this is complicated stuff… grateful for people’s input. i’ll no doubt refer again and again to these posts over time. i understand CFDs, and my thinking now is that XAUUSD is a cfd to a gold futures contract. which isn’t imaginary at all. although i don’t know why it’s called “spot gold” if it’s a futures price (?). but hopefully that will become clearer over time.
NOT ADVICE DO YOUR OWN RESEARCH
Gold is a real asset, a contract is only as good as private property rights
The futures price is used over the world as away to value an asset.
For example a company may settle a contract based on the spot market or fix the price at the current spot rate or when you go to the mint to buy gold they might use USD price on an exchange spot price.
A CFD is a over the counter brokers product. Just like betting on Federer to win a tennis match is a product created by the bookmaker.
The price is created by the broker. The liquidity is controlled by the broker. The spread is controlled by the broker. The rollover is controlled by the broker.
The broker creates the product to mimic features of a futures contract.
A spot type contract is different to a futures contract.
For the difference between spot, you need to understand what a futures contract is.
The futures contract started as away for farmer to hedge the volatile crop prices.
For example say I am producing apples which are in high demand at the moment because cider is in fashion
The price is say $3 a kilo
Now I am afraid that prices may fall by the time I harvest.
So I want to hedge the price risk and sell a futures contract.
I go to a buyer and say I want to sell my apples now and he says ok I will give you the money and you deliver in January next year the physical product.
But the buyer will lose interest in the bank on money he pays me for the contract.But I will have to pay the storage costs.
So he may say take off 3% on the price and I will say add on 1% for storage cost.
so eventually we agree the buyer purchases the apples at $2.94 instead of the current(spot) price of $3.
I get the money and the asset is delivered in january.
Now if the price of apples goes up in the mean time the buyer has gained and if they go down the buyer has lost.
After a while people realised they could make money just buying the contracts instead of actually producing/creating the asset. Just like the central banks who print money without the backing of a physical asset like gold.
Other complications like margin were introduced as well.
Now you have introduced a counterparty. Say the apple grower goes bankrupt, then the buyer will lose all of his money. That is one of the reasons people buy through an organised and regulated exchange with government regulators overlooking as well.
On margin the buyer goes to the bank and says, look i want to buy a shipment of apples but don’t have the money. so the bank says ok we will loan you the amount and use the contract asset and a deposit as collateral. if the apple price falls too much, you must sell the contract and surrender the deposit/any difference in price.
Now moving back to gold the spot is supposed to reflect the current price. The way this price is discovered as in most markets is complicated, but essentially it is supposed to represent purchasing the asset immediately. The spot contract was created to allow one to trade the asset price only without having to take into account the other factors of a future, eg: you are buying the apples now, so don’t have to worry about interest on the cash etc. In some markets it may be the front month contract used as a proxy. However some OTC brokers may just infer the price in their own contract.
when you pay rollover for a long postion, you are borrowing on margin, just like the apple buyer.
When you buy a futures, you are buying gold in xmonths time not now.
That is the difference between the spot and futures market and explains the difference in price.
In an efficient market the relationship between the futures and spot/actual asset will mean very little discrepancy when interest rates and yield,dividends etc are taken into account.
However it could be argued that in extreme circumstances and the perception of asset movements can also be priced into the future. The 1987 crash is an example of this. The futures failed to follow the market closely and alot of hedging strategies failed.
A broker can only buy a futures product from/on the exchange, he cannot create it
Otc brokers do generally not buy the product in your name from the exchange.
The benefit of OTC is the flexibility and trading with small amounts of capital
Sometimes exchanges stop shorting or governments try to intervene, eg china trying to stop selling or asx stopping shorts during the gfc.
OTC markets may often allow continuation of trading their products
The downside, is the counterparty risk, ie the apple grower going bankrupt or playing silly buggers with you.He may even stop you from buying apples from him if he knows you keep predicting apple price rises correctly.
The other downside, is that OTC you are only asking one seller of apples. You must buy from him only even if he has access to other sellers or markets. You are locked in to his conditions.
the apple seller can call it spot or futures or donkeys but only futures from an exchange are really futures.
cheers
NOT ADVICE DO YOUR OWN RESEARCH
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