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Long-term investors in physical gold and silver often watch for headlines such as these: “Silver futures rises to Rs 41,715 per kg.” It is not because they have any interest in investing in precious metals futures. However, they know that many important market players use futures to hedge their positions, and this can sometimes signal price trends.

For example, this article notes “silver prices at the futures trade were influenced mainly due to widening of positions by speculators in step with a firm trend in global markets as dollar’s weakness raised the appeal for precious metals.” 1 Indeed gold and silver futures are up thanks to an array of factors, including expectations that the Fed will be slow to raise interest rates and doubts over the new administration’s ability to boost the economy. 2

Understanding Futures Contracts

A futures contract is a legally binding transaction for the delivery of gold or silver at an agreed-upon price at a specific date in the future. The contracts can be held for physical delivery, or they can be sold at a profit or loss before the contracted delivery date. Of note is the fact that there are often significantly more contracts to buy and sell gold and silver than physical quantities of the precious metals exist. 3

Futures contracts serve at least two important functions. Most importantly, they allow industry consumers of gold and silver to control their future costs of the metal they use. For example, major jewelry manufacturers will buy futures to lock in a price per ounce for the products they are making. Likewise, makers of solar panels will do the same for silver to fix the cost of that component of their panels.

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The second function of the futures exchanges is to provide a ready market for speculators to buy and sell contracts. It is this factor that causes a larger number of contracts for the metal than could physically be delivered. These speculators are allowed to take large positions in the potential price moves without ever taking possession of the physical metal. Of course, speculators can move the price temporarily, and they are often happy to make a few pennies per ounce because their contracts control thousands of ounces.

What the Trends Indicate

Speculators can bet on the price of gold or silver going up (going long) or down (going short, or shorting). These market players assume major risks, and often lose their entire investment when they are wrong on their bets.

Of course, when investors have physical possession of gold or silver, they are immune to this risk of losing everything. Rather, they can see trends in the precious metals futures market that indicate it is a good time to buy more of their favorite holding before prices rise. On the other hand, such trends may indicate it is time to pay attention to the Gold Silver Ratio (GSR) and perhaps discuss reallocating holdings between gold and silver.

While futures serve an important role in the market for commodities, they are more important to long-term gold investors as just one more factor that affects the short-term price of precious metals. At present, gold and silver futures contracts suggest a positive trend in the demand and prices for physical quantities of these precious metals.