By Doug Young

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If you want to hold physical gold you can opt for buying gold bullion which comes in the form of coins and bars, or for gold jewellery. This is the most simple and the least risky way.

However there are also many investors who prefer not to buy physical gold and instead to buy gold mining or trading stocks, or gold certificates. Compared to investing in gold derivatives these methods are considered to be the safest because there is less risk involved. The downside is that the profit that you get by employing these methods can be pretty slow.

If you are less risk averse and are looking for quicker returns then you can consider gold derivatives.

Understanding Gold Derivatives

So what exactly are gold derivatives? Well, first you have to understand what derivatives are in general. In the world of finance derivatives are defined as financial instruments linked to assets like for example gold. The values of such financial instruments depend on the anticipated price trend of the asset or assets.

The term ‘derivatives’ is in fact a generic term that has been coined to define a specific class of financial products like ‘futures’ and ‘options’ (these are the most popular ones).

Futures

Firstly let’s find out what ‘futures’ are all about. Those who are involved in gold futures trading have to make a gold futures contract. This contract is a sort of commitment whereby the buyer or seller commits to buy or sell gold (a specified quantity) on a pre-determined date. The price is also pre-set. Investors trade such contracts on worldwide exchanges.

This type of investment is potentially very lucrative and the trader can make a lot of profit within a short time. Of course there is a risk factor involved due to the fact that the price of gold bullion determines the success or failure. This adds to the volatility, so it is recommended that you do your homework well before taking the plunge.

Options

Coming to the ‘options’ part, it is actually a right bestowed on the owner by virtue of which he can sell or buy gold at a pre-set price sometime in the future (on a specified date). Unlike with ‘futures’ there is no compulsion with ‘options’ so the owner is free to decide whether he wants to complete the transaction or not.

Under gold ‘options’ several factors are taken into consideration before determining the cost. These are: the present and anticipated price of gold, the contract price (pre-determined), the duration of time up to due date and the interest rates (official). ‘Options’ trading is done on margin so your upfront payment is just a fraction of the total value of the contract.

Because of this leverage investors consider ‘options’ to be pretty affordable particularly in comparison to the potential gains, especially since you can limit your losses but there is no limit on the amount of profit you can make.

Buying Gold Derivatives

Why Buy Them?

This question can be approached in two ways: why buy gold derivatives or why buy gold in general? We have already outlined the benefits of buying gold derivatives above so now let’s take a step back and look at the more general picture.

Gold has what is known as a negative correlation to stocks and bonds which means that when these go down, gold goes up. This correlation applies too to inflation and the value of the dollar. This is why gold is seen as a hedge for investments and why it becomes a safe haven when the economy is struggling.

This is precisely why more and more people are researching where to buy gold right now, given the extent of global economic uncertainty. Many fear that the US National Debt is out of control (it is now around a staggering $17 trillion) and that the current government policy of printing more and more money will lead to hyper inflation and seriously reduce the value of paper currencies, i.e. cash.

Everyday folk are getting restless about their pension funds which depend entirely on the stock market for performance and are looking at ways to convert a percentage of their IRA’s and 401k’s into gold and other precious metals.

So as you can see, it’s not just governments, conglomerations and the super rich who are clamouring to buy gold today. Many individual first time investors are too. And each individual has their own circumstances and requirements. Those who want to take a long term view can purchase physical gold to hold on to. Others who wish to invest in gold without owning any physically can invest in gold mining stocks. And those who prefer to be more speculative and aim for quicker returns can invest in gold derivatives.

How To Buy Them

To buy gold derivatives the first thing you need to do is open an account with a stock broker. You can do your research for one initially online and if your main focus is to be on gold then it is recommended that you look for one that either specializes in precious metals or at least has an in house trader with experience of precious metals.

You also want to consider whether you prefer to trade yourself online or by calling your broker. If you prefer the latter you need to find a broker that has their own online trading platform. First time investors in derivatives may find it better at least initially to call their broker and give them verbal instructions when opening or closing positions. This is where it would be beneficial to have an account with a broker with experience and expertise in precious metals.

Conclusion

Buying gold derivatives offers you the potential to make profits from investing in gold quickly. The downside is that you can lose quickly too. Buying gold stocks is less risky but your return is governed not just by how gold is performing but also by how the Companies you invest in are run. Buying and holding physical gold is the least risky investment option but you need to be prepared to wait longer for your returns.

This last one is our recommended option for newbie gold investors by the way and if you have read the rest of the articles on this site you will know that our overall recommendation for first time gold investors is to buy gold coins.

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So once you have made the decision to invest in gold you have to ask yourself some questions. How risk averse are you? What trading experience do you have? Can you afford to lose the money you are investing? Are you prepared to take a long term view? Would you feel comfortable holding physical gold? Answering those questions will help you determine your strategy.

About the Author: Doug Young
Doug YoungDoug is a highly experienced professional and widely trusted authority in financial investing, commodity trading, and precious metals. With over 20 years of expertise, he helps others make informed decisions by sharing a combination of personal experience, extensive knowledge and meticulously researched information on gold IRAs, precious metals investing and retirement planning. He regularly writes news items on these topics. He has considerable experience of evaluating Gold IRA and Precious Metals Companies, gained over a period spanning more than a decade.

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