What gives gold its value
Gold is one of the most ancient assets traded by humankind. This shiny yellow metal was used for thousands of years to make jewellery and other artefacts because of its intrinsic beauty and radiance. It soon became a symbol of wealth and power that transcends cultures and civilisations.
It was ancient Egyptians that first used minted gold coins in trade. It remained a practice for centuries until modern economies entered a system called the gold standard and linked the value of their coins and notes to a fixed amount of gold.
The gold standard was replaced by the Bretton Woods agreement of 1944, which created a system for all international currencies to be linked to the US dollar.
This regime set the US dollar’s value at a rate of USD 35 per an ounce of gold. Central banks around the globe were able to exchange their own currency for the dollar with the US Federal Reserve and, in turn, the dollar for gold.
The Bretton Woods system collapsed when the value of the US dollar came under pressure and members of the system requested to be paid in gold. In 1971, US President Richard Nixon ended the direct convertibility of US dollars into gold. This brought gold’s role as money to an end.
Today, gold is still used for jewellery, and it has several industrial applications, such as in computers and mobile phones – but it’s much more than raw material. It plays a significant role in global finance.
It’s a unique commodity and still functions as a store of value as it resists corrosion and doesn’t tarnish. Gold is regarded as the ultimate safe-haven asset for investors to take shelter in during periods of economic turbulence.
Even though gold retains its value over time, the gold price is quite volatile, and this makes it a popular instrument to trade.
What is gold trading
Gold is one of the most popular financial instruments to trade. Gold trading involves speculation on the price of the precious metal for financial gain.
The gold price is sensitive to economic indicators, geopolitical events, and financial market fluctuations, for instance, to the dollar's exchange rate, interest rates, etc. Traders around the world look to take advantage of the gold market’s liquidity and its price volatility.
One form of gold trading is for it to change hands in its physical form. But you don’t need to own gold bars to trade it.
You can simply trade assets linked to or influenced by the gold price, such as derivatives, gold company shares, or exchange-traded funds (ETFs).
One of the most popular derivative instruments used for gold trading are contracts for difference (CFDs). These will also allow you to trade gold with leverage, increasing the potential for gains, but at the same time might amplify losses.
The benefits of gold as a financial instrument
It’s regarded as a safe haven
The trust in gold remains ingrained into humankind. It’s seen as a solid asset, one that could always be relied on to be fairly stable in times of crisis, be it war, a pandemic or an economic downturn. These events affect the prices of other assets like stocks or bonds much more, while the gold price tends to rise over time.
It protects against inflation
While price increases (inflation) erode the value of cash, many investors use gold as a hedge against inflation to protect their capital. Gold prices may be volatile within short periods of time; however, it tends to go up over the longer-term horizon.
It can be used to diversify investments
Gold can be used to create a balanced portfolio of investments where it serves as a counterweight to riskier assets, for instance shares, which are more sensitive to economic changes or factors specific to individual companies.
The gold market is liquid and volatile
The main attraction of holding gold is its liquidity. Individuals can even borrow money against it. What’s more, world gold markets are volatile and sensitive to a number of factors moving its price in the short term. Therefore, making it ideal for price speculation.
Ways to trade gold online without owning it
There are various ways to trade on gold and its price movements without owning the underlying asset.
Spot gold: The spot gold price is the price of one ounce of gold in international markets for immediate purchase. Traders can speculate on the spot price of gold as opposed to the price of gold futures.
Gold futures: If you believe that the price of gold will significantly change in the future, you may want to trade gold futures contracts on a commodity exchange. Futures contracts enable traders to exchange gold for a fixed price on a date set in the future, called the expiry. To avoid having to take physical possession of gold, you need to close out the contract before it expires.
Gold stocks: Owning and trading gold stocks, i.e.: the shares of companies that are linked to gold, gold mining stocks, the shares of jewellery makers, etc. gives indirect exposure to gold. They can be used to diversify a share investment.
Gold ETFs: Exchange traded funds that track a basket of the shares of companies linked to gold, such as miners, refining and gold production companies provide a wider exposure to gold than a single instrument. They replicate the average returns of gold-related assets.
Options: Options contracts work similarly to futures but without the obligation to take possession of a gold delivery when buying. Options give the holder of the contract the right to exchange gold or gold futures at a set price on an agreed date. Call options give the holder the right to buy gold, while put options give the holder the right to sell it.
CFDs: As we have mentioned above, one of the most popular forms of gold trading is via contracts for difference, which also allow traders to borrow funds from their broker to trade larger positions than their initial deposit, which is called trading with leverage. Using leverage will amplify gains as well as losses, therefore, traders need to learn appropriate trading strategies to limit their risk.
To find out more about what CFDs are, check out the guide to CFD trading on the ThinkMarkets website, and read this article to learn what leverage is and how to use it in gold trading.
To start trading CFDs on gold with tight spreads and fast execution, open an account with ThinkMarkets today.
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