Futures or bars? How to avoid ending up the fool Battered investors will receive a fresh option when the Hong Kong stock exchange relaunches gold futures tomorrow. But are gold futures a good way to invest in gold? Is the entry fee low and are the returns attractive? What are the risks? How does it compare with direct purchases of gold bars or jewellery, stocks of gold producers, or gold exchange-traded funds (ETFs)? According to brokers and financial planners, it all depends on what type of investor you are and your investment goals. For general and retail investors, directly buying gold bars, jewellery or gold ETFs is better if you are bullish on gold but have low risk-bearing ability, says Denise Cheung Pui-yee, president of financial planning company Money Concepts. 'As the financial crisis rages, gold prices have increased drastically in the past few months. I don't think gold futures are suitable for retail investors, as the risks are very high given their high leverage. I think they are more suitable for professional or sophisticated investors, or those with hefty investment capital.' Ms Cheung said gold bars or jewellery and gold ETFs were a simpler, more convenient investment, allowing one to diversify investment risks while benefiting from any rise in gold prices in the long run. Gold prices have surged about 186 per cent in the past five years amid rising demand and a weakening US dollar. Bullion rose above US$900 an ounce recently, which is an exception at a time when prices of most commodities were falling. Ms Cheung said gold ETFs - such as the SPDR Gold Trust, the first gold-backed ETF that listed on Hong Kong Exchanges and Clearing on July 31 - were the most common and convenient way to participate in the great gold rush without being exposed to the risks of buying bullion physically, or to the complex world of gold futures. The entry fee or initial investment for gold ETFs is generally around US$1,000 the world over. Investors can buy as little as one board lot of 10 shares of SPDR Gold Trust, with each share priced at about one-tenth of the spot price for an ounce of gold, which means the entry fee is about HK$6,490, based on the closing price on Wednesday of SPDR, HK$649. By comparison, as a derivative product, the initial margin - or cash deposit paid to the broker - for futures is only a fraction of the price of the gold underlying the contract. The entry fee for an HKEx gold futures contract is about US$10,000 for 100 troy ounces. (One troy ounce equals 31.1 grams.) That works out to about 10 per cent of the contract value you are actually buying, says Owen Law Chor-yam, general manager of Wing Fung Futures, one of the three gold futures liquidity providers. 'Because of the low margin payment, every US$1 put in gold futures can represent US$10 worth of gold. That means your investment return may be much bigger because of the leverage ratio. But at the same time, it also means your risks will be bigger.' Mr Law said the increasing volatility of gold prices amid the current financial uncertainty meant both the return and risk were increasing as well. Historical volatility, or the realised volatility of a financial instrument over a given time, of gold prices has increased from 10 per cent in August to 50-60 per cent now. 'In the past, the volatility would have been US$20 a day, but now it may be over US$100 a day. For a US$10,000 margin you pay, a movement of US$90 in either direction of your gold futures contract could mean an overall loss for you, forcing you to settle or close the contract, or add margin,' he said. Mr Law suggests that at least during the initial years of gold futures, people should dabble in it only through professional investors. 'It takes time to understand the way gold futures work. Besides, any investment product needs time to catch on. It took investors a while to get familiar with Hang Seng futures.' Mr Law suggests investors consider their own risk-bearing ability before deciding how exactly they will buy into gold. For low-risk bearers, he suggests buying physical gold; for medium-risk takers, he advises gold-related stocks; while high rollers can consider gold futures. But remember, when it comes to gold futures, you can buy them on the up as well as down, as futures are available in all price directions. But for physical gold or gold-related stocks, you can only buy when you are bullish on gold. Horace Kwan Pak-leung, deputy chief operating officer of Celestial Commodities, another gold futures liquidity provider, said HKEx's higher transparency and stringent regulations meant there was no counterparty risk - the risk that the other party in the agreement will default - for those involved in over-the-counter trading of gold or gold futures. 'Compared with spot gold contracts, the cost of carry of gold futures is relatively low and there is no interest spread involved. So I think HKEx' gold futures will be a competitive product and will attract investors to participate,' Mr Kwan said. Contract specifications of HKEx's gold futures Trading symbol GLD Contract size 100 troy ounce (the contract value was around US$84,700, as of October 15) Minimum fluctuation US$0.1 per troy ounce Trading hours 8.30am to 5pm, Hong Kong time (no lunch break) Contract months Three contract months available for trading, including Spot Month and the next two calendar months Settlement method Cash settled in US$ Last trading day The third last Hong Kong business day of the contract month Final settlement day The first Hong Kong business day after the last trading day Final settlement price London Morning Gold Fixing carried out by The London Gold Market Fixing Ltd on the last trading day Exchange fee US$1.30 per contract (waived for the first three months) Cash settlement fee US$1.30 on final settlement Commission levy US$0.10 per contract (exempted for the first six months) SOURCE: HKEX