HOW COMMODITIES ARE PRICED

When you buy a futures contract, the price represents the amount at which you are committed to buying the underlying commodity when the futures contract expires. Similarly, when you sell a futures contract, the price represents the price at which you are committed to sell the underlying commodity when the futures contract expires. (Not all futures contracts require physical delivery upon expiration; some are simply settled by cash.) For example, if you buy a COMEX December gold future at $380 per ounce, then you have the obligation to buy 100 ounces of gold at a price of $380 per ounce in December when the future expires.

The price of a gold future constantly fluctuates in response to several factors such as supply and demand, interest rates, and prices of other precious metals. However, no matter what the price of gold does after you buy the future, you will be able to buy gold at the price of $380 per ounce – you have locked in this purchase price.

When you buy futures, you lock in a purchase price for the underlying commodity. Similarly, when you sell futures, you lock in a selling price of the underlying commodity. If prices go up after you buy a futures contract, then you will earn a profit since the futures contract has increased in value. For example, if you buy one gold futures contract at $340 per ounce and two weeks later, the same gold futures contract is trading at $350 per ounce, then your futures contract is now worth $10 per ounce more than when you bought it. One futures contract represents 100 ounces of gold, so the total profit on your gold futures position is $1,000. Obviously, the reverse could have happened and gold futures prices could have fallen instead, in which case you would have suffered a loss.

The chart shows how the North Korea nuclear tests and crisis affected the price of gold which is often used as a safe haven during global or geopolitical uncertainty. The gold price traded higher and higher as investors looked for safe haven investments.