be
that a bank can borrow money more cheaply than a speculator,
who for some particular reason wishes to purchase the December
contract in preference to another month — perhaps because he
foresees a rise in gold towards the end of the year. Another
possibility is that a local specialising in switches takes the view that
interest rates will rise. He is prepared to sell April gold and pur-
chase December at the equivalent of 11 per cent per annum, in the
belief that later on he will be able to reverse the transaction at a
spread more favourable to him, when interest rates move up.

Of course, the reverse may also happen; at times the price of the
nearest future month may be pushed up relative to later months,
although such occurrences in gold are relatively rare. In general,
when a commodity is in plentiful supply, the forward price (or price
for future delivery) is at a premium over the spot price. This is
known as a 'contango' market; when supplies of the commodity are
surplus to immediate requirements, someone must be found to
finance the excess. When the commodity is in short supply, buyers
who need immediate delivery force up the spot price relative to the
forward price. If the shortage becomes acute, the spot price may
even be higher than the forward price, as buyers compete for the
restricted supply available, and those who wish to hedge because of
the high price depress the future months. When this occurs, the
market is said to he 'in backwardation'.
Gold is a commodity in plentiful supply, as there are huge
reserves in the hands of Central Banks, as well as thoseôwned by
the public. Since the beginning of the free market in 1968, the gold
market has continuously been in a contango; generally, futures
prices have stood at a premium in dollar terms (gold having
essentially a dollar-based price) equivalent to the cost of borrowing
dollars for the period concerned. During bearish phases of the
market, however, the premium frequently falls below the cost of
finance. The reason for this is that speculators wish to be short when
they believe prices will fall, but they rarely have the credit standing
to borrow gold to sell. They therefore prefer to sell for future
delivery, and therefore depress the futures prices relative to spot. If
their persistence causes the premium for forward delivery to fall too
far relative to spot, then traders who have stocks of gold, or the
ability and standing to borrow, may reduce the pressure by selling
spot and buying for future delivery. The cash which they realise
from a spot sale is placed on deposit for the period until the maturity
of the future contract, at a rate of interest which is sufficient to allow
them to pay for the future delivery and still leave them a profit. Such
opportunities for professional dealers are most likely to occur when
speculators who are short of a nearby contract wish to switch to a
later month, because they believe that prices will fall further. The
pressure of their purchases of the nearby month and sales of the
next active futures months will cause the two prices to converge.
Central Banks who hold gold in their reserves are, of course,
losing the interest which they could obtain by reinvesting the value
of their gold in currencies. Furthermore, costs are usually incurred
Comex 39
in holding gold. If Central Banks have their own vaults, they face
the overheads of maintaining and manning them, and will probably
wish to insure their holdings against loss. For this reason, many
Central Banks are willing to lend gold to bullion dealers of suitable
creditworthiness, even at low rates of interest, in order to defray the
cost of storage and insurance. However, most Central Banks who
hold substantial reserves of gold are not willing lenders when prices
are low, as they correctly believe that by lending to the market in
this situation they are assisting speculators to remain short. Such
short positions depress prices to the detriment of the Central Banks
who are holders.
During the period from the beginning of 1980 to the middle of
1982, when the gold price fell from $850 per ounce to around $300,
speculators were frequently on the short side, and, while futures
prices remained at a premium over spot, this premium often did not
reflect the cost of interest. Furthermore, in a falling market pro-
ducers of gold are more inclined to hedge their future production by
selling it forward, thus adding to the pressure on futures prices. If
this occurs at a time of strong demand for physical gold, as was the
case in the first half of 1982, the spot price remains high relative to
the futures price. As the market price approached the level of $300
in June 1982, Central Banks became unwilling to lend, fearing a
further drop, and the contango fell to such an extent that bullion
dealers who had access to gold could sell spot and buy futures at
prices which could earn them a return of 3 per cent per annum (or in
some cases more for short periods). Of course, dealers do not
generally wait for a return of 3 per cent per annum. They are
satisfied by 1 per cent. In this case the 3 per cent became available
because, in general, dealers had committed their stocks at lower
returns and were unable to marshal further spot supplies at a time
when short-selling of futures months continued.
Although such operations are frequently made on the forward
market rather than on the futures markets, the actions of specu-
lators are most manifest in futures, so that the best opportunities for
dealers often occur there. Comex certainly had its share of this
business in the middle of 1982, to the benefit of floor brokers and
local traders specialising in switches.
Commissions
It will have become clear from the foregoing description of activities
on Comex that commissions paid by those wishing to trade in
futures there are intended to reward two main types of service. First,
there is the service of the floor broker, who actually executes the
order. No one should doubt that the life of a floor broker can be
hard, and requires considerable energy. The hours during which
gold is quoted on Comex are 9 a.m. to 2.30 p.m. New York time, a
continuous session. During these hours, a busy floor trader will be
continuously on his feet, straining ears to hear the development of
prices, and frequently shouting himself hoarse to make himself
heard above the hubbub, which characterises an active futures
exchange such as Comex. In return for these exertions he receives
'floor-brokerage' which, on Comex, is currently in the range of
$2.00 to $4.00 per contract traded (perhaps less for switch orders).
The mean rate of $3.00 per lot is equivalent to only 0.0075 per cent
of the value of one lot at a price of $400 per ounce. While such a
commission seems very low in absolute terms, it can be relatively
substantial for the floor broker. Good floor brokers may achieve a
volume of 1,000 lots or more per day, thus earning, ây, $3,000.
Out of this they must defray the cost of communications, <nainly
telephones (perhaps including direct lines to good customers), the
annual dues to the Exchange, stationery and the employment of one
or more clerks and bookkeepers. They also have to finance their
investment in a Comex seat, if they are individual members. At the
end of 1983 itwould have cost $300,000 to buy a seat, although the
last recorded sale during the year took place at a price of $150,000.
The high price of a seat reflects the potential profitability of being on
the floor of Comex, either as a broker or more particularly as a
local. While many floor traders have become very wealthy, others
have found the profession tough and sometimes unrewarding.
Floor-brokerage is not paid directly by the outside customer to
the floor broker. Once the broker has executed the order, he 'gives
up' to a clearing member (only the largest firms of floor brokers
being themselves clearing members). The clearing member records
the business in the customer's account in his books, and is respon-
sible for collecting margin, both original and variation, from his
customer. The other main element of the total commission paid by
the customers is to reward the clearing broker for processing the
transaction and registering it with the clearing house. In practice,
many of the large commission houses and some other firms give the
customer other services as well. These may include the benefits of
their research department's recommendations about the timing of
purchases and sales, and the facility for an investor inside or outside
the United States to place his orders to buy and sell through the
firm's local office. Many of these local offices will be linked to New
Comex 41
York by direct private telephone or telex wires. Communications of

this type represent an important overhead for commission houses,
and one which must be taken into account when calculating the
commission charged to customers on orders. As previously men-
tioned, commissions are today negotiable, and those charged to
customers will vary considerably according to the volume of
business undertaken, as well as the distance from New York. A
Comex non-member professional dealer located in New York
might pay as little as $10 per contract 'round-turn' if he does a
substantial amount of trading, whereas an individual speculator
who trades one or two lots at a time infrequently may be asked to
pay upwards of $50 per contract (also on a round-turn basis). The
expression 'round-turn' means that the commission covers both a
purchase and a sale for the same contract month. In the example
given above, if the commission quoted to an individual customer is
$50 per contract round-turn, he will pay $25 when he purchases,
say, a December contract, and a further $25 when he sells his
December contract out. If he elects to take delivery, rather than
close out his contract, he will nevertheless pay the $25 on the
delivery.
In addition to the commission, a buyer or seller of futures, if he is
not a member of Comex, must pay the Exchange's fee of (in
December 1984) $0.75 per lot. This fee is levied to cover the
administrative costs of the Exchange and the staff which it employs.
Structure of Comex
Until a few years ago, Comex had only a small staff of full-time
employees. Many of the officers of the Exchange were themselves
members and active as floor traders, undertaking the administra-
tion on a part-time basis. Since the early 1970s, however, the
increase in the volume of business, and the growing intervention of
the CFTC, have imposed greater and greater administrative
burdens. For this reason, Comex in October 1984 had a permanent
staff of 286 people concerned with such work, and including its
own legal and publicity departments. Comex also has a number of
committees and sub-committees covering a wide range of subjects.
These include: admissions (i.e. of new members), arbitration,
business conduct, warehousing of metals, non-ferrous metals, prec-
ious metals, new products, finance, margins and marketing, public
relations and education. In addition there is a Floor Committee and
an Options Committee.
Those serving on these committees are members of the Exchange;
committees generally meet outside trading hours. At the top of the

pyramid of committees is the Board of Governors, which has the
ultimate say in all matters relating to the Exchange, and includes
members from the main member groups (commission houses, trade
houses, and floor brokers and traders).
Comex rules
Amongst gold futures markets today, Comex is supreme in terms of
volume and activity. Success, as already recorded, has made a
certain measure of bureaucracy inevitable. The Exchange's rule
book runs to 380 pages, and covers every conceivable aspect of the
business from smoking on the trading floor (not permitted) to the
complicated procedures for delivery. Members of the Exchange
receive almost every day notices advising changes of membership
(53 full seats bought and sold in 1983), reminding them of certain
rules which are not being adhered to, or asking for financial
statements; other matters covered may include proposed changes to
the rules on which they are encouraged to vote, social functions
organised by the Exchange, additions to brands of gold acceptable
in settlement of contracts, or changes in warehouse fees. It is beyond
the scope of this book to go into great detail on these matters.
Suffice to say that today's rule book represents the experience of
nine years' trading of gold futures and 100 years of accumulated
wisdom. There will no doubt be changes in the future, as there have
been in the past, as new problems, unthought of as yet, arise, as
market conditions change, or new contacts are introduced. But for
today, everything has been thought of and is encapsulated in the
rule book.
Statistics
Comex publishes voluminous statistics about trading which are
eagerly watched by commodity analysts around the world. Many
analysts watch the technical situation of the market closely, draw-
ing conclusions from the rise or fall of the open interest according to
the daily volume of trading. A rising open interest, combined with
increasing volume on rising prices, is believed to foretell a bullish
development of prices, while the opposite, a rally in prices, not
accompanied by rising open interest, is regarded with suspicion.
The case for such beliefs is inconclusive, as particular circum-
stances, such as a forced unwinding of positions, may distort the
figures for open interest, at least in the sbort term.
Some explanation of these expressions would be in order. First,
Comex 43
open interest. During the course of trading on the floor, one floor
trader buys one lot of February gold from another; let us assume
that each is executing an order for an outside party. John Higgins is
the buyer and Desmond Brown is the seller. John instructs his floor
broker to 'give up' his contract to his clearing brokers, say Merrill
Lynch, while Desmond nominates, say, E. F. Hutton to clear on his
behalf. Once the contracts are 'given up' in this way, and assuming
that both floor brokers have agreed and checked the trade together,
they have no further interest or responsibility in it (except to collect
floor-brokerage!). Merrill Lynch and E. F. Hutton assume the
responsibility, and enter the contract in the clearing system. Once it
has been so accepted by the clearing house, Merrill Lynch and E. F.
Hutton have no further direct responsibility to each other. The
clearing house has been interposed between diem. Merrill Lynch is
long of one contract of February gold with the clearing house, while
E. F. Hutton is short of one. These are added to their respective total
positions. In Merrill Lynch's books, John is long of one contract of
February gold and in E. F. Hutton's books Desmond is short of one
contract. If there were no other contracts open between other
clearing members, then the open position in February gold would
be one contract.
Let us suppose now that John decides to sell out his long position.
His (or Merrill Lynch's) floor broker sells to a floor broker acting on
behalf of customer Fred Donatello, who clears with, say, Pruden-
tial-Bache. Prudential-Bache becomes long of one contract with the
clearing house, while E. F. Hutton remains short. The open interest
remains one lot. It will be seen, therefore, that each lot of open
interest represents a purchase and a sale which have not been closed
out, or against which delivery has not been taken or made. In fact,
even if a customer has both bought and sold for the same month, he
may elect to keep both contracts open on the books of his clearing
broker, and trade against either. As far as his clearing broker is
concerned, however, his position in the clearing house is netted
off.
In analysing the open position, it is, of course, obvious that a
large open position indicates a high level of interest in gold.
However, it is important to judge which sort of operator is long and
which sort is short. On a rising market when the contango is near or
above the cost of interest (or 'at full carry'), it is likely that
speculators will be long the market and that the trade houses, to the
extent that they have tbe financial strength and ability, will be short.
Producers hedging their future output may also be on this side of the
market. In the reverse situation, when prices are falling, speculators

may well be short; because the pressure of their selling has reduced
the contango well below full carry, the trade houses are likely to be
long of the market. The over-worked word 'speculator' does not
distinguish between individuals who dabble in commodities and the
professional or local trader who may also have a position. In
practice, in the past, individual speculators rarely took short
positions; their psychology is more attuned to rising markets. On a
falling market, it is more probable that locals and professionals
would be those on the short side. These days, however, there are as
many groups of speculators who use charts or computer models for
their trading; these are indifferent as to whether they are short or
long, provided they have confidence in the 'system' which guides
their actions.
For this reason, it is increasingly difficult to use analysis of the
open position as a tool for trading. Analysis of the size of the open
interest month by month can, however, be useful. On 15.tli March
1984 the quotational months for Comex gold were March, April,
May, June, August, October and December 1984, and February,
April, June, August, October and December 1985. The distribution
of the open interest of 133,898 lots between the quoted months can
be seen in Table 1.
Table 1 Open interest on Comex at 15th March 1984
1984 March 225

April 36,514
May 0
June 22,115
August 13,467
October 11,041
December 12,118
1985 February 14,063
April 16,057
June 6,995
August 837
October 368
December 98
It will be clear from Table 1 that the majority of the open interest
was concentrated in the earlier-dated contract months, while there
was very small interest in the later ones. March had become the
'spot' month after the February 1984 contract 'went off the board'
on 24th February. March is not an active month, and therefore
there was little open interest; nor would one expect any significant
Comex 45
interest to develop, unless a daily limit move prevents trading in the

forward months. April 1984 was the most active trading month,
being the nearest to maturity. The active month nearest to maturity
is often referred to as the 'nearby' month. As March 1984 passes, it
would be expected that the open interest in April would decline as
more holders of positions switch to a later month to avoid the
necessity of making or taking delivery. In all probability, the bulk of
April 1984 positions were switched into June which, late in March,
became the most traded contract. Some operators holding April
contracts may have taken the view that their position would not
benefit from the market movements they expect until later in the
year. They may therefore have decided to switch to a month later
than June, say August, in order to avoid the expense of paying a
further commission to switch from June to August at a later date. As
a matter of fact, the distribution of the gold open interest on 15th
March 1984 may not have been typical. Very often there is a still
greater proportion in the nearby months. In October and Novem-
ber 1982, for example, the percentage of the total silver open
interest concentrated in the December 1982 contract at times
exceeded 50 per cent. This was also unusual, but it would be by no
means uncommon to find 25 per cent or more of the total open
interest of any commodity in the nearby month.
The relatively high proportion of the 15th March 1984 gold open
interest in months as far ahead as April and June 1985 almost
certainly represented mainly switch rather than outright positions.
During any trading day by far the greatest volume of trading takes
place in the two nearest months; if it is necessary to cover positions
further out, it is often desirable to do so in an early month and
subsequently arrange a switch in order to avoid the price-risk
inherent in waiting for an outright quotation to become available in
a 'far out' month.
When two months of the same name are quoted, e.g. June 1984
and June 1985, there is the opportunity for confusion during a
trading session, particularly in fast-moving markets, or when the
'big figure' for each is the same. To avoid this confusion, the nearby
month is referred to amongst floor brokers as 'green' and then later
as 'red'. So, if a broker is seeking a quotation for June 1985, he may
ask 'What's red June?' Switch specialists will probably quote him a
price based on their switch rate between the active month April
1984 and June 1985, but it will be clear that an outright price for
June 1985 may have a considerably wider spread between bid and
offered levels than that for the more active nearby month.
Volume
Comex publishes each day the total number of trades 'cleared' (or
put into the clearing house). This should, of course, correspond
with the actual trades on the market floor, but mistakes can, and do,
occur. At the end of the trading day, floor brokers check all the
trades they have done with other brokers against what they have
given up to clearing members. A trade 'given up' to a clearing
member for which no counterparty can be found on the floor is
known as an 'out'. In volatile markets, such errors can be costly, as
they leave the broker with a position long or short. If the broker is
left with an uncovered trade, he will normally seek to cover himself
immediately if he discovers the mistake during trading hours; if he is
left with the position after trading has ceased, he will try to hedge by
trading with a dealer outside the Exchange.
Busy and volatile markets cause other problems for floor brokers.
Let us suppose a floor broker has an order to buy ten Idtsof April
gold at $402.50 per ounce when the market is trading at $404.00. It
may be that the market falls, and April is traded in some volume at
$402.60 and $402.70, but only one or two lots are traded at
$402.50 before the price once more moves higher, and remains
above $402.50 until the end of the session. He is unable to buy at
that level. He has two options open to him. Either he may give his
customer an execution at $402.50 and buy the ten lots as best he
can, taking the loss for his own account, or he may report 'price
traded unable (to buy)'. Either way, he will suffer, because if he
frequently fails to come up with an execution when a price is traded,
the customer will soon start looking for another broker, and he will
lose business. There is another possibility; at times of intense
activity and quickly fluctuating prices, the officers of the Exchange
may declare a 'fast market'; this releases the broker from the
necessity of obtaining an execution at any given price. There are, of
course, dangers in declaring a fast market. If it is done too
frequently, it will tend to bring the Exchange into disrepute. This is
particularly true, as on some other futures exchanges such as the
International Monetary Market in Chicago a floor broker is
required to give his customers an execution on a limited price order,
if that price is traded. In recent times, some floor brokers on Comex
have been increasing their share of the total business by guarantee-
ing execution on limit price orders whenever the price is traded.
In the last few years, the problem has been exacerbated, because
of new regulations introduced to avoid mishandling of customer
Comex 47
orders. Formerly it was suspected that at times some floor brokers

would not trade orders when they received them, but simply give
the customer an execution without trading. They would sub-
sequently, it was alleged, trade at a more advantageous price and
pocket the difference between the price traded and the price at
which an execution had been given to the customer. In order to
avoid this possible abuse, it is now a requirement that all orders are
time-stamped when received, and time-stamped when executed.
This procedure, of course, makes it more difficult for the broker
who chooses to guarantee executions at a particular price. He must
decide quickly whether to cover at a different price if he is unable to
trade at the right price, and the price moves away from that level.
Volume figures are, of course, carefully studied, not only by
analysts who are trying to form a view about the likely future
direction of prices, but also by members, both floor brokers and
others who wish to gauge their market share.
Warehouse stocks
Published daily and watched carefully by observers of the market
are the statistics for warehouse stocks. Each day the approved
warehouses of Comex give details of movements of gold into and
out of their vaults. Although minor movements in the figures will
have no effect on the market, a pronounced and continuing increase
in stocks tends to deter buyers, while a rapid drop may exert the
opposite influence. Of particular interest on occasions is the re-
lationship between the level of warehouse stocks and the size of the
open position in the nearest major delivery month.
On October 1976 the open interest in the December 1976
delivery month (the nearest active one) exceeded 5,000 contracts,
yet the stocks in the approved warehouses were equivalent to little
more than 2,000 contracts. However, it was well known in the
trade that US gold refineries were very busy converting into 100-
ounce bars gold purchased by dealers at International Monetary
Fund auctions held earlier in the year, and that there would be no
opportunity to have 100-ounce bars manufactured in time to meet
the December deadline. Some refiners were no doubt already
working on the production of 100-ounce bars, but no one knew
exactly what was happening. The price of gold at the time was
about $117 per ounce, but, interestingly enough, spot gold loco
London was trading at the same level as the Comex December
contract. Normally, it would have been expected that December
would be at a premium to spot London gold. This was pretty
rhs Sngug S. Macdonrilo' Ut

St. F. X. tJi
conclusive evidence that the Comex December contract was being

depressed by speculative short selling. Gold prices had been as low
as $103 per ounce in London at the end of August, and, on one day,
prices on Comex had briefly been below $100. By October a rally
had occurred, but many speculators believed this period of higher
prices would only be temporary, because the International Monet-
ary Fund was continuing to sell gold on a regular basis. A further
auction was due on 27th October, and prices just before this were in
the range $115-118 per ounce. When it was seen that the gold on
offer at this auction was readily absorbed, and indeed that many
bidders at the auction were unsatisfied, those speculators who had
sold short ran to cover their positions. The effect on the market was
dramatic. By 15th November the price of gold rocketed to over
$135.00, an increase of almost 20 per cent in under three weeks.
Perhaps the low level of Comex stocks relative to the open position
in the nearby month had only been a straw in the wind, but "analysts
of the statistics published by the Exchange could hav^. qijoyed a
field day.
If this sort of analysis sounds simple, remember that such events
occur only infrequently, and that, even when they do, the timing of
the effect on price is difficult to judge. After all, the situation had
been building up for several weeks, but no one could easily judge
what event would suddenly trigger off the price explosion.
5
Other American
markets
The detailed description of Comex in the previous chapter makes

lengthy discussion of other US futures markets unnecessary. They
have many similarities with Comex. It would, however, be
appropriate at this juncture to say something about another Ameri-
can institution, the Commodity Futures Trading Commission
(CFTC). Since 1934 US stock exchanges have been regulated by the
Securities and Exchange Commission (SEC), a Government-
appointed body whose main task is to ensure that no abuse of US
security laws occurs. Commodity trading on futures exchanges was
not so regulated until 1975, although agricultural trading has been
supervised by the US Department of Agriculture since as long ago as
1876. Prior to 1975, agricultural commodities were known as
regulated commodities, while others were 'unregulated'. With the
founding of the CFTC, all commodities became regulated.
While the CFTC was designed to perform the same tasks for
commodity markets as the SEC for securities markets, there was
little codified law relating to those commodities which had
previously been unregulated. Its task was therefore hard. From the
beginning it concentrated its efforts on reducing abuses of the sort
described in the last chapter; preventing brokers on the floors of
exchanges from taking advantage of their customer orders.
Otherwise its activities have been in the area of discovering who are
the large traders in the markets, and trying to ensure that such large
traders do not build themselves monopoly positions to the detri-
ment of other market users. In this quest, it has required regular
returns of large positions. In each commodity a reportable position
is defined. Once a trader has a reportable position, he may be

required to reveal all details of his trading, including the identity of
his customers. This requirement is naturally unpopular with foreign
users of US futures exchanges, not to speak of some Americans.
Under current law, the failure to provide required returns, or even
the refusal of foreigners to furnish details of the contracts in which
they, and through which their brokers, trade, carries a substantial
fine. Repeated refusals to divulge information may lead to a ban on
trading in any US futures market.
Many people feel that, notwithstanding these severe penalties,
the CFTC has not yet proved able to achieve its objectives. Certainly
it did not prevent the huge speculation in silver in 1979/80, which
nearly brought the Comex clearinghouse to its knees. Nevertheless,
the existence of the CFTC has certainly caused all US futures
exchanges to sharpen their own self-regulation, and many potential
abuses have been eliminated, to the benefit of all users of the
markets. The CFTC has one strong card in its hand. It mtisfcapprove
all details of a new contract before any futures exchange can
introduce it, and it could ban trading in any existing contract if it
were not satisfied with the rules of the exchange. In practice, this
power is rarely tested, and the main futures exchanges prefer to live
in harmony with the CFTC.
The existence of the CFTC may be one reason why the practices
and the procedures of the various exchanges are nowadays very
similar. Amongst exchanges with the gold contract, most important
features are the same as Comex. Differences are mainly of detail.
The greatest difference is that gold contracts on other exchanges are
less successful than that of Comex, as Table 2 shows.
The Chicago International Monetary Market

The table above will have made it clear that the second most
important futures exchange for gold in the United States has been
the International Monetary Market (IMM), a division of the
Chicago Mercantile Exchange (CME). The IMM was founded in
April 1972, although its parent, the CME, under its present name,
traces its origins to 1919, and through its predecessor, the Chicago
Butter and Egg Exchange, to 1874, and has long been one of the
leading exchanges in the country. It has a long-standing rivalry with
the Chicago Board of Trade (CBT), but the commodities which it
trades are different. While the CBT originally concentrated on
purely agricultural commodities, the CME is the principal market
Other American markets 51
Table 2 Annual turnover in gold contracts of US exchanges, 1974-84

Year Comex Chicago Chicago Mid America New York
IMM Board Exchange Mercantile
of Trade Exchange
(CBT) (NYMEX)
1974* 2,550 2,131 1,143 421 1,230
1975 393,517 406,968 54,331 6,872 36,733
1976 479,363 340,921 10,940 2,573 2,351
1977 981,551 908,180 13,758 2,650 3,650
1978 3,742,378 2,812,870 56,470 45,153 3,368
1979 6,541,893 3,558,960 110,353 200,363 704
1980 8,001,410 2,543,419 71,479 447,494 10
1981 10,373,706 2,518,435 14,749 469,460 —
1982 12,289,488 1,533,466 19,515 383,499 —
1983 10,382,805 994,132 302,745 349,044 —
1984 9,115,504 8,841 302,717 60,975 —
Total 62,304,165 25,207,640 958,200 1,966,504
*31st December only.
Comex and IMM have a contract size of 100 ounces. In 1978 Mid America changed from a
one-kilogram contract to 33.2 ounces. In 1979 CBT changed from three kilograms to 100
ounces, and in 1983 to one kilogram. NYMEX started with a one-kilogram contract, and
added a 400-ounce contract in 1977, but withdrew its contracts because of lack of support in
1982. In July 1984 Mid America introduced a 'New York contract'.
Sources: Consolidated Gold Fields, Gold 1983; and Futures Industry Association Inc.,
Volumes of Futures Trading 1979-1983.
for pastoral products. Amongst such products which it trades today

are live cattle, hogs and pork bellies.
The decision of the CME to set up a new division dealing in
international monetary instruments was a wise and far-sighted one.
Financial futures of one sort or another have become a very fast-
growing area of the futures business. The IMM started with
currency contracts at a time when floating foreign exchange rates
were in their infancy, and has achieved a well-deserved success in
this field. The foreign currencies traded there are the Japanese yen,
the Swiss franc, the Deutsche Mark, the pound sterling, the
Canadian dollar, the Dutch guilder and the Mexican peso. While
business in these currencies was slow to get underway, the IMM
and the operators there today have a reputation as a significant
influence in foreign exchange markets. At first ignored by the major
commercial banks, who prior to its foundation enjoyed virtually a
monopoly of foreign currency trading in the United States, the IMM
now has the satisfaction of knowing that many active foreign
exchange banks use its market.
Against the background of the currency trading, gold seemed a
natural new contract when the trading of this commodity became

possible at the end of 1974. As on other US futures exchange, gold
began relatively slowly, but, in the tradition of the IMM, all
members were required to trade the new contract. In 1975, the first
full year of trading, its volume exceeded that of Comex. As activity
in gold increased, the IMM flourished, and obtained an excellent
market share. With a different set of local traders and different
quotational months, there were often attractive arbitrage possibili-
ties, and many bullion houses in New York and elsewhere started to
allocate one of their dealers, or even set up small departments, just
to undertake arbitrage between Comex and the IMM. Table 2
shows that the IMM continued to vie with Comex to be the most
active gold futures market in the United States in the late 1970s. A
good deal of business was attracted directly from Europe, as many
European dealers at the time considered that the depth ofj:he IMM
was superior to Comex, and executions faster and more reliable.
The IMM gold contract is the same as Comex's in ortiyone sense:
one lot of gold equals 100 ounces. The active months quoted on the
IMM are March, June, September and December, and originally,
except during these months, there was no spot quotation. The
number of future months quoted today is eight each year — January,
March, April, June, July, September, October, December — plus the
spot month, although the quarter-end months remain the most
active.
In other respects, the operations of the IMM are very similar to
those of Comex as regards the floor-brokerage system, delivery, the
trading on the floor and the clearing house. Original margins may,
of course, vary from time to time, but are generally at a level
comparable with those of Comex. One advantage of the IMM is
that, if you enter a limited price order, and that price is traded, the
floor broker having your order in hand at the time may be required
to give you an execution at the price.
The arrangements for physical gold and the delivery thereof are
somewhat different. In the first place, delivery may only be made
into the Exchange's approved warehouses directly from an
approved refiner in the United States. Secondly, delivery may be
made in either New York or Chicago. Some of the approved
warehouses in New York, but not all, are also on the list of Comex,
so that, in return for a fee, there is limited exchangeability between
the two markets. As is normal on US futures markets, delivery is at
the option of the seller, so that a buyer cannot be sure whether he
will receive warehouse receipts entitling him to gold located in
Chicago or New York. It will have been noticed that IMM and
Comex active delivery months coincide twice in the year, in June
and December. However, arbitrage between the two exchanges
must be approached with some caution, as there is no guarantee
that the time or place of delivery of contracts purchased on one
exchange and sold on the other will necessarily coincide. It may,
therefore, be necessary to close out both sides of the arbitrage on
each of the exchanges in order to close out the total position. It is
always uncertain whether such unwinding of positions can be done
without significant cost. There have indeed been occasions where a
shortage of stocks has occurred on one exchange or the other, so
that a premium of some magnitude has arisen. For this reason, it is
usually advisable to try and unwind an arbitrage position in good
time before the beginning of the delivery month in question.
While no great time has been spent on describing the IMM,
because it has many features in common with Comex, it should be
noted that it has until recently remained an important exchange for
gold futures trading, even if in terms of volume it has lost out
considerably relative to Comex. It is not easy to explain this decline,
because the IMM is a well organised and soundly based exchange.
In all probability, the reduction in volume there can at least partly
be explained by the general decrease in gold trading since 1980; in
particular the number of professional traders engaged in arbitrage
has fallen as price movements became less volatile. The differences
in delivery locations mentioned above should not have had great
effect, as so few futures contracts are held until physical delivery
takes place. The decline of arbitrage activity and foreign interest on
any market will lead to local traders seeking their fortune in other,
more active, commodities. This has undoubtedly been a feature on
the IMM, where the currency futures, being until recently unique in
the United States, have enjoyed much greater volume. Equally, the
introduction of a variety of financial futures contracts has diverted
interest.
Furthermore, Chicago has perhaps never been a natural gold-
trading centre, having no concentration of gold consuming
industries, gold mines or refineries in its catchment area. Nor can it
portray itself as such an important financial centre as New York. It
would be fair to conclude that the IMM's former success in gold
futures trading was due to the strong commodity trading tradition
established in Chicago, and to an excellently organised market.
Chicago's trading strength and tradition still remains. In 1983 more
than 74 per cent of all US futures trading took place on its
exchanges, but the emphasis has shifted, either back to the agri-
cultural and pastoral commodities, or to the newer financial con-
tracts. The importance of the IMM may well grow again when
interest in gold once more becomes widespread, or if the proposed
link-up with the Gold Exchange of Singapore proves successful (see
Chapter 6).
The Chicago Board of Trade

Given the dominance of New York, both as a financial centre and as
a market for gold, it is curious that the two remaining US futures
exchanges are both located in Chicago. The first is the august
Chicago Board of Trade (CBT). This great Exchange traces its
origins to 1848, and has for many years been the US futures
exchange with the largest total turnover. In 1983 it achieved a
record volume of 62.8 million contracts in all the commodities
traded under its roof. This staggering figure represented almost 45
per cent of all the futures contracts traded in the United States
during that year. Its success, however, was mainly in the agri-
cultural and financial contracts. The commodities traded there (at
end 1983) were wheat, corn, oats, soya beans, soyabean oil,
soyabean meal, silver, gold, plywood, gasoline, heating oil and nine
financial futures. Of these, the huge success story of recent years has
been the 20-year US Treasury Bond. Turnover in this instrument
has rocketed from 555,350 lots in 1978, when the contract was
introduced, to an astonishing 19,550,535 lots in 1983, when the T-
Bond, as it is known, enjoyed the largest volume of any futures
contract in America. In the same year, soya beans (13.7 million
contracts) and corn (11.9 million contracts) also enjoyed outstand-
ing activity.
By contrast, the achievements of the CBT in gold have been
modest indeed. In his book Trading in Gold, Paul Sarnoff quite
rightly adduces two main reasons for the lack of success. First, the
CBT's members, like those of the IMM, did not have a strongly
entrenched trading tradition in metals, although the Exchange has
certainly had its moments of glory in silver. The bulk of the
membership have always been, and remain, dedicated to grains.
Secondly, the CBT, partly in an attempt to be different, started its
gold futures trading on 31st December 1984 with a contract, not of
100-ounces, but of three-kilogram bars (approximately 96.5
ounces). The metric system being unfamiliar in the United States,
this failed to attract much interest, and certainly made arbitrage
with other exchanges that much more difficult. In 1979 the CBT
recognised the error of its ways, and changed the contract to 100
ounces; but the damage had already been done. The 100-ounce
contract there never achieved a viable turnover, and failed to attract
the interest of the local traders on the Exchange, who had more
interesting instruments to trade. Because of the lack of interest in
this contract, the Exchange was faced with the decision whether to
continue trading gold or not. In April 1983 it decided to go back to
the metric system, and introduced a one-kilogram gold contract.
The decision was perhaps surprising in view of the previous
experience, but has been rewarded with a certain amount of
success. In 1984 302,717 contracts were traded. Perhaps it is too
early to forecast the future popularity or otherwise of this contract,
but the initial performance during the dull conditions which
prevailed during most of 1983 was good.
By comparison with the CME, the CBT has not engaged in major
marketing campaigns to publicise its products outside the United
States. That is not to say that it has not been successful in attracting
international business. No exchange which has such a huge share of
the total volume of US futures markets could achieve such a leading
position without attracting international traders. In grains such
traders send a great deal of business to Chicago to be executed on
the CBT. Furthermore, the CBT's T-Bond contract regularly sees a
huge volume of international hedging business from traders and
issuers of US Government securities, US domestic bonds and
Eurodollar issues. This Exchange certainly has the potential to
capture a bigger slice of gold futures business, but so far has not
used its muscle to this end. Its introduction of a one-kilogram
contract suggests that it is aiming at the smaller trader. Perhaps in so
doing, it is shooting for a sector of business which has not been fully
developed.
The Mid America Commodity Exchange

The last remark is by no means intended as a criticism. The Mid
America Commodity Exchange in Chicago has long acted as the
'odd lot' commodity exchange, offering the smaller trader the
opportunity of partaking in commodity futures, without the need to
put up large sums of money. In this role, the Mid America offers a
range of contracts which parallel, but are smaller than, those
quoted on the large Chicago markets. It offers wheat, corn, soya
beans and T-Bonds, whose main market is on the CBT; live cattle,
live hogs and T-Bills from the CME; refined sugar, paralleling the
sugar contracts on the New York Coffee Sugar and Cocoa
Exchange, and two silver contracts, one for 1,000 ounces deliver-
able in Chicago, and the other a New York silver contract. Finally,
'on the board' of Mid America is a gold contract of 33.2 ounces,
which has been in existence since 1978, and which replaced a one-
kilogram contract introduced when US gold futures started at the
end of 1974. Mid America's gold contract has long been one of its
more successful, along with soya beans and corn. In 1984 60,975
contracts were traded, compared with 349,044 in 1983, and
469,460 in 1981, its most successful year. Mid America claimed the
record of the first ever gold futures contract traded in the United
States when it instituted a special session to trade gold beginning
immediately after midnight on 31st December 1974. Since the
initial publicity at that time, the Mid America has not been in the
limelight of gold trading, but it has continued to offer the smaller
man the opportunity to trade in a custom-made contract in a
market which offers reasonable liquidity, with a turnover which in
1983 exceeded 1,000 lots daily. ^ ♦
The oddity of the Mid America gold contract is the size of its lots,
which is 33.2 ounces. As mentioned above, Mid America started in
1974 with a one-kilogram contract (32.15 ounces gross), but this
was not very popular with the customers, because one-kilogram
bars come in different degrees of fineness - they may be 99.5 per
cent pure gold or 99.9 per cent, or 99.99 per cent, and each fineness
means that the actual amount of gold paid for will vary. So it was
that it decided to adopt a standard weight, albeit a strange one, and
do away with the complications of physical delivery. The Mid
America gold contract is one which involves a cash settlement.
Either you close out your contract before maturity, or, if you choose
not to do so, then settlement is made at maturity on the basis of the
current price. Any profit or loss between the original contract price
(as adjusted by intermediate margin payments) and the settlement
price on the date of 'delivery' is made in US dollars.
We must conclude that the structure of the US gold futures industry

is a strange one. On one side stands New York, a long-standing
centre for the trading and delivery of gold. Many of the established
users of gold are on the eastern seaboard of the United States. There
is the jewellery industry in New York itself and on Rhode Island;
there are still copper refineries in New Jersey, which produce
substantial amounts of gold, and there are major fabricators of a
wide range of special products for the jewellery and other gold-
consuming industries. Further, there are huge quantities of gold
stored in the vaults of the Federal Reserve Bank in New York,

forming part of the United States' own reserves, and those of many
other countries. The 'Fed' is one of the delivery points for gold
accepted by members of the IMF, along with the Bank of England in
London, the Swiss National Bank in Berne, and the Reserve Bank of
India.
This wealth of natural business in the New York catchment area
is supplemented by the position of New York City as a major
international banking and financial centre, attracting huge volumes
of business in deposits, government securities, bond and stock
exchange trading. All these natural benefits support a very success-
ful gold futures exchange, Comex.
On the other side is Chicago, a mighty trading centre for
agricultural and pastoral products, and in recent times financial
instruments, in which it surpasses New York. Yet its impressive
futures exchange still offer three gold futures contracts, which
presumably pay their way, without any of the natural advantages of
New York.
Perhaps the recent dominance of the New York exchange has not
been fully recognised yet. In the gold-trading industry, many still
refer to the importance of US futures markets as a short-term
influence in determining the direction of gold prices. Today that
influence is negligible outside New York. Yet no one can deny the
influence of New York, and, whatever the future may bring, the
effect of New York's activity in gold futures has been to bring
forward a host of imitators in other countries.
6
From frozen wastes
to tropical beaches
The Winnipeg Commodity Exchange h. »

While futures markets are very much an American institution, their
existence is by no means restricted to the United States. Modern
gold futures in fact had their origin in neighbouring Canada. In
1972 the Winnipeg Grain Exchange introduced the world's first
gold futures contract. As its name implies, this Exchange specialises
in grains, and is well situated for this business, being in the centre of
the Canadian prairies. Its decision to begin the trading of gold was a
bold departure from its traditional role. There is no doubt that the
Exchange adopted the new commodity with more than a sidelong
glance at its southern neighbour, the United States. Already in 1972
gold was becoming volatile in price and attractive to the commodity
speculator, of whom there were not a few in Canada, but many
more in the United States. The latter, of course, were not permitted
to own gold, but it would be surprising if some of the activity
generated by Winnipeg did not originate there.
The Winnipeg gold contract, while the first of its kind, had many
features common to US futures markets - defined contract, active
trading months and a mutual guarantee and clearing house. One
feature not repeated on later futures markets was the size of the
contract. In the interests of simplicity, Winnipeg adopted as a
delivery medium the 400-ounce standard bar, which was, and is,
the basis of the London and Zurich gold markets. Indeed, the list of
gold refiners whose bars were acceptable on the Winnipeg
Exchange was identical to that of the London Gold Market.
The market in Winnipeg attracted some interest in the early days,
From frozen wastes to tropical beaches 59
and its gold contract was actively marketed in Europe with some
success. For a short period in the early 1970s, London dealers
maintained an active contact with the new market, although the
turnover was limited. The initiative for the Winnipeg gold contract
was largely that of one man, Bob Purves. Everything possible was
done to establish Winnipeg as a significant centre for trading gold,
but it was probably inevitable that this would not succeed. In 1974
a smaller contract, the centum, with a 100-ounce lot which was
introduced to match those of the same size in the United States,
scarcely caused a ripple on the international gold scene. Attempts to
encourage arbitrage with other futures markets had only limited
success, as Winnipeg itself never achieved the required liquidity to
make such activity viable. As Tim Green wrote: 'Once Americans
could trade gold at home, the whole raison d'etre of Winnipeg
vanished overnight.'
Nevertheless, a gold contract of 20 ounces still exists there, even
if it is not rewarded with huge volume, and the Winnipeg Com-
modity Exchange, as its name is/today, richly deserves its place in
history as a pioneer of gold futures markets and gold option futures.
It certainly introduced many a European gold dealer to the concept
of futures trading at a time when few had much experience, and
prepared them for the major impact on the traditional markets
which US futures were to have. Winnipeg deserves the thanks of all
for its leadership.
No other gold futures market outside the United States was
formed until 1978. The gold-trading industry watched the arrival of
US gold ownership at the end of 1974 with some dismay. Great
expectations had been built up of the size of demand which would
emanate from the United States, and many bullion traders, both
domestic and international, had geared up in preparation for the
event. The absence of significant physical demand was a source of
sorrow, as it seemed to indicate that what promised to be an
important new sector of the market might easily fade away. More
perceptive European traders greeted the slow start of futures
trading with considerable satisfaction. They had worried that gold
business might be attracted to these new markets in large amounts,
in a manner which could only mean that they would lose market
share. Furthermore, they had feared the even greater volatility that
a horde of small speculators might cause.
Effect of the IMF gold auctions

As the months passed in 1975 and early 1976, the European traders
could breathe more easily, seeing little sign of burgeoning activity in

futures, and a relatively stable price by comparison with the period
preceding American ownership. Perhaps their worst fears had been
misplaced. Occasionally there were unexpected price movements
on the US futures markets, caused by speculators, but these were
usually contained by bullion dealers trading in the opposite direc-
tion, and very often the pressure was reversed when physical
trading resumed in Europe on the following day.
Just when European dealers had lulled themselves into the belief
that they could continue to control the market, some new factors
became apparent. First, the gold market in the Far East, particularly
Hong Kong, suddenly increased its activity and turnover, and
started to develop a direction of its own. This resulted from the
removal of the ban on imports of gold into Hong Kong in 1974.
Following this, activity on the Kam Ngan exchange grew quickly,
and the Chinese community, not only in Hong Kong but in other
major cities of the Asia Pacific region, began to satjpfy their
predilection for gambling by operations on the Exchange.
Secondly, the International Monetary Fund announced and
began a series of gold auctions, the proceeds of which were placed in
a Trust Fund for the benefit of developing nations. The first of these
auctions came upon an unwilling market in June 1976. At this time,
the inflationary pressures resulting from the 1973/74 oil crisis had
to some extent been contained, as the developed countries had
shown the ability to cut back their demand for oil, and had chosen
to accept a modicum of economic depression, rather than blatantly
inflate their way out of trouble. For a short period, the gold price
was depressed by the forthcoming offerings from the IMF which
would considerably increase the new supply of metal. Dealers
around the world focussed on the offering at auction of 24 tonnes
(780,000 ounces) every six weeks. The amount to be sold each year
was equivalent to some 15 per cent of the total supplies coming to
the whole world market in 1975. The concentration of the sales in
large lumps was expected to cause problems of digestion. Bullion
dealers began to look at US futures markets in a new light. Perhaps
they could be relied upon to provide some of the demand necessary
to absorb these quantities. In any event, they offered the possibility
of a short-term hedge against amounts which leading dealers would
bid for at the auctions. Small wonder, then, that, as the time of the
first auction approached, short positions were built up on the
futures markets. So much so, that immediately before the auction
on 2nd June 1976 there was some nervous covering of short
positions, and the market rallied, in the belief that buying by

Central Banks might support the auctions.
While the results of the early IMF auctions cannot be said to have
had much influence on the growth of volume on futures exchanges,
as time passed this influence became more evident. The adoption by
the IMF of an auction mechanism whereby buyers paid the price
they had bid (rather than a common price established at the level at
which buying orders covered the quantity on offer) increased
competition among dealers, and therefore their need for a hedge.
Furthermore, it increased the uncertainties about the level at which
gold would be sold at each auction. The requirement for a greater
volume of hedging coincided with a resumption of investment and
speculative buying of gold when it became apparent towards the
end of 1976 that the market was quite capable of absorbing the IMF
gold at prices of, say, $120 per ounce or upwards.
There can be little doubt that the realisation that IMF gold
auctions were less depressing to gold prices than at first seemed
likely stimulated interest in gold from investors. In early 1977
the volume of business on the US futures markets began to
grow, as more and more participants, speculators and dealers
alike, came forward to use them, at a time when the US dollar
came under renewed pressure in foreign exchange markets. This
trend continued as the year went by, but it was not until the fourth
quarter of 1977 that a remarkable spurt of activity occurred.
During this three-month period, 446,031 contracts were traded
on the Chicago IMM. This surpassed the total annual turnover
in each of the years 1975 and 1976. Similarly on Comex the
months October to December saw a volume of 472,249 lots,
which compared with the annual figures of 479,363 in 1976 and
393,517 in 1975.
So it was that the established gold-trading community came to
realise that the futures markets were here to stay. The futures
industry, too, recognised that in gold they had a viable product.
Little surprise then, that other gold trading centres began to
consider the feasibility of setting up their own gold futures markets,
modelled on the American pattern which was now successful.
The success of gold futures in the United States soon spawned
imitators in other countries. Perhaps it is not surprising that other
trading centres attempted to cash in on the financial riches and
employment opportunities which such markets had achieved. By
and large they have failed to do so, at least until today. Certainly,
almost without exception, gold futures contracts or exchanges
outside the United States have not achieved anything more than
local importance, if that.
Gold, being in the 1970s such an important medium for invest-
ment and speculation, represented a natural choice for a new
contract on futures exchanges seeking to expand their business.
Where gold futures have been introduced outside the United States
they are, in the majority of cases, additional contracts on existing
markets, rather than totally new exchanges.
In analysing the various gold futures contracts available today,
one may distinguish between those operating in countries which
were already important trading centres for gold and those which
sought to establish themselves as significant gold markets.
The Kam Ngan

Since the gold price 'floated' in 1968, there has been a^ marked
concentration of trading in three distinct time zones - the Asia
Pacific region, Europe and the United States. The libehalisation of
gold imports into Hong Kong in 1974 allowed that city to become
an international centre for gold trading, to an extent which the
previous restrictions had prevented. Hong Kong had long been a
significant centre for gold, both for manufacturing and for clandes-
tine distribution to neighbouring lands, where, in many cases, gold
ownership was legally banned. Furthermore, the long-established
Kam Ngan (already referred to in Chapter 1) was a relatively active
market. The freedom to import gold allowed this market to expand
its activity rapidly, and it soon became a forum which catered for
the Chinese love of gambling, as well as servicing the needs of local
manufacturers and traders.
It has been said that the system of trading on the Kam Ngan is
essentially that of an 'undated futures' market. This apparent
contradiction in terms is best explained by describing briefly its
operations. The similarities with true futures markets are several.
First, there is a standard size of contract or lot. The tael is an ancient
Chinese measure of weight, but unfortunately not uniform
throughout China. In Hong Kong the weight used is the Cantonese
tael, equivalent to approximately 1.2 troy ounces. On the Kam
Ngan a lot is 100 taels.
The second similarity is that trading takes place on an organised
market floor by a form of 'open outcry', at which buyers and sellers
vie with each other to transact business. As on futures exchanges,
trading on the floor is limited to representatives of member firms,
who were 192 in number in August 1984 when the society
celebrated its seventy-fifth anniversary. The method of trading is

not dissimilar in that a number of hand signals are used to assist in
making intentions known above the hubbub of the market place.
To consummate a deal, however, it is necessary to make physical
contact with the other party.
There is an organised system for the settling of trades very much
akin to a clearing house, and specifications for bars which may be
delivered. As on other gold markets, only bars produced by certain
refiners are acceptable. Such bars have a weight of five taels, and
must have a gold fineness of at least 99 per cent.
So far the description suggests strong affinity with futures
markets in the United States and elsewhere. The main difference
from such futures exchanges is that there are no specified delivery
months. In place of delivery months we find a procedure by which
every open contract is rolled forward on a daily basis. This is done
at a rate of interest which depends largely on whether there is a
shortage or an over-supply of gold in the market. If physical gold is
in strong demand and buyers wish to take delivery, but sellers do
not wish to deliver, the interest rate for the carry forward from one
day to the next will favour the buyers, while in the reverse case the
opposite will apply. This mechanism means that theoretically it is
never necessary to close out a position; rather, a position can be
carried forward indefinitely without payment or delivery, subject
only to the payment or receipt of interest and the maintenance of the
required margin. It is for this reason that the Kam Ngan may
correctly be termed an undated futures market.
In describing the Kam Ngan, one must be cautious in suggesting
that it is a market worthy of consideration by those seeking a gold
futures involvement in the Far Eastern time zone. The Kam Ngan is
essentially Chinese, and its detailed workings are not easy for
westerners to understand. The description is included by way of
background to the Hong Kong market place.
Because of the great activity on the Kam Ngan, Hong Kong has
attracted a large number of European and United States-based
bullion dealers to set up dealing operations there. Each of the five
London Gold Market members trades in Hong Kong through a
subsidiary company or branch office, and they have been followed
by the leading Swiss and German banks, plus a small number of
bullion dealers from elsewhere. As a result, a 'parallel market' in
loco London gold has been firmly established in Hong Kong. While
this parallel market today has a strong identity of its own, in its
early days it relied to a considerable extent on the Kam Ngan to
provide liquidity. Even today, arbitrage between the loco London

market and the Kam Ngan represents an important sector of
business for the non-Chinese traders. Furthermore, several mem-
bers of the Kam Ngan have internationalised their own trading, and
participate in such arbitrage.
This activity has, as already recorded, been assisted by the
London dealers' introduction of new facilities which match the
Kam Ngan's mechanism. Such 'deferred settlement' facilities allow
the account holder either to purchase spot gold without making
payment (the dealer advances the US dollars for the purchase
against the security of the gold bought and charges the customer
interest), or to sell spot gold without delivering (the dealer advances
the gold against security of the sales proceeds which he retains;
again he charges the customer interest on the gold borrowed, but
also pays the customer interest on the US dollar sale proceeds). If he
can acquire such facilities from the bullion dealer, the customer can
freely go long or short of gold within limits agreed, subject only to
maintaining a balance between his assets and his liabilities with the
dealer. For example, if the customer has bought 4,000 ounces of
gold from the dealer at $400 per ounce, his accounts in the dealer's
books will show as follows:
Gold account: Credit 4,000 ounces
US dollar account: Debit $1,600,000
If subsequently the price of gold falls to $3 80 per ounce, the value of
the customer's 4,000 ounces of gold will be $1,520,000, while his
dollar account still shows a debit balance of $1,600,000. In all
probability the customer will be asked by the dealer to pay him the
difference of $80,000. The exact terms for such facilities will be set
by the bullion dealer according to his assessment of the creditwor-
thiness of the customer. It is likely that, except for a customer of the
very highest standing, he will insist on a margin - in other words,
that the customer's assets with him must exceed his liabilities by a
percentage, probably in the range 10 to 25 per cent.
Such deferred settlement facilities can be seen to mirror almost
exactly the procedure on the Kam Ngan exchange, and it will be
readily observed that they make arbitrage with that market simple.
A Hong Kong dealer might well sell short on the Kam Ngan
exchange 4,000 taels (approximately 4,800 ounces) while
simultaneously buying from a bullion dealer on a deferred settle-
ment basis 4,800 ounces loco London, if the price available on the
Kam Ngan is higher than the loco London price. His aim would be
to reverse the positions when the Kam Ngan price is lower than the
loco London price. There are, of course, uncertainties. In the first
place, the gold price on the Kam Ngan is quoted against Hong Kong
dollars, while the loco London price is in US dollars. The arbitra-
geur between the two markets must therefore enter into a foreign
exchange transaction, selling Hong Kong dollars against US dollars
in order to avoid the risk of the exchange rate moving against him.
As he neither receives the Hong Kong dollars from the Kam Ngan
nor pays the US dollars to the bullion dealer for his purchase, he
must also make arrangements to borrow Hong Kong dollars from a
bank and deposit US dollars, probably with the same bank. He is
therefore left with interest rate exposure and almost certainly some
cost. It is quite likely that the rate which he earns on the Hong Kong
dollars in the Kam Ngan will be less than that which he must pay the
bank to borrow in order to meet his foreign exchange contract. On
the other hand, he may well be paying more for the US dollars he has
borrowed from the bullion dealer than he receives for the US dollars
on deposit with the bank.
Let us look at this in schematic form, using the example of the
imaginary Glorious Gold Company, If we assume that when gold is
bought dollars are sold and vice versa, the transaction looks like
this:
Type of transaction Glorious Gold buys Glorious Gold sells
1. Gold Hong Kong dollars ^JCamNgan gold: 4,000 taels
gold price risk neutralised
2. Gold Loco London gold: US dollars
4,800 ounces
3. Foreign US dollars Hong Kong dollars
Exchange
However, because neither currency is delivered in the gold transac-

tions, this leaves Glorious Gold without Hong Kong dollars to
deliver in fulfilment of the foreign exchange contract and with US
dollars surplus to immediate requirements. Glorious Gold must
therefore enter into two more transactions:
4. Loan (Borrow) Hong Kong dollars

5. Deposit (Lend) US dollars
We can now see that Glorious Gold has no risk on the outright
move in the gold price because he is long on one market and short
on another. Nor has he any risk from possible movements in the
exchange rate of US dollars against Hong Kong dollars. He is,

nevertheless, left with two risks. First, the possible change in the
relationship between the price of gold on the Kam Ngan and that of
loco London gold. Secondly, a change in the relationship between
the interest rates of Hong Kong dollars and US dollars. If, for
argument's sake, he is depositing US dollars with the bank at 91 per
cent per annum, while the bullion dealer charges him 10 per cent on
the US dollars borrowed, he has a loss of 0.5 per cent per annum to
contend with. If, furthermore, as is entirely possible, he receives 13
per cent per annum on the Hong Kong dollars left with the Kam
Ngan, while paying 15 per cent per annum to the bank to borrow,
the running loss on his position is increased to 2.5 per cent per
annum in total. This means that he can only afford to hold the
position for a certain period.
However, it may be that the price of gold on the Kam Ngan falls
by 0.50 per cent (or approximately US$2 per ounce) over a few days
relative to the loco London price. In such an event, he canTdVerse all
his transactions and take a tidy profit.
Because the deferred settlement facilities are so flexible, an
arbitrage as described could just as well be set up between the loco
London spot market and a futures exchange. The main requirement
is the ability to deal in the two markets simultaneously.
The Hong Kong Commodity Exchange (HKCE)

In addition to the Kam Ngan, there is in Hong Kong a true gold
futures market, the gold contract on the Hong Kong Commodity
Exchange. This market was founded in 1977, and introduced a gold
contract in August 1980. In early 1984 the other commodities
traded there were raw sugar, raw cotton and soya beans. There are
plans to introduce financial futures on the exchange, but, although
the HKCE has developed such contracts, the reconstituted
exchange, whose membership will be doubled to about 300 by the
sale of new seats, is unlikely to be ready before early 1985.
The HKCE operates its gold contracts very much on the lines of
US futures markets, offering six trading months, February, April,
June, August, October and December (as on Comex). It quotes gold
in US dollars per ounce, the size of a lot is 100 ounces, and there is a
clearing house. Unlike the US futures market, the clearing facilities
and guarantee are not provided by a body of clearing members.
These functions are undertaken by an outside company, the Inter-
national Commodities Clearing House Limited (ICCH), based in
London, and operating in Hong Kong through a subsidiary com-
pany, International Commodities Clearing House (Hong Kong)

Limited. In return for a fee levied on each lot traded on the HKCE,
ICCH guarantees the performance of every contract.
If delivery of gold is required against an HKCE contract, this is
achieved by the seller handing over a warrant representing gold to
the ICCH in return for payment; ICCH in turn delivers the warrant
to the buyer in return for payment. Gold represented by the HKCE
warrants is located in Hong Kong, although at the onset delivery
was loco London.
The HKCE's gold contract has not been very successful. In 1984
only 5,845 contracts were traded, compared with 6,106 lots the
year before, and 32,740 in its best year, 1981. As the HKCE is
located in such an important gold-trading centre as Hong Kong, its
failure to attract much business is at first sight surprising-the more
so, since Hong Kong directs a significant amount of business to the
futures markets of the United States. It is not therefore any dis-
satisfaction with the structure of futures markets which is respon-
sible for the lack of interest. Rather may it be attributed to the
competition from the established gold markets in Hong Kong. The
HKCE is sponsored by a mixture of British and Chinese interests,
and its operations in other commodities, where there is local
interest and little competition, have been quite successful. The
requirement that local gold traders should be members of a
recognised commodity exchange in order to enjoy trading rights in
the Crown Colony resulted in a boom in the value of HKCE
memberships, but failed to provide the boost necessary to make the
gold futures contract more active. We must conclude that the
established position of the Kam Ngan and the arbitrage oppor-
tunities provided by the loco London market, which have interna-
tionalised Hong Kong gold trading, have provided sufficient
infrastructure to make a futures contract unnecessary.
The Tokyo Gold Exchange

The Asia Pacific time zone has four gold futures contracts in four
different countries, all having somewhat different characteristics;
each is situated in a city whose activity in gold trading has gained, or
is gaining, in importance. Tokyo certainly falls into this category.
The Japanese gold manufacturing industry has grown considerably
in the last few years, particularly following the increased import-
ance of the electronics industry. Furthermore, gold jewellery has
become more popular in Japan, and has tended, amongst the
younger generation at least, to supersede that made from platinum,
which was traditionally the premier precious metal and widely

purchased by the public.
In addition, successive Japanese Governments have progressively
removed the barriers to gold ownership. As a result, gold has
become much more widely current as a medium for investment and
speculation. This increased popularity has, however, not yet
resulted in the strong development of an active gold futures market.
Commodity traders have not enjoyed a good reputation in Japan,
and the gold futures market there has failed to rid itself completely
of this inheritance, despite the growing popularity of the metal, and
the support of several leading trading companies.
Gold futures trading started injapan on 23rd March 1982, under
the auspices of the Tokyo Gold Exchange. Since the beginning of
1984 (26th January) the same Exchange has offered silver and
platinum contracts as well, and silver in particular is reported to
have attracted considerable interest. There are 40 floor members as
well as a number of 'general members'; although international
participation on these markets is permitted, there has been little so
far. This is no doubt in part due to a lack of familiarity with
Japanese practice, but dealers from outside Japan have also been
deterred by the high rate of original margin required on Japanese
gold futures contracts, which was of the order of 20 per cent. The
Tokyo Gold Exchange has embarked on a marketing effort in an
attempt to widen interest, and since the start of 1984 original
margin requirements are being progressively reduced to a level of
approximately 5 per cent of the contract value for non-members of
the Exchange, much more in line with international practice.
Margin deposits for members are much lower than for
non-members.
It is as yet too early to judge the effect of these changes, but the
growing importance of Tokyo as a financial and trading centre may
in due course allow the metal futures markets there to develop a
greater activity. For the time being we must reserve judgement,
while recording the basic features of the gold contract available
there.
Gold is quoted in Japanese yen, and the contract size is one
kilogram. Deliverable gold must be 99.99 per cent fine, and bars
from a number of Japanese and international producers are accept-
able. There are two trading sessions, from 9.10 a.m. until 11.30
a.m. and from 1.10 p.m. until 3.45 p.m., and trading is divided
between official calls (three per session), known as auctions, and
'personal trading', which takes place between the auctions. There
are some restrictions on the type of order which can be executed

during personal trading.
Delivery months quoted are the spot month and the five follow-
ing calendar months, and delivery is normally by a 'warehouse
warrant', representing gold held in an Exchange-approved ware-
house. The minimum fluctuation in price is one yen per gram, and
the maximum permissible daily movement from the previous day's
closing price level is 5 per cent.
The Sydney Futures Exchange (SFE)

Australia has a distinguished past in the world of gold, having been
a significant producer, ever since the metal was first discovered
there in 1851. In the period following the Second World War,
however, gold ownership, as in many other countries, was illegal,
and Australia was subject to considerable exchange controls, not
just limited to gold. This made it impossible for an international
market in gold to develop there, although, as the 1970s progressed,
ownership of gold within Australia became possible. Australians,
like Americans, have a long-established interest in trading com-
modities, so that as the popularity of gold investment and specula-
tion grew internationally in the period between 1975 and 1980, a
market within Australia also developed. In April 1978 the Sydney
Futures Exchange (which was the successor to the Sydney Greasy
Wool Futures'Exchange founded in 1960) began business in gold, in
addition to the commodities already traded, namely wool and live
cattle.
The number of gold contracts traded in 1978 was 30,359, but
there was considerable growth in the market during the following
two years.
Because of exchange controls, trading in the gold contract was
restricted to Australian residents. In view of this limitation, the gold
contract must be judged a success, although the volume of interest
has fallen away more recently. In 1980, the most successful year,
233,842 gold contracts were traded on the SFE, an average of
almost 1,000 per working day, but by 1982 only just over 25 per
cent of that turnover was recorded. In 1983 volume slumped
further to 27,099 and by 1984 only 2,299 contracts were traded.
The gold price is quoted in Australian dollars per ounce, and the
size of one lot is 50 ounces. Delivery months quoted are the spot
month and March, June, September and December. Contracts are
guaranteed by the Australian branch of ICCH. As in New York and
on the Hong Kong Commodity Exchange, delivery is by means of a
warehouse receipt, which entitles the holder to gold held in ware-

houses recognised by the Exchange. All of these are located in
Australia.
The SEE can obviously not be considered an international futures
market for gold; there are, however, three factors which could
influence its future importance. First, the present Australian
Government has to a considerable extent abolished the exchange
controls relating to gold, as a result of which participation on the
SEE gold market by non-residents of Australia has become possible.
Second, there is a growing demand for trading of gold in the hours
between the close of the New York Commodity Exchange and the
opening of the Hong Kong market on the next day. Sydney is two to
three hours ahead of Hong Kong, depending on the season, and
thus well placed to intervene between the two important markets.
Third, it was announced in February 1984 that the SFE was in
discussions with the New York Commodity Exchange with a view
on
to finding a means for each exchange's members to the
other market. This proposed association with the world's leading
gold futures market may have immense repercussions for the SFE
and certainly offers it the opportunity to make a huge advance. No
formal announcement of the link-up has occurred at the time of
writing, but it is privately reported that discussions on it are at an
advanced stage.
No conclusion about the future importance of the SFE's gold
contract can be reached at present, but, even without a Comex link-
up, the prospects are good because of Sydney's position in the
world's time zones and because the financial and gold markets there
are acquiring a much greater international flavour. There is already
quite an active market in spot gold established, and the dealers
established there are keen to develop a market on expanded lines.
The Gold Exchange of Singapore (GES)

The fourth centre in the Asia Pacific region with a gold futures
market is Singapore. The GES was formed in 1978, and commenced
business in November of that year. Unlike the other futures markets
discussed in this chapter, it was purpose-made to trade gold and,
until now, nothing else. The formation was partly inspired by the
Government of Singapore, as part of an attempt to make Singapore
a rival to Hong Kong as a centre for the trade of gold.
Until the early 1970s Singapore's importance in gold was mainly
as a distribution centre, serving the needs of local jewellery
manufacturers and neighbouring countries, particularly Indonesia,
where the official import and export of gold was restricted. Gradu-
ally local investment and speculative interest in gold increased, and
several international dealers have been attracted to set up in
business in Singapore. Currently three of the five major London
Gold Market members are represented there, Rothschild, Samuel
Montagu and Johnson Matthey, as well as Republic National Bank
of New York and the major Swiss and German banks.
They have been joined by a growing number of Chinese firms,
and American commission houses, so that in 1983 and 1984
Singapore has developed a gold market of importance, with con-
siderable volume and good physical business. The Gold Exchange
of Singapore was at its inception largely a local organisation,
although from the beginning it encouraged overseas representation
through a special form of membership. Apart from overseas mem-
bership, the GES originally had separate categories of dealer mem-
bers and broker members, both of whom were actually represented
on the floor of the exchange. The dealer members were mainly
associates of the four largest local banks, Development Bank of
Singapore (now DBS Bank), Overseas Union Bank, Oversea
Chinese Banking Corporation and United Overseas Bank. The fifth
dealer member was New Court Merchant Bankers (now N. M.
Rothschild & Sons (Singapore) Limited). The first four were in a
strange position, because they also provided the clearing house of
the exchange and guaranteed the performance of the contract;
unusually, the clearing house operated a manual accounting system.
At the beginning of trading, the broker members were five in
number. All the firms in this category were commodity brokers,
whose speciality heretofore had been in rubber and other important
products of the Malay Peninsula.
Trading on the GES was a relatively sedate affair, as each broker
or dealer member sat at a desk. Although the eleven members could
at times generate a good deal of noise, it could hardly be compared
to the hubbub of the US exchanges. Also unlike the US markets, the
trading day was divided between 'open outcry' trading and official
calls, when all business transacted was recorded by hand on a board
which dominates one side of the trading room.
All in all, the GES has many unusual features. Its procedures were
borrowed as much from the commodity markets of London and
Kuala Lumpur as from the United States. The main contract size, in
line with US markets, is 100 ounces and the currency of contract is
US dollars, but delivery was satisfied only by three one kilogram
bars, with a fineness of 99.99 per cent (equivalent to 96.444 fine
ounces). In practice, warrants representing unallocated gold were

the normal medium for delivery. Furthermore, only bars produced
by one manufacturer, Johnson Matthey, were acceptable. There
was also a one-kilogram contract from 1980.
The GES was no great success in its early days. It failed to attract
the truly international business, and volume scarcely reached a level
to give sufficient liquidity to the market. But in Singapore they do
not believe in failure; 'if at first you don't succeed, try, try and try
again' might well be their motto. The GES has undergone consider-
able changes in recent years. Full membership was expanded to 18
at the end of 1982. Membership of the GES has, since the beginning
of 1984, been a prerequisite for any company to trade in gold in
Singapore. The Exchange has been reorganised, has moved to new
purpose-built premises, and has recently been expanded to include
financial futures contracts under a new name, Singapore Inter-
national Monetary Exchange, or Simex. An association with the
IMM of Chicago has been forged, so that member^ \)f either
exchange are able to trade on the other exchange without being
subject to margin arrangements outside their own country.
The clearing house of Simex has become a member of the clearing
house of the IMM and vice versa. A system of offsetting margins,
known as 'mutual offset', has been introduced, although, as of
October 1984, the gold contract's link with the IMM in this way
still awaits the approval of the US Commodity Futures Trading
Commission.
Even without this link, the GES improved its level of activity in
1983, assisted by lower clearing fees and tax reductions on income
from offshore gold transactions. Its total volume of 133,743
contracts during the year was 40 per cent up on the previous year,
making the GES the most active gold futures market in the Asia
Pacific region.
Although Simex's link with the Chicago IMM for two other
contracts was completed on 7th September 1984, its gold contract
had begun trading in the new building on 5 th July. It was not the
physical surroundings alone which changed; the new trading floor
does indeed have every modern aid for communication, both
internally and with the outside world, and the clearing system has
been computerised.
More importantly, a new breed of members has been encouraged
to take its place on the trading floor. 'Locals', so familiar on US
futures exchanges, have made their debut in Singapore. Under the
careful tutelage of experienced local traders from Chicago, these
'high net-worth' individuals have been busy learning the finer

points of floor-trading from their American counterparts. By
September 1984 they numbered 100. The gold contract is still 100
ounces, but now delivery is made in London, by means of a transfer
of gold on an unallocated account at the branch of the Morgan
Guaranty Trust Company of New York. The trading months are all
the even-numbered months (as on Comex), plus March and
September.
Even without the link-up with Chicago, this revitalised market
has been rewarded with a daily volume which at times exceeds
1,000 lots. It is perhaps too early to judge the efficacy of all these
changes, but the bold moves to develop Simex as a major inter-
national futures market, with a range of financial contracts (gold,
Eurodollar deposits and two currency contracts), has strong official
backing and has every chance of success.
The London Gold Futures Market

We have seen that no futures market outside the United States has
met with conspicuous success. There have been many explanations
advanced for this. Probably the most convincing is that outside the
United States there is little understanding of the futures market
concept. Certainly as telling is the existence, in the various centres
where gold futures exchanges have been formed, of other gold
markets, which are at once better established and already serving
local needs. It has also been suggested that a gold futures contract
will not be successful outside the United States unless it is denomi-
nated in a currency other than the US dollar.
It was against these themes that discussion began on the forma-
tion of a London gold futures market in late 1979, after the
abolition of exchange controls in the United Kingdom. Two
organisations were interested in sponsoring such a market — the
London Gold Market and the London Metal Exchange. In the early
days it appeared possible that two new markets might be started.
The London Gold Market wished to add to the services which it
already offered to the gold industry and to investors and specu-
lators, while the London Metal Exchange was keen to add gold to
the contracts which it previously traded—copper, lead, zinc, tin and
silver — and to its new contracts, aluminium and nickel.
It soon became clear that it would be more sensible for the two
bodies to co-operate than to compete, which they did from July
1980, co-sponsoring the formation of the London Gold Futures
Market, which opened its doors on 19th April 1982. It had in all 38
floor members, five from the London Gold Market, 26 from the
London Metal Exchange; of the seven others, five were commission
houses based in the United States and two were bullion traders. A
trading floor, originally designed for an Arabica coffee market of
the London Commodity Exchange, had been extended and remod-
elled to house the LGFM. The contract details were to a large extent
on classic futures market lines, but, instead of alternate trading
months, prices were quoted for spot delivery and for delivery in
each of the succeeding six months. Delivery is achieved through a
clearing house, the instrument being a warrant representing gold
held in London. The clearing and guarantee facilities are once again
provided by ICCH as in Hong Kong and Sydney.
After not a little discussion, it was decided that the contract
would be denominated in sterling, it being felt that this would
differentiate the market from the existing gold market in London,
and encourage investors in the United Kingdom to participate. The
practice would also be in line with that of the Loqdgn Metal
Exchange for the metals traded there.
In other respects the market conformed broadly to the US futures
market norm, while including some features more typical of the
London Commodity Exchange, London's market for soft com-
modities. The trading day was divided into two separate sessions,
morning and afternoon, each session beginning and ending with an
official call, at which opening or closing prices for each trading
month are established. The practice exists that, when a limit price is
reached, trading in forward months ceases for thirty minutes.
Unlike many other futures markets, trading is permitted to resume
after the half-hour recess without further limit on price movement
until the end of the session. Finally, the proceedings, whether at the
opening or closing calls or during open outcry trading between
them, are under the supervision of an official employed by the
Exchange as 'Call Chairman', who sits on a raised rostrum and is
flanked by representatives of the clearing house who enter transac-
tions directly into the clearing computer as soon as trading slips
have been agreed and initialled by the buyer and seller.
The ICCH is a unique corporation engaged in the business of
clearing commodity transactions in London (and more recently
elsewhere) since 1888. One of its strengths is its total independence
from any trading house or exchange member, so that it has no
possible conflict of interest, a situation which cannot always be said
to obtain in the United States futures exchanges, where the clearing
houses, although administered separately, consist of a group of
clearing members of the exchanges, who also execute orders for

customers. The independence of ICCH allows it to decide on
differential rates of original margin (known in London commodity
markets as 'deposits') according to the size of each member's
positions and creditworthiness. Every member of the LGFM must
also be a member of ICCH, and those who are members of more
than one commodity market cleared by ICCH may benefit from
offsetting deposits and variation margins.
ICCH's established margin system used to require that members
with loss positions had to pay in these losses to ICCH, but those
with profit positions did not receive their profits. They did,
however, receive credit interest from ICCH, calculated on their
profit position. The LGFM began with this traditional system, but
with the growth in arbitrage activities between the LGFM and US
futures markets a revised system, originally developed by ICCH for
the London International Financial Futures Exchange, was adopted
in October 1983. LGFM members' profits held by ICCH may now
be withdrawn and used to cover adverse variation margin require-
ments on arbitrage positions on other futures markets.
This has not been the only change adopted by the LGFM during
its existence. In October 1982 it was decided that the sterling
denominated contract was not suitable for gold, which is a com-
modity whose prices in US dollars is recognised the world over. The
change to dollar quotations certainly increased the volume of
business on the Exchange. During the period from 19th April to
December 1982, a total turnover of 130,566 contracts were traded.
Of these, 74,660 were against sterling, the majority being traded in
the first six months; 55,906 dollar denominated lots were traded
between 19th October and the end of the year.
This increased momentum continued into the early months of
1983, when activity in gold markets generally was at a high level,
but fell away as interest in gold subsided during the remainder of the
year. During the summer of 1983, the LGFM considered the
possibility of introducing platinum and silver contracts, but elected
to continue as a pure gold market, at least for the time being. From
October of the same year, however, it further refined its structure,
by changing its operating hours to a continuous session from 8.30
a.m. to 3.30 p.m. London time. This move was designed to attract
business from the Far and Middle East, as well as the beginning of
the European day, while retaining some time overlap with the US
futures markets. To further assist trading with those markets, there
are arrangements for unofficial trading between members on an
'inter-office' or 'kerb' basis, such trading being registered with the

clearing house, and thus covered by the ICCH guarantee.
Furthermore, new contract months were adopted. There are still
six trading months in addition to spot, but these have been spread
so that they coincide with the Comex months — February, April,
June, August, October and December.
While all these changes have been made to try to boost volume to
a level which should allow the LGFM to attract substantial busi-
ness, which its position astride the main gold-trading time zones
should permit, so far the response has been disappointing. Daily
volume average in 1983 was lower than in the last quarter of 1982.
To a large extent this no doubt reflected the reduced investment
interest in gold prevailing since March 1983 after the sharp price
fall. Nevertheless, the LGFM could take heart from the fact that in
1983 in terms of a volume of 180,458 contracts it was th? most
active gold futures market outside the United States,
In 1984 the daily turnover showed a declining trend, mirroring
conditions in other gold markets. The LGFM's unique position as a
futures market offering only one contract — gold — became a
weakness. Against the background of diminishing volume, the
board of the LGFM commissioned a report from a consultant in
July 1984. This report, circulated in the following October, raised
the various possibilities for future development, including the
introduction of additional precious metal contracts or linking up
with another exchange. Turnover in 1984 was little more than half
the 1983 figure, at 93,266 lots. On 31st January 1985 the Board of
the LGFM announced that the response to a questionnaire sent to
floor members had indicated insufficient support for continuing the
market and that action would be taken to bring about an early
closure.
7
Who uses futures?
In Chapter 4 we described some of the people who use futures

markets, but the nature and extent of their activities is worthy of
further study. In very broad terms, we may distinguish three
categories of traders, apart from floor brokers. These are hedgers,
professionals and speculators. It will be noticed that investors have
been omitted. There is little evidence that true investors go to
futures markets to make their purchases or sales. Being conservative
by nature, investors prefer to buy gold for spot delivery, and hold it
in a safe place — in the vaults of a bank or of a bullion dealer. Once
they have purchased, investors may decide to sell futures against
their spot position, if they believe tbat the market price of gold has
gone up too quickly. But they sell with a view to repurchasing when
the price falls back. In so doing, they become hedgers.
Hedgers
Hedging may be undertaken for a variety of different reasons, but,
in terms of futures trading, there are just two operations — the buy
hedge and the sell hedge. These are sometimes also referred to as the
long hedge and the short hedge. In essence, a futures hedge, whether
long or short, is designed to protect the person hedging against a
movement in the price which may be adverse to his position or to his
business. The greater the volatility of the gold price, the more most
users or traders of gold require a hedge. Let us leave aside pro-
fessional operators for a moment, and consider the needs of
producers and consumers of gold.
Producers
A great many producers of gold are large corporations, employing
substantial amounts of capital in their production processes. Such
large-scale operations involve a long-term commitment. In the case
of a new gold mine, several years of exploration, geological testing
and project costing may be undertaken before a decision is made to
go ahead. The decision to proceed necessarily involves many
assumptions, in particular about the future trend of costs and the
price of gold.
Let us consider the case of a hypothetical new mine, Consolidated
Bear Lake, faced with gold price movements which actually
occurred between 1982 and 1984. Let us imagine that in early 1982
the company had identified a new mine which, it was calculated,
would be able to produce 100,000 ounces of gold annually at a cost
of $300 per ounce in 1984, and that this cost of production is
assumed to rise by 7 per cent per annum. The mine is^^pected to
have a workable life of 15 years before its supply of ore is
exhausted. In early 1982 the price of gold is $380 per ounce. The
decision is taken to go ahead with the new mine. The ruling price of
$380 gives a satisfactory return on the investment. The problem, of
course, is that gold prices have been highly volatile for a number of
years. While the $380 price is far below the peak of $850 seen in
January 1980, there is no guarantee that the price will still be at this
level when production begins in 1984. After all, the first time that
gold rose above $300 was as recently as July 1978. The go-ahead is
given on the assumption that gold prices will not fall below $300
again. The second assumption is that prices over the 15-year period
will increase on average by at least the 7 per cent per annum
necessary to meet the projected rise in costs. If neither assumption
proves correct, then the new mine will incur losses at some stage
during its life. Mining companies know from experience that there
is a high probability that the price of their product will not rise
evenly over long periods of time. There are bound to be peaks and
troughs in demand for their products, and resultant volatility of
prices.
At the beginning of 1982 it was a reasonable assumption that the
price of gold would not fall below $300 per ounce, but over the
succeeding months there were some uncomfortable moments, as
the quotation fell first to $312 on 15th March. A month later it
recovered to almost $370, on the uncertainties surrounding the
invasion of the Falkland Islands by Argentina, and the subsequent
Who uses futures? 79
armed repossession by the United Kingdom. Not a few mining

companies took advantage of this rally in prices to hedge some of
their production. How right they were! Despite continued fighting
in the Falkland Islands, and during late May and early June the
invasion of the Lebanon by Israel, gold prices once more fell back,
actually falling below $300 for a brief period in late June. If our
friends the Consolidated Bear Lake Mining Company had decided
to sell some of their future production as a hedge in April, they
would have been feeling satisfied with their action, if not for the
trend of gold prices. In April 1982, when spot prices were around
$365, they could have sold December 1983 futures contracts on
Comex at approximately $454 per ounce. December 1983 was the
most distant contract month with a reasonable volume quoted at
the time. A sale at $454 would have 'locked in' a profit of $154 per
ounce against their estimated cost of production for 1984. They
would, of course, not be in a position to deliver in December 1983,
but would have the possibility of repurchasing their December
1983 short position at any time before maturity, and, if they
wished, simultaneously selling the same quantity for a later delivery
month. Suppose they had decided to sell 20 per cent of their
estimated 1984 production at $454 for December 1983 delivery.
The effect of this would have been to reduce their cost of production
for 1984 from the original estimate of $300 per ounce to $262. (The
original cost of 100,000 ounces was $30,000,000, but they had sold
20,000 ounces for $9,080,000. Therefore they need only sell the
remaining 80,000 ounces for $20,920,000 (or $262 per ounce) in
order to recoup their costs.) In 1982 many producers of gold,
whether established or new mines, had costs of around $300 per
ounce, and were extremely anxious when the price approached this
level. The pressure to take some protective action was heavy, and
hard to resist.
Perhaps the decision to hedge in April 1982 sounds an easy one.
Many mines were, in fact, successful in taking the decision at the
time, but the subsequent development of market prices made life
very difficult. After touching a low point just under $300 in June,
spot gold prices recovered once more, reaching $365 in June, and
soon moving to $380 in the middle of August. Most observers felt at
that time that there was little chance of gold going above $400 per
ounce; so that there were new pressures on higher-cost mines to
begin new hedging programmes. Several did sell a part of their
production at this time around $380 per ounce, an action which
proved misguided.
80 Trading in go Id futures
Against most expectations, the gold price shot up to $500 in the

early part of September. The effect on those who had taken short
hedges at $380 was little less than disastrous. The market had
moved $100 per ounce against them in three weeks. Not only had
they lost the opportunity of selling at higher levels, but they were
landed with the cost of putting up adverse variation margin on their
earlier sales. We will assume that the Consolidated Bear Lake did
not fall into this trap. Having sold December 1983 contracts at
$454 per ounce, it decided that it would not indulge in further
hedging unless the spot price reached $425 per ounce. Its hedging
programme was designed to sell the whole of its estimated 1984
production at an average spot price of $485 per ounce, plus
whatever contango could be obtained for delivery periods spread
over 1984. Having sold 20 per cent at $365 basis spot, it was
prepared to sell another 20 per cent at each $60 per ounce rise from
this level. In early September 1982 it sold a further 200 contracts, or
20,000 ounces, at $527 for February 1984 delivery, o^S$25 basis
spot, and a few days later 200 contracts for April 1984 delivery at
$578 or $485 basis spot. By then it had sold 60 per cent of its 1984
production at an average price of $520. In the light of subsequent
events, this proved to be an excellent decision, for although the spot
price of gold again moved to $500 in January 1983 (in fact to $515)
it subsequently fell back to below $400 in late 1983 and early 1984.
Nevertheless, Consolidated Bear Lake's action was somewhat
risky, and incurred some variation margin cost. On average, it had
sold 600 contracts, or 60,000 ounces, at $520 per ounce for an
average delivery date of February 1984. In the first half of Septem-
ber 1982, the price of the February contract was at times as high as
$567 per ounce, so that Consolidated Bear Lake was obliged to put
up to Comex $47 per ounce of adverse margin, or $2,800,000 on
60,000 ounces. By 13th October the February 1984 contract had
fallen to $512, so that Consolidated Bear Lake had received back all
the previously posted variation margin and more (as the average
price for its short hedge was now higher than the market price). In
later October, February 1984 had fallen to $475 and Consolidated
Bear Lake was receiving $45 per ounce positive variation margin or
$2,700,000. Throughout October, November and December this
respite continued, but on 10th January 1983 the market price for
February 1984 had again surpassed Consolidated Bear Lake's
average short price, a condition which continued until the end of
February. During this period, the maximum adverse cash flow to
Consolidated Bear Lake was $2,400,000 when the February 1984
contract reached $560 on 31st January. From 1st March 1983,

Consolidated Bear Lake enjoyed a positive cash flow until the end of
the year.
So it had a highly successful hedging programme as it reviewed
the situation at the end of January 1984, when its production was
coming on stream according to schedule, and prior to which it had
switched its December 1983 sales to February 1984. Its first 8,000
ounces of production were sold spot to a dealer at $370 per ounce,
at which time it repurchased 80 contracts of February 1984 Comex
short position at the same price, thus realising a profit of
$1,200,000 on this portion of its hedge. The remaining 320
contracts of February were also repurchased at $370 against a
simultaneous sale of 80 contracts each for June, August, October
and December 1984 delivery, in order that its hedge position more
nearly matched its expected deliveries from production. In making
these switches, it took the profit on its original hedge, and re-
established new hedge positions nearer to the ruling market price.
These short hedges were liquidated as it sold its production gold to
bullion dealers when the gold became available.
We cannot, of course, quantify Consolidated Bear Lake's profit
on its hedge position, because we do not yet know what the average
gold price for 1984 will be. We can, however, say that at the time of
writing (October 1984), with spot gold at $340 per ounce, the
benefits look immense, notwithstanding the costs inherent in hedg-
ing. For one thing, Consolidated Bear Lake benefited from the high
forward premium or contango when it sold futures in April and
September 1982. At that time, US dollar interest rates were around
13 per cent per annum, and have subsequently fallen. On average, it
also turned to its advantage the variation margin, as it enjoyed
positive variation margin for a longer period than it suffered
adverse flows (and on average for more dollars). Furthermore, it
sold 60 per cent of its 1984 production at an average price of $520,
when the 1983 spot average was no more than $424 and the
average for January to October 1984 as little as $366. Unless gold
prices were to rise astronomically during the remainder of 1984, it
would still come out a long way ahead.
If successful hedging appears so easy, why do more mining
companies not try it? Many never hedge, and still more hedge only
exceptionally. Well, hedging involves risk. What could have hap-
pened to Consolidated Bear Lake? Its hedging programme was
designed to provide benefits on the assumption that prices between
1982 and 1984 would at some time go up, but subsequently fall
back. It could have occurred that they went up and stayed high.
Under such circumstances, Consolidated Bear Lake would have
suffered a continuous cash drain to fulfil variation margin require-
ments. It could also have been that the average price of its hedging
worked out to be less than the average price for gold in 1984, so that
it would have been better off without hedging. This would hardly
have been a disaster, as it would have locked in a considerable profit
by comparison with its costs of production. At worst, such a
situation would have caused lost opportunity.
Perhaps more serious would have been the opposite possibility;
that, having sold only 20 per cent of its 1984 production at $454,
the market had never risen far enough to trigger the next action in
Consolidated Bear Lake's hedging programme, and had later fallen
back to below $262 per ounce and stayed there. That is the problem
with hedging. In a volatile commodity such as gold, a hedging
system needs to be flexible. Yet, in the example given, the chances of
going wrong with a flexible system were too many.'sUnder the
development of prices which actually occurred between April 1982
and January 1984, the mechanical or automatic system followed by
Consolidated Bear Lake would almost certainly have given better
results. The temptation to be flexible at the wrong time could have
been disastrous, or at least ineffective. Unless a hedger is working to
a mechanical system, it is all too easy to listen to majority opinion,
which has so often been wrong in the past about gold prices, and
will probably repeat such mistakes in the future.
Before we leave Consolidated Bear Lake, let us consider a
sobering fact. Consolidated Bear Lake's clever hedging did not
make the best of the opportunities which the movement of prices
presented over the period. In the interests of greater safety, Con-
solidated Bear Lake did not go for broke and try to sell their 1984
production at the top of the market. Still more sobering, they have
only dealt with a single year's production from a mine with a
possible life of 15 years. With the gold price in late 1984 at a level of
only 15 per cent above their cost of production, they face a new set
of problems. Should they wait for better times, or lock in more
profit while it is there?
Refiners
By comparison with mining companies, the problems of gold
refiners seem small. Often refineries are called upon to buy material
which contains a number of different metals, perhaps ores, con-
centrates or, more likely, scrap. Let us take the example of scrap
material weighing in total 3,100 kilograms or 99,667 ounces, and

containing 3.2 per cent of gold, which is offered to ABC Refinery.
The customer wishes ABC to buy the gold content on the day that
an agreed assay is reached. ABC test the material, and calculate the
gold content at 3,190 ounces. Their customer requires payment
within a week, but ABC know that it will take two months to
complete the refining and to produce the gold bars which they can
sell and deliver on the market. The date is February 1984, and the
spot price of gold $370 per ounce. Who knows what the price will
be in April when ABC have the gold available?
In order to protect themselves from price fluctuation, ABC have
two choices. They can either sell the gold forward now to a bullion
dealer, or they can take out a short hedge on a futures market. They
obtain a bid from a bullion dealer, but find that the price for April
delivery on the futures market is somewhat more favourable.
Recognising that they have a possible problem of adverse variation
margin, they nevertheless feel that a futures sale will be advanta-
geous to them, because they do not have to nominate a fixed date for
delivery as they would have to with a bullion dealer. While the
dealer also offers the possibility of changing the date, ABC are not
sure what such a change will cost them, so they elect for the futures
market hedge. They have calculated that the premium available for
April delivery on the futures market is enough to recoup the loss of
interest for die period between the date when they pay the
customer, and the day when they will receive payment for the gold
they have produced. Their borrowing cost is 11 per cent per annum,
while the premium for April is $7.30 per ounce, equivalent after
deducting commissions to 11.2 per cent per annum. They sell 32
lots of April futures at $377.30. They will be charged a commission
of 20 cents per ounce ($20 per lot) on both the hedging sale and on
the repurchase or delivery. Simultaneously, they agree to purchase
the gold content of the material, being 3,190 ounces, at $370. Thus
they have hedged their price risk, and know that they have locked in
the profit which they will make on the refining charges made to the
customer. They also have built in some flexibility. If the refining
process takes less time than anticipated, say six weeks instead of
two months, they will be in a position to close out their April
contracts early at the same moment as they sell their gold bars. If,
however, the refining process takes longer than expected, they may
switch their hedge forward to the next delivery month, June, and in
due course close out their June short position when the refined gold
is ready for sale. Of course, by switching they will be paying
additional commissions, so that the final result will be less favour-

able, but at least they will have hedged their price risk. What can go
wrong? They calculated the value of the hedge on their borrowing
cost of 11 per cent per annum. If interest rates rise sharply, the value
of their hedge will diminish, but this problem is no greater than for
any other business which borrows money in the normal course of
business.
While the hedging of gold contained in a refining contract is
normally of a fairly short-term nature, refineries are sometimes
asked to make bids for a regular supply of material containing gold,
say for one year. Probably the pricing of the gold content will be
based on the spot price for gold on the date of receipt (or assay) of
the material. This may lead to the refiner making a series of futures
operations such as outlined above. It could be that the refiner, in
making a proposal to his customer for the annual contract, will be
making an assumption about the level of interest rajtes during the
year, with the result that he will be at risk if interest #ates fall
significantly during the period.
Let us suppose that he wishes to build into his bid for the refining
contract an interest rate of 10 per cent per annum at a time when the
contango available on the futures market offers a net return of 10.5
per cent. This situation is different from that discussed in the earlier
example, where the refiner merely had to hedge the loss of interest
involved by paying his supplier on receipt of the material, and
wished to cover himself for the interest rate for the period between
the payment to his customer and the date when he can sell the gold
he has refined. That example represented a hedge against move-
ments in the price of gold, as well as protection against possible loss
of interest from paying his customer 'early'. In the example we will
consider now, we assume that the refiner believes that interest rates
will fall, or that he has access to cheap finance, and wishes to take
this belief into account in making his bid for the refining contract. In
other words, he is in a competitive situation, which will require him
to keep his charge for refining to a minimum if he is to obtain the
contract. He is confident that on average he will be able to borrow
the money required to pay the customer at 9 per cent per annum,
and wishes to use the difference between this assumed cost of funds
and the contango of 10.5 per cent per annum available in the futures
market to 'subsidise' his quote to the customer. In order to do this,
he may choose to enter into a futures switch programme, whereby
he buys nearby contracts and at the same time sells the equivalent
amount for further maturity dates. This action will have the effect
of locking in the required interest rate of 10.5 per cent.
For example, in December 1983 he makes a refining contract for
material which will be delivered each month during 1984, and
which is expected to contain 5,000 ounces of gold in each shipment.
The spot gold price is $380 per ounce, and futures markets offer a
premium equivalent to 10.5 per cent per annum for each delivery
month in 1984. The futures prices therefore range from $393.30
per ounce in April to $419.90 in December (at 10.5 per cent per
annum based on $380 the premium would be approximately $3.37
per ounce per month, or $13.58 for the four months to April 1984,
and $40.45 for the twelve months to December). The refiner takes
the view that he can afford to take the risk for the first two ship-
ments of refinable material due in 1984, but that he needs a hedge in
respect of the remaining months. The total quantity to be delivered
in 1984 is 60,000 ounces, but he deducts from this the January and
February deliveries aggregating 10,000 ounces, so that he needs
cover for the remaining 50,000 ounces. He therefore decides, on
confirmation that he has won the refining contact, to buy 50,000
ounces of April 1984, while simultaneously selling 50,000 ounces
for December 1984. This operation is purely to ensure as far as
possible (i.e. for eight months) that he benefits from the 10.5
per cent per annum contango available in the futures market.
However, it is possible to carry out his normal short-term hedging
programme utilising the 500-lot long April against short December
position.
In January, when he receives the first 5,000-ounce delivery of the
refinable material, he would in normal circumstances hedge by
selling 50 contracts for February or April. As he already had a long
position in April, he now offsets that by selling 50 contracts. This
operation is repeated when the 5,000-ounce deliveries contained in
the February and March deliveries are received. When the refining
of these 5,000-ounce consignments is completed and the refiner
sells the resulting physical gold, he does not buy back the April
hedge, but rather repurchases part of his December short position.
Of course, this will result in the refiner still having a long position in
April as that delivery month approaches. As he does not wish to
take delivery of this gold, he will switch to a later month, perhaps
part to August and part to October. He continues the short-term
hedging programme in a similar way, perhaps utilising his original
position, or perhaps using other delivery months. A summary of
the required actions for the whole programme (Table 3) may make
this clearer. Positive figures indicate a long position and negative
short. It is assumed that the refining period is one month in each
case.
Table 3 Summary of hedging programme

Receipt of Availability
and payment of refined
for refinable gold for sale
material (pays (receives Net hedge
Date customerl payment) Long hedging Short hedging position
1983
1 Dec. +50,000 Apr. —50,000 Dec.
1984
1 Jan. +5,000 — 5,000 Apr. -5,000
1 Feb. +5,000 -5,000 + 5,000 Dec. — 5,000 Apr. -5,000
1 Mar. +5,000 -5,000 + 5,000 Dec. — 5,000 Apr. -5,000
1 Apr. +5,000 -5,000 + 5,000 Dec. —35,000 Apr. -5,000
+ 15,000 Aug. (Apr. position.
+ 15,000 Oct. closed) *
1 May +5,000 -5,000 + 5,000 Dec. — 5,000 Aug. -5,000
1 June +5,000 -5,000 + 5,000 Dec. — 5,000 Aug. -5,000
1 July +5,000 -5,000 + 5,000 Dec. - 5,000 Aug. -5,000
(Aug. position
closed)
1 Aug. +5,000 -5,000 + 5,000 Dec. — 5,000 Oct. -5,000
1 Sept. +5,000 -5,000 + 5,000 Dec. — 5,000 Oct. -5,000
1 Oct. +5,000 -5,000 + 5,000 Dec. - 5,000 Oct. -5,000
(Oct. position
closed)
1 Nov. +5,000 -5,000 0 0 -5,000
1 Dec. +5,000 -5,000 + 5,000 Dec. - 5,000 Feb. 85 -5,000
(Dec. position
closed)
1985
1 Jan. -5,000 + 5,000 Feb. 85 0
This programme of hedging is relatively complicated, and there is

no absolute certainty that it will totally achieve the required effect,
because the contangos paid during the switch from April to August
and October contracts (15,000 ounces to each month on 1st April)
may be higher than anticipated. Furthermore, in reality the intake
of new material each month may not be contemporaneous with the
sale of refined gold, if there is any delay in the refining process.
Assuming, however, that the refining process takes not more than
one month, the sales of refined gold may be delayed to match the
price of new incoming material. The refiner's risk on variation
margin will be limited to 5,000 ounces or 50 lots at each stage, just
as in the earlier example. If, however, he is correct in his assumption

that interest rates will fall, he should benefit from a narrowing of the
premium between his long position (initially April, later August and
October) and his short position in December. As the major part of
his position is a switch, he will benefit from reduced original
margin. However, he must still estimate the cost of his variation
margin, and that of commissions in his total programme.
Apart from considerations of cost, the examples given so far for
hedging by refiners have been ones where market conditions are
favourable; in other words, where the interest rate available on the
contango is at least sufficient to cover his interest cost.
Unfortunately, there is no guarantee that this will be the case,
although with gold there have been few occasions when the future
premium diverges too far from interest rates. It has been pointed out
that gold contangos tend to be based on Eurodollar rates, that is
international interest rates for the US dollar. There may be occa-
sions when such rates are different from domestic US rates. This
would, of course, affect the hedging programme of a United States
refiner who looks to the domestic market to borrow his funds.
Indeed, in February 1984, the prime rate, that is the rate charged by
US banks to their corporate customers with the best credit-ratings
for short-term borrowings, was 11 per cent per annum, while
Eurodollar rates were about 1 per cent lower. At times during late
January and early February, the contango available on Comex gold
futures was even lower than 10 per cent. If such conditions prevail,
then the refiner will be losing the difference between his borrowing
cost and the contango, and he must allow for this in the calculation
of his refining costs. Even if he does, he may still suffer if he is
quoting for an annual contract; it may be that the difference
between his cost of borrowing and the contango will widen still
further over the period of his contract. Nevertheless, this risk is
clearly still preferable to that of having no hedge against a possible
move in the price of gold.
Consumers
Whereas the refiner is normally seeking in his hedging programme
to avoid any exposure to movements in the price of gold, the
consumer may, like the producer, try to go further. He may wish to
optimise the opportunities presented by price movements. It is true
that the consumer, like the refiner, has to face a period during which
he transforms bullion into a saleable product. His simplest hedge
would be to sell futures contracts at the time when he purchases his
raw material, and repurchase the futures contracts at the moment

he sells his manufactured article. This solution to his problem of
risk is, however, by no means perfect. For one thing, certain
consumers make small end-products, and the volume of sales can be
too little to permit efficient hedging. He may therefore have to allow
sales to accumulate over a period of time before he can 'lift' his
hedge. Furthermore, it may not be easy to alter the price of the end-
product frequently. His customers may baulk at suddenly paying
higher prices, so that the market for his products diminishes, or
even disappears. For these reasons, the margin of profit built into
his sales price will often allow for a considerable variation of gold
prices before profit margins are unacceptably eroded. This may
often preclude a requirement for short-term hedging. Let us sup-
pose that the price of gold built into gold sheets manufactured for
the jewellery industry is $450 per ounce. It is probable that a sudden
rise in the price from this level to, say, $500 cannot be quickly
passed onto the customer. On the other hand, a fall to $400 does
not bring immediate pressure for reduction of the selling price of the
end-product. The problems of such a manufacturer arise in two
ways. He will be anxious if the price of gold rises above $450 and
would like to protect himself against such an eventuality. Equally,
he knows that if gold prices fall moderately he will increase his
margin of profit in the short term, but be subject to competitive
pressures if the price remains low.
During the era of rising gold prices in the late 1970s, many
jewellery manufacturers profited from maintaining a stock of gold
in bullion form which was greater than their immediate needs for
manufacture. They did, however, need to replenish this stock from
time to time. In conditions of rising prices, they might not have
sufficient funds to replenish their stock on suitable dips in the gold
price. A solution to this problem was to buy a futures contract when
the price was deemed to be low. At the end of the 1970s the very
sharp and sudden increase in the gold price considerably reduced
the demand for gold jewellery. This development caused manufac-
turers to wish to reduce their stock. The desire to maintain a low
level of stock became greater once gold prices were seen to be falling
from their peak levels of early 1980. Faced with much greater gold
price volatility, a jewellery manufacturer should resort to a hedging
programme with the aim of stabilising demand for his products and
avoiding possible losses on his stock. If demand for his products
remains relatively stable, with gold prices between $400 per ounce
and $500, but is likely to increase by 20 per cent if prices remain
below $400 for several months and decrease by 20 per cent if prices
similarly remain above $500, the manufacturer will have difficult
decisions to make. The movements in the gold price will be only one
variable. His decision will have to take into account his maximum
productive capacity, as well as his profit margin. It may be that even
if gold rises about $500 he will be able to maintain sales if he does
not increase his end prices. He might benefit more from maintaining
production at 100 per cent of capacity while keeping prices stable
than he would from increasing prices and allowing capacity utilis-
ation to fall to 80 per cent. If the price of gold reaches $450, and is
perceived as rising further, the manufacturer may wish to hedge by
buying futures to the extent of three months' requirements. This
would allow him to maintain end-prices despite a rise in the price of
gold, without excessive risk. If prices do not rise as anticipated, he
may either sell out his futures contracts, or take delivery of them as
the contracts mature and absorb the gold into his future produc-
tion. He will, of course, be at risk if the gold price actually falls, but
he has some protection against this eventuality built into his profit
margins.
The conclusion is that futures markets can be very useful for
manufacturers, but that the decision as to how and when to use
them is a complex one, not depending entirely on the ruling price of
gold, or the manufacturer's perception of its likely development.
Where possible, a manufacturer will wish to use a simple hedge to
match the price of his purchases of gold to his larger orders for
products, but in many cases his hedging decisions will depend on a
number of other variables.
Professionals
It may seem strange that, in discussing simple hedging techniques,
all the hedgers we have come across need to sell futures contracts.
The mining company, the refiner and the consumer are all long of
gold when they need the protection of futures markets. Each has
gold which he is not yet in a position to sell. In the case of the miner,
his short-term hedge may be to protect himself in respect of gold
which has already been dug from the ground and has gone through
a preliminary smelting process, but is still contained in a con-
centrate which requires final refining. He may also seek a longer-
term hedge by selling futures against gold which is still in the ground
when he believes that the price is right. The refiner buys gold
contained in material, perhaps scrap, which he must refine before he
can sell it, and the manufacturer buys physical gold which he will
transform before the end-product can be sold. All therefore are

likely to sell futures as a protection. With this array of sellers
permanently in the market, who provides the 'other side'? In large
measure it is speculators and to a lesser extent investors who buy
futures. Such participants, particularly speculators, do not
generally buy spot gold, as they prefer the gearing which futures
markets offer. With gold almost always in plentiful supply,
someone must finance spot holdings, to be able to offer futures
contacts to speculators. This service is mainly performed by bullion
dealers, who are prepared to finance such transactions either with
their own funds, or, more likely, with money which they borrow
from banks. In order to realise a profit on such financing trans-
actions, they must recoup the cost of money borrowed, and earn a
margin in addition. If they use their own funds, they seek a return
greater than they can obtain by placing their money elsewhere, that
is, at least, more than they can obtain by placing the money on
deposit with a bank. It is for these reasons that the futures price of
gold is normally the spot price of gold plus a premium to reflect the
cost of finance for the future period.
The bullion dealer who is prepared to undertake a cash and carry
transaction will calculate the future premium he requires as
follows:
spot price x (borrowing cost x number of days to future delivery

divided by 360) + storage and insurance costs.
The number of days will be the days to elapse between the date on
which he will pay for spot gold (two working days after purchase)
and the first date on which he can receive payment for tbe futures
delivery (this is generally the second or tbird day of the delivery
month). This formula, of course, assumes that the spot gold he will
purchase is in the same form as that he will deliver against his
futures sale. If it is not, he must add in the cost of transforming the
gold into the correct form and transporting it from its present
location to the futures market warehouse. The latter cost would
include the charges levied by the futures exchange warehouse for
handling the gold and issuing a warehouse receipt.
Let us take an example. On Thursday, 2nd February 1984, the
price of spot gold on Comex is $385 per ounce, and the dealer's cost
of borrowing Eurodollars from 6th February (when he will pay for
his spot purchase) until 3rd April 1984 (the first day on which he
can receive payment for the Comex April contract) is 10.25 per cent
per annum. The period is 57 days. In addition, he must include the

cost of storage in his calculation. Such storage charges are payable
monthly, so he must assume two full months. Insurance is covered
by the warehouse and included in this charge. Further, he must
include the cost of commissions, which we assume will be $6 per lot
(or 6 cents per ounce). He will, in fact, pay four commissions (on the
trade and the delivery for each of the spot and future ends of the
contract). The total costs of dealing are therefore as follows:
Interest $6.25
Storage ($6 per contract per month) $0.12
Commissions $0.24
Total $6.61
As it happens, the required premium of $6.61 per ounce was not

quite available on 3rd February 1984, as evidenced by the official
closing or 'settlement' prices published by Comex on that day.
These were $386.50 for February and $391.80 for April, a
premium of $6.30 per ounce. Why was this? There were perhaps
two reasons. First, short-term funds, that is for borrowing from day
to day, were available at considerably less than 10.25 per cent per
annum, perhaps 9.5 per cent per annum; some dealers would risk a
possible rise in interest rates and cover themselves with day-to-day
finance, rather than borrow for the fixed period. Some financially
stronger dealers would also have been able to borrow fixed rate
Eurodollars or US domestic funds at less than 10.25 per cent per
annum (nearer to the interbank offered rate of 9.75 per cent per
annum). This would have reduced the interest cost from $6.25 to
$5.95 per ounce, bringing the total cost down to $6.31 — almost
exactly equal to the premium quoted on Comex. Moreover, there
was a large open position in tbe February 1984 contract. At the
close of business on 1st February, there were still open interests
amounting to 4,629 contracts. This was unusually large for a
delivery month which has passed the first notice day (in this case
30th January). Normally, sellers wish to receive their money as
soon as possible. They therefore tender for delivery on the first
possible date, provided they have the gold or warehouse receipts to
deliver. The fact that so many did not suggests that there were still
short positions in the February contract. In other words, there was a
temporary shortage of Comex warehouse receipts for immediate
delivery, although in the gold market as a whole there was no
tightness of supplies.
The reduction of such distortions of spot and futures prices is

very much the province of professional dealers, who will prevent
futures premiums from rising too far beyond the cost of finance by
making cash and carry transactions. They will also, however,
prevent the forward premium from contracting excessively, at least
to the extent that they have the ability to borrow gold.
While professional bullion dealers may be the leading players in
this game, we have already seen in Chapter 4 that local traders on
Comex and other futures markets will also act in a similar capacity.
The latter, however, rarely go into the spot market, preferring to
avoid physical delivery.
It is arguable whether bullion dealers who even out the 'spread',
or difference, between the spot month and futures months are
genuine hedgers. It can be said that they are always in some way
hedging other positions, whether these be gold or money positions.
So if a bullion dealer has a previous long spot position in Comex
gold and is short for futures delivery, he can be said to feejiedging
this position when he reverses it. In fact, of course, because bullion
dealing is a continuing activity, he is, in fact, changing his position
for his greater profit.
In other circumstances, the bullion dealer is most certainly a
hedger. During his working day he is continuously buying and
selling bullion, mainly for spot, but sometimes for forward,
delivery. He is quoting a bid price and an offered price. The spread
varies according to market volatility from time to time, but in
February 1984 was typically $0.50 per ounce. Let us imagine that
he is quoting a buying, or bid, price of $385 per ounce, and an
offered, or selling price of $385.50 per ounce, and has a square
position. A customer contacts him and, without revealing his
intention, asks for a quote. The dealer makes his price of $385—
385.50. The customer sells the dealer 4,000 ounces at $385. The
dealer is now long of 4,000 ounces, which he wishes to sell. He has
three options. He can either adjust his price to $384.75-385.25 and
hope that the next person who approaches him will buy at $385.25;
or he can contact other dealers in the hope of finding one who is
bidding more than $385, and sell at say $385.10; or he may hedge
by selling 40 contracts on the futures exchange. In practice, he will
probably try all options at the same time, seeking quotations from
other dealers and from the futures market, while adjusting his own
price. The efficient dealer will have at his fingertips the premium
over spot which he needs in order profitably to hedge a position, but
he will also watch the size of his spot position. If the futures market
barely gives him a profitable hedge, he will wish to limit the size of
his spot against futures position in case the differential moves more
favourably. As his ability to borrow funds (or gold) is finite, he will
wish to be able to take advantage of more favourable rates if and
when they occur.
The professional dealer is not just aware of the differentials
between spot and futures gold; he also follows the relationship
between two gold futures months, and the equivalent months on the
financial futures markets, watching the yield available there on
Eurodollar futures, and perhaps other instruments such as US
Treasury Bills. If these move out of line with yields on gold futures,
he will try to take advantage of the difference. While such oper-
ations would be considered interest arbitrage if the two sides of the
operation are transacted simultaneously, they may be categorised
as a form of hedge if one side of the position is pre-existing, and is
covered by execution of the other side as a single operation.
The investor
The last of the hedgers is the investor. By definition, investors are
people who buy a security or commodity in anticipation of its
longer-term appreciation. Classically, an investor is not considered
to be influenced by short-term price movements of the commodity
he has purchased. He is prepared to wait for gradual appreciation.
Investors in gold often purchase not only for capital appreciation,
but as a protection against uncertainties. Today the classical
investor has, in most cases, changed his spots. He is prepared to take
a shorter-term view, if it suits him. Today, also, there is a much
greater dissemination of information than in the past, and because
of rapid communications, investment instruments, be they securi-
ties or commodities, are more volatile in price. Thus an investor in
gold who finds the price rising quickly to his advantage may decide
to hedge his long position by selling futures when he judges that the
market has risen far enough in the short term. He still believes that
he should retain gold, but wishes to increase his return by selling
futures with a view of repurchasing them when the price has fallen
back. This, like the other operations described in this chapter, is a
form of hedge — a protection against future uncertainty. We have
seen that the majority of hedgers who operate in gold futures
markets, do so to protect themselves against movements in the price
of gold. There are others who use it as a hedge against interest rate
fluctuations, but these tend to be professional traders of some sort
or another. We have not considered in this chapter the use of gold
futures as a hedge against option positions. This will be discussed in

a later chapter.
We have covered, then, all the major users of the gold futures
markets, except speculators, to whom we shall turn in the next
chapter.
8
Great or unusual
gain
According to the Shorter Oxford Dictionary, the word 'speculator'

was first recorded in 1555. A speculator at that time was defined as
'one who speculates on abstruse or uncertain matters; one who
devotes himself to theoretical reasoning'. By 1778 the word was
also used to signify 'one who engages in commercial or financial
speculation'. Four years earlier speculation had the meaning 'the
action or practice of buying and selling goods, stocks and shares,
etc., in order to profit by the rise and fall in the market value, as
distinct from regular trading or investment; engagement in any
business enterprise or transaction of a venturesome or risky nature,
but offering the chance of great or unusual gain'. These definitions
hold good today, over 200 years later. The volatility of gold prices
certainly offers the chance of great or unusual gain, and it is for this
reason that speculators in great multitudes have become an integral
part of the market. According to some economists, speculators play
an important economic role in markets, by buying commodities
when they are in plentiful supply, and thus reducing the downward
pressure on prices; likewise, they are prepared to sell short, when
the commodity becomes scarce, and thus limit upward movements.
While there may be some truth in the theory, the huge movements
over the last few years in the price of gold, a commodity with a
relatively steady new supply, suggests that speculators are more
likely to cause exaggerations, both upwards and downwards, in its
price movements.
Who, then, are speculators? An interesting study was carried out
by the Chicago Board of Trade in 1983. According to the Financial
Times of 22nd October, 2,230 private speculators in the United

States were surveyed. The first fact to emerge was that profit, rather
than sport, was the overwhelming motive for engaging in futures
market speculation. Rather interestingly, the study estimated that
only 200,000 Americans, or less than 1 per cent of the population,
engaged in futures trading. Thus commodity speculation, despite
15 years of rapid growth, is still a rather esoteric occupation. It was
further estimated that only 3.3 per cent of speculators are women,
so that speculation remains essentially a male preserve. Speculators
admitted that futures market operations were the most time-
consuming of their 'investment' activities; few relied on speculation
as their main source of income, as 61 per cent had other income of
over $50,000 per annum, and total investments of $100,000. It was
estimated that 35 per cent hold graduate or post-graduate degrees.
Farming, ranching and engineering are the most likely occupations
for speculators, with scientists least likely to participate^ Despite the
recent growth in financial futures, metal contracts wereithe most
widely favoured, with 63 per cent of all speculators trying their
hand in these markets. Although this point was not covered, it
seems safe to assume that gold featured strongly in the activities of
most of those surveyed. The age of speculators was also interesting,
perhaps surprising. About half were over 50, while less than 15 per
cent were under 35. It also emerged that more than half those
interviewed felt it was necessary to have some 'system' for trading;
they relied on programmes made available by commodity brokers,
chartists or newsletters, or ones which they had designed
themselves.
Perhaps this last point is the most telling. By and large, specu-
lators are not motivated by the fundamental situation of the
commodity in which they operate. They prefer to rely on market
action to guide decisions. Today gold futures markets are insensi-
tive to developments in the markets for physical bullion. A large
demand for physical metal will not necessarily cause the price
to rise, nor will heavy selling of bullion always cause the price to
fall.
This profile of the commodity speculator, while fascinating, does
not tell us how he operates in the market. It will be clear, however,
from the original definition that the speculator is after profits, and
generally big profits at that. He probably enjoys risk as well, even if
the CBT study portrays the average speculator as being conserva-
tive. No one can deny on the basis of the price volatility over a
number of years that gold offers risk, excitement and the potential
Great or unusual gain 97
for profit. Even this is not enough for most speculators; they enjoy
the additional gearing which futures markets provide. That is the
way to 'super-profits'. We have seen that in early 1984 as little as
$1,300 would allow the speculator to buy a gold futures contract of
100 ounces, valued at $37,000, or, to put it another way, he needed
only to put down $13 per ounce to have access to a metal where
movements of $6-7 per ounce during a day were commonplace. He
had therefore the opportunity to get a return of 20 per cent on his
money in a single day, and to repeat the operation at frequent
intervals. The problem is, of course, how to make the best of such
opportunities. That is not so easy. Everyone close to gold knows
that its price movements, particularly in the short term, are unpre-
dictable or, at best, hard to predict. As we have been told, most
speculators feel they need a system to help them, but no system yet
developed correctly predicts prices at all times.
So where should a new speculator start? The first lesson is that,
whatever approach is espoused, one must be disciplined. In essence,
this means not standing in the way of the market if it goes against
you. There are many expressions commonplace in the trading
world to describe this requirement, but it is perhaps best summed
up by the phrases 'Take small losses but big profits', or 'Cut your
losses and let your profits run.' These sentiments are simple to
understand, but very hard to put into practice, because no one likes
to admit that he is wrong. Generally the lesson is learned the hard
way, by bitter experience, and many who once try their hands at
commodity trading never recover from it, and often lack the will to
repeat the attempt.
The second rule is to be clear in one's objectives. First, you must
recognise the time horizon in which you are working. We discussed
above the opportunities for short-term trading, even within one
day, which could be so rewarding. Rewarding, yes; tantalising,
probably; and dangerous, certainly. In 'normal' market conditions,
day-trading should be only for professionals. To be successful in it,
you must be close to the market, preferably on the market floor, and
ready to watch the development of prices every moment of the
trading day. Non-professionals are rarely in this position, and
should avoid such very short-term operations. Of course, if you
enter the market on any particular day, and later the same day are
lucky enough to see a satisfactory profit (more quickly than you
expected), there is no harm in taking it. For one thing, on futures
markets, you will generally benefit from reduced commission on
'day-trades' and avoid the costs of putting up margin.
Nevertheless, the would-be speculator is advised to take a longer-

term view. Only he can decide whether he wants to enter the market
for a week, a month or longer, but he should make that decision. He
should also determine his price objective. Is he in the market for a
'ride' of $10 per ounce, or $25, or $50? Much more importantly, he
must decide how much he is prepared to risk if he is wrong. In the
case of gold futures, no one should chance more money than he
needs to put up as margin at the price he wishes to buy plus a reserve
of 10 per cent. That is not to say that he should allow the market to
move 10 per cent against him before he 'bails out', but a con-
tingency reserve is always advisable. So for a speculation at, say,
$400 per ounce, he needs the original margin of $1,300 per lot
minimum, plus $40 per ounce, or $4,000 per lot.
Such advice might seem no more than common sense, but it is
surprising how many speculators are prepared to enter the market
with insufficient reserves. This is largely because they believe In the
system which they have learned from someone else or deve^pged for
themselves. Such systems are diverse, but most involve the use of
charting techniques or a technical assessment of the market.
Increasingly today trading models are maintained on computers
and can be updated in a matter of seconds. These systems do not
take note of the fundamental position of gold, i.e. whether demand
exceeds supply in the short term or vice versa, nor of any potential
change in those 'fundamentals'. It is assumed that those fundamen-
tals are built into the movements of the market, because someone
somewhere is acting as a result of each demand for or supply of
physical gold. If the Russians are selling gold in large quantities, one
or more of the world's larger bullion dealers knows about it, and is
on-selling what he buys from them, perhaps by hedging in the
futures markets. If there is a strong demand for physical gold in the
local market in Hong Kong, some dealer will be supplying the gold
and covering himself by buying back in another market, be it
London, Zurich or New York. It may even be that he is buying more
than he has so far sold, because he anticipates further demand
tomorrow. In any event, that dealer's action is having its effect on
the total market, either by pushing the price higher than it would
otherwise have been, or by preventing it from falling. The technical
trader believes that he can safely ignore all these causes, in that they
are built into the price movements. Therefore, if he merely studies
those price movements and interprets them correctly, he will have
all he needs at his disposal. It is an attractive theory and one which,
in gold, has gained an increasing following in recent years. But, of
course, everything depends on the interpretation. That is the hard

part!
Interpretation of charts is based mainly on the belief that historic
trends will be repeated — that if a graph of price movements can be
seen to follow a shape which is the same or similar to one which in
the past was followed by a certain development, that development
may be expected again. While many such historic examples do
undoubtedly repeat themselves, even the most dedicated chartist
can never be quite sure. At some stage he will have to admit if he is
honest that he can only identify a probability. He will say that he
believes the market will move up, but that, if his graph fails to hold a
trend line, the effect he expects will be delayed, or even can no
longer be expected, because a 'reversal' has occurred. In the short
term such uncertainty can be all too frequent for comfort. When he
takes a long position because the charts indicate that the market
should rise, the chartist sets himself an initial objective. His charts
will indicate that there is a resistance point, say $ 12 per ounce above
the level at which he bought. Other things being equal, he will
expect and wait for the price to reach that resistance level before
deciding on his next move. The problems arise if the price does not
approach this level. This may occur because some new event affects
the market. Perhaps an unexpected rise in interest rates encourages
selling, and in the short term the market is forced down. Our
chartist's graph will only show this new influence after it has
happened, but this event may force him to reassess the position. So
his price objective today may be different from that of yesterday,
and so it goes on. It is rather like weather forecasting. You can build
into your forecast by computer 200 years of experience, but the
results are never quite certain. There is a high degree of probability
that what happened in the past with a certain pattern of isobars will
happen again, but there is always the chance of some unexpected
development.
Accepting this, the chartist seeks protection. He confidently
expects the market to rise, but if it does not he must decide on a price
level at which he should abandon his long position. This will
normally be at the failure of the market to hold a level of expected
support.
In the end, the difficulty is that other chartists will be drawing the
same or similar conclusions. They can all identify levels of support
and resistance, and their actions will be predicated on the market's
price movements relative to those price levels. The more chartists
reach the same conclusions, the greater the likelihood of their
actions becoming self-fulfilling. In the short term the activities of

chartists and those operating on similar principles increase price
volatility. Some years ago, chartists were essentially trying to
capitalise on only longer-term trends and would enter the market
taking a view on the next month or longer. While these operations
are still valid, there has also grown up a new generation whose
trading is on a much shorter-term basis, perhaps only over a few
days. They are trying to interpret movements in the market from
day to day, and use large-scale charts, often drawn up on a 'point
and figure' basis to these ends. Given that chartists try to protect
their action and positions with 'stop-loss' orders, it can readily be
seen that, the more widespread the practice of placing such orders
becomes, the more volatility there is likely to be in short-term
movements.
Let us describe these techniques in rather more detail by taking a
specific example. Suppose that a chartist's graph or system tells him
to buy April 1984 Comex gold contracts at $385 pervpqnce, and
indicates that he should expect the market to rise to $400. He enters
the market on the long side at $385, but simultaneously places a
'stop-loss' selling order at $377.50 per ounce, which is just below
the most recent level of support. This means that he believes that the
support previously found at $378 is likely to be repeated if the
market again falls, but, if the support fails to materialise, he expects
the market to be vulnerable to a further fall. He therefore places his
stop-loss selling order at $377.50. This means that, if the price of
$377.50 is traded, his floor brokers should immediately sell out the
position 'at market' (that is at the best possible price he can obtain).
There are several problems with stop-loss orders, which in any case
would be better described as 'limit-loss orders' as they do not
prevent losses, but rather limit their extent. The first problem is that
there is no guarantee that they can be executed at the price given (i.e.
in this example $377.50). It may be that, because there are a large
number of similar orders in the market, the selling pressure sud-
denly increases when $377.5 0 is first traded, and the next trade is at
$376, so that that price is the best that can be obtained, and there-
fore the loss is larger than anticipated. Indeed, in very active and
volatile markets there can often be much greater gaps between the
price level chosen for the order and the actual level at which it can be
executed. This problem is aggravated because floor brokers and
other operators will know the price levels at which such stop-loss
orders exist and will act accordingly by holding back buying orders
which they may have in hand. Indeed, there are many operators
who will try to 'trigger-off the selling represented by the stop-loss

orders for their own benefit.
It might therefore be argued that it would be beneficial for the
speculator to withhold his orders from the market until he is sure
that the level has been touched or penetrated, before entering his
selling order. Needless to say, this also has its dangers. Some chart
operators will only act if the picture painted by their charts is
confirmed at the end of the trading day. In other words if, in the
above example, the price of $377.50 is traded during the daily
session, they will take no action unless that level (or lower) is still
current on the closing 'call' — which on Comex is the last minute of
trading. This policy will, of course, avoid the dangers of being
'stopped out' if the market trades at $377.50 during the session, but
subsequently recovers. It does, however, leave open the risk that by
the time the closing call is reached the price may have fallen much
further.
Thus, having entered the market at $385, our speculator must
decide what he will do to protect himself if, against his expectations,
the market falls rather than rises. He must decide what action will
best limit his loss to the amount he believes he is risking. There is no
easy answer to the conundrum of stop-loss orders, and each trader
must make up his own mind how to deal with the difficulties.
Let us, however, suppose that on this occasion he does not have
to face the problem, because the market does not fall as far as
$377.50. It merely dips a little below his entry point of $385, and
then rises to $388 and closes at that level at the end of the day.
Having plotted this new closing level on to his chart, he remains
convinced that his target of $400 is still obtainable. (We are
assuming in this example that the chart operator is charting only the
closing prices. As pointed out, however, there will be other chartists
who are painstakingly plotting every price move during the day,
and reaching their own conclusions.) Having seen a gain of $3 per
ounce from his entry point, our chartist decides that he should do
nothing except retain his long position and wait for $400 to arrive.
He still, however, wishes to protect himself in case things do not go
according to plan. One way in which he can reduce his risk is to
increase the price of his stop-loss selling order to, say, $380 per
ounce. There will be arguments for and against doing so. On the one
hand the price level of significant support may not have changed
from $378, so that a dip to $380 would not necessarily invalidate
his assumption that the market is still heading for $400. If therefore
he raises his stop-loss level to $380, he runs the risk that the market
dips below that level, at which time his position is sold out, and then
recovers. On the other hand, by raising his stop-loss level, he is
reducing the probable quantum of his loss if things go wrong. Again
this is a decision which each market participant must make for
himself. It would be agreeable if the price development were such
that the market moved up a little each day, and that, by progress-
ively raising his stop-loss selling limits, our friend could, in due
course, arrive at the situation where his stop-loss limit is above his
entry point. Unfortunately, in practice, life is rarely so easy! In this
case, however, we will assume that he has been lucky. Passing on a
few days, we find him still 'long' at $385 and with the market price
for April contracts at $396. The upward progression of prices has
not, however, been continuous. On one day the closing level was $2
per ounce lower than on the previous close. Based on this move-
ment, a new level of short-term support has been indicated by the
chart at about $387. Our friend decides to play safe. He raises his
stop-loss limit to $390. It now seems that he cannot losej ejyen if the
market falls back, as his stop-loss order, if executed, should show
him a profit over his entry point of $385. There is only a faint
chance that a plethora of stop-loss orders at this level would result
in the gap between $390 being traded and the next tradable price
being as much as $5 per ounce lower.
He can therefore relax and sit back waiting for the market to
reach his target level of $400, secure in the knowledge that, even if it
does not, he will still get out at a small profit when his stop-loss
selling order is triggered. If the price does reach $400, he still has his
options open. It may be that by then the chart will be indicating a
further advance, and he will be free to follow its lead, protecting his
position with a stop-loss selling order ever closer to the rising price.
This description of a possible market development, and our
chartist's reaction to it, may give too rosy a view of the difficulties of
trading by charts or by any other method or 'system'. But the pitfalls
have been hinted at. The truth is that these days many market
operators are following short-term trends. They will be most
influenced by the day to day action of the market. It may be that
these short-term operators were bullish at $385, just as was our
chartist. They were content to follow the market as it moved higher,
but more than likely they would be influenced by an event which
occurs or by a temporary interruption of the upward tendency. If
they became convinced that the market has insufficient strength to
move higher, they may not only abandon their long positions, but
simultaneously go short. Such actions may exert considerable
pressure in the short term (during one trading session) to such an

extent that the upward movement is not only lost, but reversed.
Furthermore, some short-term operators may remain bullish in
outlook, but decide to take their profits before the end of the day,
preferring to start again tomorrow. It is particularly true that many
traders prefer to 'square' their positions before a weekend for fear
that some untoward event or news will affect the market before they
have the chance to trade again. For this reason, it is not uncommon
for exaggerated price movements to occur on a Friday or before a
public holiday in the United States, when 'book-squaring' can be
the major influence on the market.
This leads us back to the technical analyst. In Chapter 4 we saw
that the statistics issued daily by futures exchanges are carefully
studied by many analysts in an attempt to determine whether it is
the short positions or the long which are in stronger hands.
Remember that each lot in the total open interest represents a
contract sold and a contract bought. A contract sold may be an
outright speculative short position, or part of a hedge (by a
producer, consumer or dealer). A contract bought may be an
outright long position or a dealer hedge. The secret to unlock is
whether the holders of long positions are stronger financially and
have stronger nerves than the shorts, or vice versa.
It is generally assumed that speculators are weaker than pro-
fessionals in this respect, the latter being endowed with deeper
knowledge of the market place, and better financed than specu-
lators. Yet this need not be the case. A dealer who has hedged a
physical position by selling futures has probably taken a view about
how far the market is likely to run against him, and therefore of the
extent to which he will be required to put up negative variation
margin. If the market runs against him because of heavy speculator
buying, he may decide that he has more to lose by leaving his hedge
in place than he has by abandoning it. In this case, he will buy back
his short position, temporarily leaving himself unhedged, and thus
add to the buying pressure.
Today, moreover, professional dealers, who by and large earn
their profits from continuously trading in and out of the market, or
by arbitrage, are probably more averse to risk than some of the
larger and well-financed speculators. So it is rare for professionals
to be the dominant influence on the market over more than a short
period of time.
It will be clear that the term 'speculator' covers a multitude of
operators in the gold futures markets of the world. There is first the
104 Trading in go Id futures
private individual, who looks upon commodity speculation as an

adjunct of, or substitute for, investment — as a means to make profit
for himself. Then we discern the professional short-term specu-
lators or local traders who make money by continuously trading in
and out. Lastly there is the trade speculator, or bullion dealer,
whose speculations mainly involve either delaying or advancing his
hedge operations. Perhaps at first sight the bullion dealer does not
fit the bill as a speculator, but when trading normally he is earning
only a small 'turn' on his buying and selling of gold. When he desists
from strict hedging, there is no doubt that he is seeking unusual or
exceptional profits, and his operations then fall into the definition
of speculation.
We can see that speculation of various types is an essential feature
of futures markets, and not least those where gold is traded. Many
people involved in the physical gold industry feel that there is too
much speculation for the good long-term health of the market.
There is criticism of the short-term price volatility v^hkh results
from it. Frequently comments are made that these price movements
have no relationship with any change in the pattern of supply and
demand for gold. Of course, this is true, but those who criticise are
often in the gold business themselves. While they may at times suffer
from the phenomenon of volatility, there can be little doubt that
their profits often benefit from it, and that they have before them
opportunities which a high level of speculation offers, whether or
not they take best advantage from them. In commodity trading
generally, there are always winners and losers; but there are few
examples of bullion dealers, producers or consumers going out of
business in the last fifteen years. In the case of those who have, the
cause has generally been bad management or greed, or both. On the
other hand, true speculators come and go, and not a few have been
'wiped out' in the gold futures markets, never to return. The same
faults of greed and bad management are much more prevalent
amongst speculators, and as a body they give to the market more
than they take from it.
At the beginning of this chapter we saw that, to have a chance of
success, the individual speculator must be disciplined; particularly
he should not be greedy and tempted to trade beyond his means. He
must set targets for profit and limits for loss, and stick to such
targets. As has been shown, there are many pitfalls to be avoided.
The nature of futures trading and the inherent instability of prices
are attractive to charlatans, but, even if these can be avoided, the
excitement of futures is often tempting. If you cannot balance this
excitement by the necessary discipline, then you should not trade.

Over the years I have received many letters from people who seek
advice when they are, at best, disappointed by a foray into com-
modity futures trading; some have been ruined, often losing their
life savings just when they can least afford to do so, at the beginning
of retirement. Many have been tempted by unscrupulous salesmen,
but all have succumbed to greed and the prospect of rapid or instant
riches. Once they have lost, they are only too ready to heed sensible
counsel, but it is usually too late. In an attempt to help newcomers
to the market, I have drawn up a list of points (see Appendix A)
which should be at least considered before any trading of a
speculative nature is undertaken. It may not be exhaustive, and
certainly does not guarantee success, but should equally certainly
enable the worst pitfalls to be avoided. Not all relate specifically to
gold, though many do, and all are applicable to gold futures
trading.
9
Options
The years 1983 and 1984 have been quiet ones in the gQl^ markets,
and bullion dealers have found their telephones less busy, indeed
their whole market in gold neglected in favour of what are perceived
as more attractive assets — first bonds, then equity securities. The US
dollar has been strong, and inflation in developed countries lower
than for some years and on a declining trend; economic growth,
particularly in the United States, has resumed.
The reaction of gold dealers to these factors and to the resulting
neglect of their market has been to seek new products; one of the
most popular has been options. Commodity options, of course, are
not new, and at least two companies — Valeurs White Weld SA of
Geneva and Mocatta Metals Corporation of New York—have been
active traders of gold options for a number of years. In 1983 and
1984 many gold dealers have joined them.
Options give the right to buy or sell gold at a predetermined price
(the striking price) within a certain period of time, in return for the
immediate payment of an 'option premium'. Options to buy are
known as 'call options' or 'calls' and options to sell as 'put options'
or 'puts'. Those buying options (either puts or calls) are often
known as 'takers', while sellers of options are called 'writers' or
'granters'.
Simple options are those which once bought (or sold) are not
transferable, but may be exercised within (or in some cases at the
end of) the period for which they have been granted. The options
dealt in by bullion dealers normally fall into this category. Traded
options are those which once bought may be transferred to another

party, or once sold can be repurchased.
A full discussion of gold options is beyond the scope of this book,
but any work on gold futures markets must mention them, as they
are slowly becoming an established part of these markets. The
credit for pioneering traded options on gold futures exchanges must
go, as it did for gold futures, to the Winnipeg Commodity
Exchange, where they were introduced in the spring of 1979. As
with futures, Winnipeg took the opportunity offered because of
restrictions in the United States.
For many years commodity options in the United States have
been very strictly controlled, following a number of frauds in the
early 1970s, and the CFTC would not permit options to be traded
on futures exchanges. This ban came to an end in October 1982
when Comex was authorised to introduce traded options for gold.
Needless to say, such options give the buyer of calls the right to take
up a long position in a Comex gold futures month. (Each option has
one Comex gold futures contract as its underlying asset.) Having
acquired that right, the option holder may exercise it at any time
until the option's maturity, but he may prefer to trade out of the
option by reselling on the separate market for options which trades
daily on the exchange.
There have been great hopes expressed for options as a major
growth area of futures trading. At the start of gold option trading
on Comex, several commentators predicted that activity in options
would soon outstrip that of futures. So far this has certainly not
been the case, but after a slow start options are gaining in
popularity.
The advantage of options is the limited financial risk. The most
that an investor in options can lose is the option premium. Plainly,
such limited risk can be very attractive in a commodity as volatile
and unpredictable in price as gold. The only disadvantage of
options is that they reduce profit if you are right; but in essence an
option is a form of insurance premium. If it is worthwhile having
the insurance, it is worthwhile paying the premium. The rate of
premium depends on the price volatility. With the exception of a
brief period, the gold market has not been particularly volatile since
the introduction of Comex gold options. They have prospered, and
gradually gained ground, as the volume figures in Table 4 testify.
In theory, the introduction of exchange-traded gold options on
Comex was a pilot scheme, and could therefore be brought to an
Table 4 Volume of gold option trading on Comex, 1982-84

No. of options
traded
1982
October 23,014
November 16,168
December 17,570
Total for 1982 (three months) 56,752
1983
January 30,736
February 32,497
March 26,146
April 20,212
May 19,996
June 23,029
July 21,617
August 25,393
September 31,425
October 50,580
November 43,486
December 61,384
Total for 1983 386,501
1984
January 83,898
February 92,293
March 86,236
April 100,144
May 151,848
June 125,706
July 145,114
August 118,057
September 131,852
October 134,563
November 129,168
December 133,635
Total for 1984 1,432,514
end at any time. In practice this seems unlikely, as the demand for
them, and a good rate of growth, would make it hard to justify their
withdrawal. Exchange trading in options has been extended to
other financial commodities as well. It looks as though they have
come to the United States to stay.
When gold options were introduced, many commentators
expressed the view that they would become so popular that they
would soon eclipse futures trading. Such prophecies are a long way
from being fulfilled, and probably never will be. Options on futures
and futures themselves have a considerable interdependence. Any
holder of futures contracts, whether his position is long or short,
Options 109
can use options to hedge his position risk or to enhance his profit.
On the other hand, option holders may take delivery of futures
contracts when their options mature, and will wish to close out such
futures positions. In many ways, therefore, futures and options on
futures are complementary. It is, however, entirely probable that
the limited risk attaching to options will be appreciated by investors
and speculators alike, while providing income to holders of gold
who are prepared to write calls on a regular basis. For these reasons
it may be anticipated that the growth in exchange-traded gold
options, a fairly new product, will continue to outpace that of the
seasoned futures markets. This movement was already well in
evidence in 1983 when gold options volume on Comex as a
percentage of gold futures volume increased from 2.6 per cent in
both the first and second quarters of the year to 3.6 per cent in the
third quarter and 6.9 per cent in the last. The development became
much more marked in 1984, when option volume was 1,432,514
contracts or 15.7 per cent of total futures turnover.
The attraction of gold options has not escaped the notice of other
gold futures exchanges, many of whom offer options. Simple
options are available on the London Gold Futures Market.
Exchange-traded options are also available on the European
Options Exchange in Amsterdam, which also trades stock options.
This well-established market is making arrangements to link up
with exchanges in Montreal and Vancouver to extend the coverage
of gold options. Recently it was announced that the Sydney Stock
Exchange in Australia was contemplating the introduction of a gold
option contract.
10
The future
We have seen that the market in gold futures has been growing fast
in the years since the first futures contracts were offered on the
Winnipeg Exchange in 1972. We have also seen that the popularity
of these markets has so far largely remained an American affair. The
growth in the United States, and particularly on Comex, has been
tremendous. It must be concluded that there, if not yet elsewhere, a
pressing need has been served. The United States is but one element
in the international gold market, a market which, with new
developments in Australia and Japan, looks set to operate 24 hours
per day.
Will futures markets in gold become the most important feature
of the total market? This is a hard question to answer, but some
suggestions on the likely outcome can be made.
United States markets

Turning first to the United States, the following points can be made.
There is no doubt that the ability of American citizens to own gold,
coming at the end of 1974, was a heaven-sent opportunity for the
establishment of successful gold futures contract there. The United
States was already, and remains, an important centre for trading
physical gold, with substantial quantities of gold produced either in
the United States or in other countries of the western hemisphere.
There is also an important consumer base in the electronics,
jewellery and dentistry industries. Furthermore, New York is one of
the leading delivery centres of the world, by virtue of the large
quantities held by the Federal Reserve Bank of New York, rep-
The future 111
resenting in part the reserves of the United States, and in part the
holdings of foreign governments or Central Banks, as well as the
International Monetary Fund. These stocks have become more
mobile since the freedom granted to IMF members to buy gold at
free-market prices in 1978 (they were allowed to sell at any price in
November 1973). The greater willingness to mobilise such stocks,
particularly through IMF and US Treasury auctions during the late
1970s, undoubtedly assisted the development of New York as an
international trading centre for gold. The mechanisms for selling at
such auctions increased the need amongst bullion dealers for a rapid
and efficient hedge. The most convenient hedge was available on US
futures markets, but there was no certainty at the outset that they
could provide the necessary depth. That they did in fact do so is
sound testament to the organisation of those markets, and their
ability to attract international business.
At the time when IMF auctions were instituted in 1976, there was
widespread concern that the gold market would be unable to
absorb the offerings, so great did the quantity appear in relation to
the normal flow of gold production and consumption. Fur-
thermore, it is widely assumed that the main purpose of US
Treasury gold auctions was to try to contain pressure on the US
dollar, and to prevent a rise in the price of gold, which represented a
potential threat to the dominance of that currency. Whether or not
this was the. true motive, the effect of the sales was quite different.
The combination of IMF and US Treasury auctions actually
brought gold into a public arena, which it might otherwise never
have entered. The publicity surrounding these auctions promoted
interest in gold to an extent which five years of expensive advertis-
ing might never have achieved. The public came to believe that, if
gold was something which major commercial banks and even
governments were vying with each other to buy at historically high
prices, then they too should be considering it seriously. It was as if,
faced with inflation and possible economic depression, those in the
know in high places looked upon gold as a protection. How then
could the uninformed man in the street resist it?
Today we hope that the worst excesses of inflationary policies
and economic depression are behind us. We see major governments
fighting inflation by limiting increases in the money supplies of the
principal industrialised countries. There has been a willingness to
sacrifice economic growth and to ignore unemployment in the
interests of sound money and more stable purchasing power. Three
years of such policies in the United States have been rewarded by a
resumption of economic growth there and more recently elsewhere.

Yet gold has not completely fallen from favour with investors.
After all, at $340 per ounce today it is still higher than in any year
prior to 1979, and the dollar has appreciated in value. This
development strongly suggests that investors, despite the recent
attractions of bonds and securities, are not yet convinced that
inflation has gone away for good. Rather, they prefer to retain an
interest in gold which has served them well in the past, and show its
ability over a long period to maintain purchasing power. As is well
known, the traditional advice of Swiss investment managers to
investors is to hold between 5 and 15 per cent of their total portfolio
in gold, the percentage within that band to be adjusted from time to
time according to the particular circumstances of the investor and
the perceived attractiveness of gold relative to other investment
media. There are some indications that the percentage is moving up
within the band, as profits are taken in securities. But, in the final
analysis, investors and speculators in general will turnnfrjendly to
gold in a larger way when inflationary expectations are rising, and
'gold rushes' tend to occur when fears of galloping inflation are
present.
Can we expect a repeat of the second half of the 1970s, and if not,
is interest in gold likely to decline? There are no certain answers to
these questions, but some pointers. The inflation of the late 1970s
was no doubt in part caused by governments following profligate
spending policies and failing sufficiently to curb increases in money
supply, but in part it was also due to the extraordinary rise in the
price of oil, engineered by OPEC countries holding to ransom the
industrialised countries who were too heavily dependent on a
narrow source of supply. That dependence has been greatly reduced
over the last ten years, so that it is doubtful whether the OPEC
exercise could be successfully repeated, except for short periods,
and under particular circumstances, such as a total block on oil
supplies from the Arabian Gulf region coinciding with a growth in
consumption. Most oil-producing countries would now suffer
severely if their oil revenues were cut off for any significant period.
It must be judged therefore that the threat of rampant inflation from
oil price rises is considerably diminished.
Nevertheless, other threats to financial stability remain. If the
economies of industrialised countries fail to sustain or improve on
the recent levels of economic growth, the temptations for govern-
ments to inflate will return. Furthermore, the problems of lesser
developed countries persist; their burden of debt will not be easily —
The future 113
perhaps never — reduced, and, if the burden becomes intolerable,

several of the most heavily indebted countries may fail to pay even
interest either through conscious decision or through total inability.
The scale of this problem could, but need not, become much greater
than it is today. A total repudiation of debts by even one larger
debtor country could force the authorities in those other countries
whose commercial banks are most at risk from such a decision, to
take action which is inflationary in nature to protect them.
So, in either event, gold would stage a comeback in popularity.
And yet there is no certainty that either of these possibilities will
occur. At the time of writing, most of the industrialised countries
are following, if not deflationary policies, then at least policies
which are not blatantly expansionary. The desire for sound money
has never been stronger since the advent of floating exchange rates
in the early 1970s. The United States has shown in 1983/84 that a
resumption of economic expansion is possible, while inflation is still
on the downward path. Unemployment there has fallen quite
sharply, accompanied by an increase in corporate profits and a
return of consumer confidence. If this growth without inflation
continues, the prospect for an upward movement in gold prices is
probably no better than moderate.
In the second and third quarters of 1984, the US dollar has risen
strongly against the background of high interest rates in real terms.
Gold prices have been weak against the dollar but steady against
other currencies and physical demand has picked up.
All this is to say that there remain many uncertainties about the
future of gold. It is certainly true that gold prices have paid scant
attention to the underlying fundamental position. As a broad
generalisation, the amount of new gold produced in the western
world since 1968 has been absorbed merely by fabrication of one
sort or another. If we take the figures published by Consolidated
Gold Fields p.l.c. for the years since the beginning of the free market
in 1968, we see the picture shown in Table 5.
From this it will be clear that fabrication demand for gold initially
declined with the onset of higher prices in 1973/74, but staged a
recovery in the late 1970s after the market had adjusted to higher
price levels. The figure for fabrication demand includes the
manufacture of jewellery, and from 1975 onwards demand for
jewellery included an increasing proportion from countries in the
newly rich Middle East. This was very different from the traditional
high-mark-up jewellery manufactured in developed countries,
demand for which was relatively stable. The demand for low-mark-
Table 5. Gold production and fabrication in the non-

Communist world, 1968-83 (in tonnes)
Mine Total fabricated
production gold (net)
1968 1,245 1,221
1969 1,252 1,200
1970 1,273 1,376
1971 1,233 1,388
1972 1,177 1,345
1973 1,111 845
1974 996 724
1975 946 974
1976 964 1,384
1977 962 1,426
1978 972 1,595
1979 959 1,317
1980 952 544
1981 973 1,033
1982 1,023 1,073
1983 1,088 1,002
Total 17,126 18,450 1 %
up jewellery products has proved much more volatile and sensitive

to price, as will be seen by the decline in demand during the year
1980 when prices were high.
It is also true that the pattern of hoarding demand for gold has
changed in the last few years. The traditional hoarders of the
Middle and Far East purchased according to their cash position,
which in predominantly agricultural communities depended largely
on the success or otherwise of their crops. More recently, however,
it is becoming clear that greater urbanisation and sophistication, as
well as the substantial upward movement in price, has changed the
established view about gold. Once it was perceived as being innately
cheap in price, but this is no longer the case. Nowadays hoarding
seems to develop when gold prices are believed to be relatively
cheap, but to disappear completely, and even be replaced by
dishoarding, when prices are deemed high. In 1980 and 1981 the
net dishoarding reached appreciable proportions, perhaps on a
gross basis as much as 300 tons in 1980.
Faced with this recent instability of demand, we can foresee a
continuing need for an efficient mechanism for hedging, such as that
provided by futures markets. This is without consideration of the
volatility of investment and speculative buying (or selling) which
has been so marked over the last ten years.
We may conclude therefore that, with so many uncertainties, the
prospects for gold futures markets remain good. There is a devel-
The future 115
oped need for them, which is unlikely to decline over the near term.
It may well be that future gold price volatility will be less pro-
nounced than that of the late 1970s, because inflationary fears will
be lower, and because there will be no repetition of the upheaval in
the price of gold which occurred after 1968, when the metal caught
up with 40 years of unchanged prices.
The main possible threat to the growth of futures markets would
be a return to a fixed or controlled price, such as existed until March
1968. At present this danger does not loom large. Movements in
exchange rates remain unstable, not only because there is a wide
range of inflation rates in different countries, but also because the
abolition or reduction in exchange controls in many nations allows
a greater volume of investment funds to move from one currency to
another. Investment managers are becoming more and more inter-
national in outlook, and do not hesitate to use the avenues open to
them to switch currencies. At the same time, official institutions
have lost the will to control the destinies of the currencies for which
they are responsible, preferring to limit their activities to smoothing
out trends.
Against this background, it is hard to see a return to a fixed or
controlled price for gold. The problems of managing a gold price
are certainly no less than those of managing a currency. Today, no
Central Bank wishes to stand in the way of the market. In January
1980 when gold prices soared, the Central Bankers of the world's
main developed nations are believed to have considered interven-
tion in the market to prevent too strong a rise, but, in the event, they
did not have the courage, despite the large quantities of gold at their
disposal.
It seems scarcely possible that one day gold will return to the
epicentre of the world's monetary system. At present, the con-
ditions necessary for a fixed gold price do not exist, and, despite a
considerable improvement in efforts to restrain inflation in devel-
oped countries, there are no great hopes that an era of financial
stability is just around the corner.
Thus both recent developments in the psychology of gold and the
general financial climate seem likely to preserve an interest in gold
and gold markets.
Amongst gold futures markets, some will no doubt prosper more
than others. In the United States, the importance of the New York
Commodity Exchange should not diminish. New York remains as
the pre-eminent financial centre in the United States and has, as
earlier explained, a good physical basis of gold transactions.
Chicago, by contrast, has no such advantage, and lives on its

reputation as a centre for trading many commodities. Its futures
exchanges are huge and well organised, but will always seek new
products. If gold is not attractive, its trading fraternity will turn to
something else. That this can happen quickly is evident from the
level of gold trading on the IMM in 1984. There was a sudden
collapse in the volume of gold traded there. In the first nine months
of 1984 only 8,639 contracts were traded, and in September only
four, compared with 312,780 in 1983.
Even against the background of a generally inactive gold market,
this sharp decline is surprising, but it is strange that it occurred just
as the link-up with the Gold Exchange of Singapore was planned.
The only reasonable explanation is that the trading community
there, whether floor brokers, commission houses or exchange
officials, have found other futures business more rewarding. It is no
accident that the successful launching of a Deutsche Mark option
contract coincided with the start of gold's sudden declineareactivity
in early 1984.
More debatable is whether those futures contracts located in
centres where gold trading is established and popular will be able to
carve a niche for themselves, and successfully meet the competition
from other forms of gold trading.
Markets outside the United States

The Sydney Futures Exchange is well placed with the relaxation of
Australian exchange controls, and from its position in the time
zone. There is an increasing demand for gold prices between the
closing of US markets and the opening of Hong Kong on the
following day. We do not yet know whether the proposed link-up
between the SEE and Comex will be cemented, but even without
this Sydney's prospects are much improved.
In Hong Kong and Singapore the futures markets for gold face
the competition from the well-established loco London market and,
in Hong Kong, from the Kam Ngan. With official backing and
assuming some benefit from the link-up with the Chicago IMM, the
Singapore International Monetary Exchange should succeed, but it
is by no means certain that the gold contract will be amongst that
exchange's most popular.
The recently announced demise of the London Gold Futures
Market underlines the difficulties of young futures markets operat-
ing alongside established and efficient markets. Its short history is
not encouraging to those other markets in the same position.
The future 117
In Tokyo, the introduction of silver contracts in February 1984

has initially been successful, and gold futures may become more
popular now that the rate of original margin has been reduced to a
level more in line with international futures practice. However,
commodity trading does not enjoy a first-class reputation, and,
despite the presence of leading trading houses amongst its member-
ship, acceptance of the Tokyo gold futures market is not yet very
great amongst the Japanese public. Perhaps it will need a few more
years before this market attracts a significant volume of business.
On 30th November 1984 a gold futures contract was introduced
in Rio de Janeiro, Brazil, which supplements one in Sao Paulo.
In view of current conditions in Brazil, no discussion of these
contracts has been made in this book. Rio's turnover had reached
1,010 lots of 250 grams each by year-end. The contract is denomi-
nated in Brazilian cruzeiros.
On 25th October 1984 a new computerised gold futures market,
Intex, based in Bermuda, began trading. This market has no trading
floor. Orders are entered through 'trading stations' (computer
terminals) located in the offices of Intex's members. Intex has many
advantages over traditional futures markets, not least that its
charges for commissions and fees are low. No detailed description
of Intex is given here, however, since it its revolutionary in concept,
quite different from established futures markets, and has had little
time to prove itself.
We may conclude that outside the New York Comex there are as
yet no truly international gold futures markets. The other markets
are still young and at early stages of development. Given a return to
more active conditions in gold generally, Singapore and Sydney
should become futures markets with significant international par-
ticipation, but Hong Kong and Tokyo probably need more time and
marketing effort.
Appendix A: A word
of advice to potential
speculators
The risks are great

Gold still has many attractive qualities as a hedge against inflation and
currency devaluation; it may be expected in the future to retain its real
value just as it has done in the past. But it is subject to price falls as well as
rises, and either are unpredictable in the short term.
First think carefully about the nature of futures markets. They are
designed to permit gearing or leverage; they give the opportunity to earn
large profits in return for a modest outlay. It should be self-evident that
potential losses can also be large in relation to that outlay.
The volume of futures trading has grown immensely in the last twenty-
five years in the United States from 3.9 million contracts in 1958, to 139.9
million in 1983 (source: Futures Industry Association, Inc., Washington
DC). Employment in the futures industry has risen accordingly, and
profits for dealers and brokers are often high. The growth has not been
blunted by the arrival of negotiated commissions in the late 1970s, in fact
the rate of growth has increased (total futures trading increased three and a
half times between 1963 and 1973, but over five times between 1973 and
1983). Much of this growth has come from professional trading, but a lot
more from the rise in the number of individual speculators, who generally
pay the highest rates of commission.
The importance of study

Do be prepared to devote time to understanding the fundamentals of gold,
and to following the market movements, so that you understand what
influences them. The study by the Chicago Board of Trade, referred to
earlier in Chapter 8, revealed that the majority of speculators surveyed
found involvement in futures trading the most time-consuming of all their
investment activities.
Appendix A 119
Choosing your broker

Having decided that you wish to participate in gold futures, choose your
broker carefully. All respectable brokers should get you to sign a form
stating that you understand the risks involved. This is known in the United
States as a 'risk disclosure statement'. Be sure you read it carefully, and do
not sign it unless you truly understand it. It may give the broker consider-
able powers to deal with your position at his discretion if you fail to fulfil
certain obligations.
Start trading in a small way

Do not be tempted to take too large a position until you have some
experience of the market. Even if you encounter success initially, do not
succumb to the temptation to raise the size of your trading or its frequency
too soon. Never trade beyond your means or your ability to take losses.
Are advisers necessary?

In any form of investment, one has the choice of managing one's own
affairs, or delegating this to professional advisers. This latter course is also
available for commodity trading. If you are attracted by commodities, but
do not feel you have the time or inclination to follow the markets, then by
all means put yourself in the hands of a professional manager or com-
modity fund. But remember to choose one who is known to be respectable
and has a proven track-record. On the other hand, beware of exorbitant
claims of success over a short period—such success usually implies a high
degree of risk, and thus the potential for loss is also high. Do be sure to
ascertain the terms of trading, and discover if you have the right to get out
when you wish.
Above all, if you choose to manage your own trading, do just that. Do
not succumb to the blandishments of salesmen, and do not deal unless you
feel it is right. In many cases futures salesmen and account executives
receive a portion of the commission which they earn for their companies
from their clients. Their motivation is to earn as much as possible, so they
encourage their customers to trade as frequently as possible. The sensible
trader knows that it is almost certainly not right always to have a position
in the market. There may be times when the trend of prices is hard to
discern, and the market is moving 'sideways'. Those earning commission
from commodity broking are always likely to encourage you to trade in
and out for small profits. Such 'churning' is bread and butter to them, but
there is always the danger of taking a number of small profits and then
finding oneself with the wrong position when the direction of the market
becomes established. Better by far to await the right opportunity.
Taxation
Obtain knowledge of the taxation aspects of futures trading. Professional
advice can easily repay its cost. In broad terms, the Inland Revenue rules in
the United Kingdom are not friendly towards commodity trading com-
pared with other forms of investment. If you engage in frequent oper-

ations, you are likely to be designated as a trader, and therefore to attract
income tax at your highest rate. In the United States special tax rules apply
to futures trading.
Undisciplined trading will rarely be profitable, and profit once achieved is

all too easy to lose. Nevertheless, well-managed speculation can be most
rewarding as well as stimulating. In short: gold futures trading can be
dangerous to your health, but need not be.
Appendix B
Commodity Exchange Inc., Official List of Approved Refiners and Brands (deliverable
against Commodity Exchange Inc. gold contracts)
*No longer produced.
Producer Refined at: Computer Brand marks

code
All Union Gold Factory USSR cccp cccp (with hammer &
sickle)
Argor SA Chiasso, Switzerland argo ARGOR SA CHIASSO-SAA
ASARCO Incorporated Amarillo, Texas asat ASARCO GOLD-AMARILLO,
TEXAS
Perth Amboy, NJ aspa *ASARCO PERTH AMBOY
Canadian Copper Montreal East, ccrl CANADIAN COPPER
Refiners Ltd Quebec REFINERS LTD
Compagnie des Metaux Paris, France cmpp COMPAGNIE DES METAUX
Precieux PRECIEUX-PARIS
Paris, France sdbs 'SOCIETE DE BANQUE
SUISSE
Comptoir Lyon- Paris, France clal COMPTOIR-LYON-
Alemand Louyot ALEMAND,
LOUYOT-PARIS
Deutsche Gold und Frankfurt, W. degu DEGUSSA
Silber Schneideanstalt Germany
Vormals Roessler
H. Drijfhout & Zoon's Amsterdam, hdza H. DRIJFHOUT 8i ZOON
Edelmetaalbedrijven Netherlands AMSTERDAM-MELTERS
BV
Engelhard Industries Newark, NJ enne engelhard (with large
letter E (on underside
of bar)
Newark, NJ bake baker (within circle
atop triangle)
Engelhard Industries Cinderford, enci ENGELHARD LONDON
Ltd Gloucestershire, UK (with large letter e)
Producer Refined at; Computer Brand marks

code
Engelhard Industries Thomastown, ENTH ENGELHARD INDUSTRIES
Pty Ltd Victoria, pty ltd (with Assay e
Australia Office)
Engelhard Industries of Aurora, Ontario ENAU ENGELHARD (with circle
Canada Ltd connected to > moon to
left of brand)
Handy He Harman Attleboro, Mass. HAND HH HANDY & HARMAN
W. C. Heraeus GmbH Hanau, W. Germany HERA HERAEUS FEINGOLD (with
Heraeus Edelmetalle
gmbh-Hanau encircling
3 roses)
Homestake Mining Lead, South Dakota HMCO HMC HOMESTAKE MINING
Company COMPANY
Johnson Matthey Brampton, Ontario JMCA jm Canada (with crossed
Limited hammers) ^
Brampton, Ontario JMMC *JOHNSON MATTHEY &
MALLORY-ÂNADA
Johnson Matthey Royston, JMLO JOHNSON MAKHEY
Chemicals Ltd Hertfordshire, UK LONDON
Johnson Matthey & Brussels, Belgium JMPA JOHNSON MATTHEY &
Pauwels SA PAUWELS
Matthey Bishop Inc. Winslow, NJ MBUS MATTHEY BISHOP USA
Matthey Garrett Pty Kogaran, New South MGPS MATTHEY GARRETT
Ltd Wales, Australia PTY-SYDNEY
Metalli Preziosi SpA Paderno Dugnano MPSP METALLI PREZIOSI SpA
(Milan), Italy (with mp inside a
diamond)
NV Metallurgie Hoboken, Belgium MHOV METALLURGIE HOBOKEN
Hoboken Overpelt OVERPELT
Hoboken, Belgium MEHO "metallurgie HOBOKEN
Hoboken, Belgium SGHM "SOCIETE GENERALE
METALLURGIQUE DE
HOBOKEN
Metaux Precieux SA Neuchatel, MPSA METAUX PRECIEUX SA
Switzerland
Neuchatel, SBCO SWISS BANK
Switzerland CORPORATION
Mitsubishi Metal Osaka, Japan MMCO MITSUBISHI METAL
Corporation CORPORATION
(with 3-diamond mark)
Norddeutsche Affinerie Hamburg, W. NAHA NORDDEUTSCHE
Germany AFFINERIE
HAMBURG
The Perth Mint Perth, Western PMAU THE PERTH MINT
Australia AUSTRALIA
(with swan motif mint
mark within circle)
Appendix B 123

Producer Refined at: Computer Brand marks
code
Rand Refinery Limited Germiston, Transvaal RRSA RAND REFINERY Ltd
SOUTH AFRICA
(encircling picture
of springbok)
Royal Canadian Mint Ottawa, Ontario RCMI ROYAL CANADIAN MINT
(encircling a crown)
Schone Edelmetaal BV Amsterdam, GSNV GUARANTEED BY SCHONE
Netherlands NV AMSTERDAM
Sheffield Smelting Co. Sheffield, UK SSCL THE SHEFFIELD SMELTING
Ltd CO. LTD - LONDON &
SHEFFIELD
State Refinery USSR CCCP cccp (with hammer &
sickle)
Swiss Bank (See Compagnie des
Corporation Metaux Precieux &
Metaux Precieux SA)
(Societe de Banque
Suisse)
Tanaka Kikinzoku Kanagawa Pref., TIME TANAKA TOKYO-MELTERS
Kogyo KK Japan
United States Assay New York, NY USNY SEAL OF UNITED STATES
Office (with year & location of
production)
San Francisco, Cal. USSF 'seal of united states
(with year & location of
production)
United States Metals Carteret, NJ DRW DRW
Refining Co.
United States Mint Denver, Colorado USDE 'seal of united states
production)
Philadelphia, Pa. USPH "'SEAL OF UNITED STATES
production)
Valcambi, SA Balema, Switzerland CRSU CREDIT SUISSE (with
assay
stamp chi)
Balerna, Switzerland VSBS VALCAMBI SA
(with assay stamp chi)
Index
account/account trading, 14 Chicago Mercantile Exchange (CME), 50-

active months, 29, 44—45, 53 51, 55
advisers, 119 China, 2
agricultural commodities, 16, 19 Chinese Gold and Silver Exchange Society
air freight, 12 {see also Kam Ngan), 12
approved warehouses, 34 clearing house, 18, 31—32, 34, 40, 46, 74
arbitrage, 13, 14, 35, 52-54, 66, 93, 103 clearing member (or broker), 18, 32,34,40
arbitrageur, 13, 14, 65 clerks, 17, 28-29
Argentina, 78 coinage, 2, 4, 19
Aron, J., & Co., 35 Comex (Commodity Exchange Inc., New
assay, 83, 84 . York), 3, 20-22, 27-48, 61, 70, 76,
assay certificate, 34 107, 115, 117
Australia, 69-70, 116 Board of Governors, 42
authorised traders, 17 committees, 41—42
members, 35, 41—42, 46
Babylon, 2 rules, 42
backwardation, 38 commission, 39—41, 97, 118
Bank of England, 4, 7, 57 commission houses, 17, 35, 40, 74
Bermuda, 117 Commodity Futures Trading Commission
Bimetallic standard, 19 (CFTC), 18, 32, 41, 49-50, 107
Brazil, 117 Consolidated Goldfields Pic, 113
Bretton Woods, 5-6 Contango, 38, 43-44, 85-87
bullion dealers {see also trade houses), 39, contract, 17, 18, 30, 34
92-93,103-4,106 see also lot
contract rules, 18
convertibility of US dollar, 8, 9
California, 19 copper, 20, 27
Call Chairman, 74 corporate privileges, 35
call (options), 106 craftsman, 1
cash and carry operations, 37, 90, 92 currency,
cash settlement, 56 devaluation, 6, 118
Central Banks, 2, 8, 11, 25, 38-39, 61, 115 weakness, 6, 8
charts, 98-100, 102-3
Chicago, 16, 53, 116 DBS Bank, 71
Chicago Board of Trade (CBT), 16, 17, daily limit, 30-31
50-51, 54-55, 95-96, 118 day-trades, 97
126 Index
deferred settlement, 14, 64—66 hedging, 6, 16, 21-22, 43, 60-61, 77-93,
delivery against payment, 35 103, 114, 118
delivery of futures, 33—35, 90—91 Hong Kong, 12-13, 14, 60, 62, 64-65, 98,
depositor, 34 116, 117
deposits, 75 Hong Kong Commodity Exchange (HKCE),
Depression, the 19—20 66-67
devaluation of the US dollar, 24 Hutton, E. F. & Co. Inc., 32, 35, 43
electronics, 2 India, 2
European attitude to gold, 23 Indonesia, 70
Exchange fee (Comex), 41 Inflation, 4-6, 11, 23-24, 111-13
Exchange members, 17 insurance, 12
execution of orders, 17, 28 interest rates, 37—38
International Commodities Clearing House
Falkland Islands, 78—79 Limited (ICCH), 66-67, 69, 74-75
'far-out' month, 45 International Monetary Fund (IMF), 47,48,
'fast market', 46 57, 59-61, 111
Federal Reserve Bank of New York, 57 International Monetary Market of Chicago
financial futures, 51 (IMM), 46, 50-54, 61, 116
fineness, 34 investors, 9, 11, 77, 90, 93—94, 109
five-tael bars, 12 Intex, 117
fixing, 3
floating exchange rates, 5, 9—10, 25-26 Japan, 2, 67-68 ^ »
floor brokers, 36-37, 40, 43, 46-47, 77 jewellery, 2
forward contract, 13 Johnson Matthey, 71
'full carry', 43—44
fundamental analysis, 96, 98
futures exchange, 17 Kam Ngan, 12-14, 60, 62-66, 116
futures markets, v, vi, 12,14,15—22,23,27.
future (or forward) premium, 38, 87, 90,92 local traders ('locals'), 36—37, 72, 104
see also contango loco London, 13—14, 47, 63-66
London Commodity Exchange, 74
'give-up', 18, 40, 43, 46 London Gold Futures Market, 73—76, 116
gold, London Gold Market, 3, 5—7, 10—11,
colour of, 1 13-14, 58, 63, 71, 73-74
consumers, 77, 87—89, 103 London International Financial Futures Ex-
ductibility, 1 change, 75
fixed price, 115 London Metal Exchange, 73—74
malleability, 1 long positions, 14, 25, 30, 33—34, 36, 85,
miners, 89 100, 102-3
official price, 4-5 lot, 30, 34
ownership by US citizens, 8, 20, 25 see also contract
producers, 77—82, 103
production, 2, 113 margin,
refiners, 82—87 original, 10, 18-19, 30-31, 40, 75, 97
revaluation, 5, 9, 20 variation, 10, 18—19, 32—33, 40, 75,
standard, 3—5, 19 80-81, 83, 103
US dollar parity, 5, 20 market liquidity, 36
as a hedge, 6, 11, 22, 118 markets, v, 1
as an investment, 2, 23 Merrill Lynch, 32, 35, 43
as money, 2, 19 Mid America Exchange, 51, 55—56
as a store of value, 2, 6 miners, 2
Gold Exchange of Singapore (GES), 54, Mocatta & Goldsmid Ltd, 3
70-73, 116 Mocatta Metals Corporation, 106
Gold Pool, 7, 10 Montagu, 3, 71
goldsmiths, 2 see also Samuel Montagu & Co. Limited
grain, 16-17 Morgan Guaranty Trust Company of New
guarantee of contract, 18, 31, 71, 74 York, 73
Index 127
Napoleonic Wars, 4 short positions, 14, 30, 33-34, 36, 38-39,

National Metal Exchange, 20 48, 60-61, 79, 85, 103
'nearby' months, 45 silver, 4, 20-21, 31-32
New Court Merchant Bankers, 71 Singapore, 70-71, 116
'New Deal', 20 Singapore International Monetary Ex-
New York, 28, 57, 98 change (Simex), 72, 116
New York Coffee Sugar & Cocoa Exchange, South African Reserve Bank, 7-8
55 Soviet Union, 4, 6
New York Mercantile Exchange (NYMEX), Special Drawing Right (SDR), 9
51 speculation, vi
speculators, vi, 9, 44, 48, 59-60, 90,
95-105, 109, 118
'odd lot', 55 spot month, 44
oil prices, 11, 24, 112 spot prices, 38
open interest (or open position), 42-43, 47 spot transactions, 3, 8, 15, 90
open outcry, 62, 74 'spreads', 37
options, 106-9 see also switch
Organisation of Petroleum Exporting Coun- statistics, 42-48, 103
tries (OPEC), 10, 11, 24-25, 112 sterling, 4-5
original margin, 10, 18, 19, 30-31, 75, 97 stop-loss orders, 100—2
'out' trade, 46 supply of gold, 38
Oversea Chinese Banking Corporation, 71 Swiss Bank Corporation, 8
Overseas Union Bank, 71 Swiss Credit Bank, 8
Swiss National Bank, 57
switch, 30, 36-39
parallel market, 63 Sydney Futures Exchange (SEE), 69-70,116
Persia, 2
Philipp Brothers, 35 tael, 12, 14, 62
physical delivery, 2—3 taxation, 119
physical transaction, 15 technical analysis, 42-43, 103
'pit', 17 telephone books, 28
platinum, 67 tender notice, 34
point and figure charting, 100 Tokyo Gold Exchange, 67-69, 116-17
price signal, 17, 28-29 trade houses, 35, 43
price volatility, 96, 98-101, 104, 107, 115 trading floor, 17, 28
prospectors, 1—2 'trading stations', 117
Prudential-Bache, 32, 35, 43 trading systems, 96, 98
put (option), 106 Transvaal, 4
Treasury Bond (T-Bond), 54
reportable position, 50
Republic National Bank of New York, 35, Union Bank of Switzerland, 8
71 United Kingdom, 4—5
Reserve Bank of India, 57 United States, v, 7-8, 15, 18-19, 20-22,
reserves, 3-5 23-24, 27-28
ring, 28 US dollar, 7-8, 24
Rio de Janeiro, 117 US Treasury, 21, 25-26, 111
Roosevelt, President, 5, 20 Bond (T-Bond), 54
Rothschild, N. M. 8c Sons Limited, 3, 71
'round-turn', 41 Valeurs-White Weld, 106
variation margin, 10, 18-19, 32-33, 75,
80-81, 103
Samuel Montagu 8c Co. Limited, 3, 71 volume of business, 42—43, 46-47
Sao Paulo, 117
Securities and Exchange Commission (SEC), warehouse receipt, 34
49 see also warrant
seigneurage, 20 warehouse stocks, 47
Shearson/American Express, 32, 35 warrant, 74

1985 - Robert Beale - Trading in Gold Futures

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1985 - Robert Beale - Trading in Gold Futures

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TRADING IN

rne Angus L. Macoonalcl UDrary

Since time immemorial gold has fascinated man, because of its

Though they differ in detail, they have many features in

Gold: who needs

Throughout the 5,000 years of recorded history, gold has been

the requirement for a market which facilitates the exchange of gold

coinage in many countries was mainly gold, although silver was

gold bullion standard) by the United Kingdom in 1925, when the

standard, to a metal prized as a hedge against inflation and currency

requirements of customers who required gold for manufacture. It

placed it at a considerable disadvantage to other markets. The three

saw great opportunities in the new era of floating exchange rates.

established market for gold in the period running up to the

was at first difficult, because the two markets operate in different

type of facility to arbitrage traders. This is known as the 'account/

In the first chapter we saw how the established gold markets of

ficient to attract the speculator, such an individual will come to the

variation margin is payable or receivable in cash, whereas on some

market price of the metal, and the quantity produced by US mines

Who needs gold

In the preceding chapters we have contrasted the attitude towards

accustomed to investment in stock markets and prepared to risk

was not expected because it would not be popular with their

adjusting to the new conditions of the 1970s, including floating

over was 393,517, equivalent to 1,224 tonnes of gold, or 110 per

These signals are sold to the leading newswire services, which

in another month. Special margins may be required for open

The clearing house

much higher) than the minimum fixed by the Exchange. Whatever

Comex members who are themselves not represented on the floor,

in the United States as 'spreads', are the simultaneous purchase of

spread more favourable to him, when interest rates move up.

York by direct private telephone or telex wires. Communications of

committees generally meet outside trading hours. At the top of the

market. In the reverse situation, when prices are falling, speculators

Table 1 Open interest on Comex at 15th March 1984

1984 March 225

interest to develop, unless a daily limit move prevents trading in the

orders. Formerly it was suspected that at times some floor brokers

rhs Sngug S. Macdonrilo' Ut

conclusive evidence that the Comex December contract was being

The detailed description of Comex in the previous chapter makes

is defined. Once a trader has a reportable position, he may be

The Chicago International Monetary Market

Table 2 Annual turnover in gold contracts of US exchanges, 1974-84

for pastoral products. Amongst such products which it trades today

natural new contract when the trading of this commodity became

The Chicago Board of Trade

The Mid America Commodity Exchange

We must conclude that the structure of the US gold futures industry

stored in the vaults of the Federal Reserve Bank in New York,

From frozen wastes

The Winnipeg Commodity Exchange h. »

Effect of the IMF gold auctions

could breathe more easily, seeing little sign of burgeoning activity in

positions, and the market rallied, in the belief that buying by

The Kam Ngan

celebrated its seventy-fifth anniversary. The method of trading is

provide liquidity. Even today, arbitrage between the loco London

However, because neither currency is delivered in the gold transac-

4. Loan (Borrow) Hong Kong dollars

exchange rate of US dollars against Hong Kong dollars. He is,