Please consider sharing this with your friends:
Share this Image On Your Site
Introduction on Hedging
Precious Metal prices have been known to fluctuate significantly on a week-to-week or even a day-to-day basis. This means that gold and silver bullion dealers must be careful as to not end up on the wrong side of a large price swing. Hedging large inventories of gold, silver and platinum are not standard practice for many bullion dealers, and a lot of local coin shops and even online gold and silver retail stores don't fully hedge their positions. This can be problematic and could potentially lead to other issues like longer shipping times and large monetary losses on the part of the company.
Largest Gold and Silver Price Movements of the Past
In the past, gold and silver spot prices
have had days that saw a move of 10% or more in either direction. Some days that are worth noting include September 15th and 16th 2011, where silver saw a 23% drop in price. Over those two days, silver fell from a high of around $39.75 to as low as $30.68 the following day. Another big day for precious metals was April 15th, 2014 when gold spot price fell $110 in one day of trading.
On days like these, dealers who didn't hedge their inventory could have potentially experienced very large losses if they were not using proper hedging techniques. Situations like these have helped bullion dealers improve and master the hedging of large inventories. This has helped dealers protect themselves against risk and make their business safer and more predictable for both them and their customers.
What Exactly is Hedging?
In short, hedging is the process of playing both sides of the market to provide protection against fluctuations in precious metal prices. Bullion hedging means that the dealer has offset their long positions with their short positions and vice versa. By doing this, the dealer is ensuring that they never have an overall long or short position. This helps the company be somewhat immune to price movements that gold, silver and platinum see on a day to day basis. Below we will go into further detail on both long and short positions.
Long Positions vs Short Positions
A long position refers to any inventory that a bullion dealer has in their possession or that they have ordered from a supplier. This type of position is one that would benefit the company when prices move upwards. In contrast, a short position is one that would benefit the dealer if prices declined. A short position simply refers to any incoming orders that the dealer has yet to fulfill. When the long position is combined with the short position it is referred to as the "net house position."
Based on their overall position, the dealer will then trade futures contracts to offset or hedge against the net house position. Standard futures contracts are traded in increments of 100 ounces of gold, 5,000 ounces of silver and 50 ounces of platinum.
Example Hedging Situation
Now that you understand the basic aspects of hedging precious metals, we will go over a sample situation. In our example, a dealer has 5,000 ounces of physical gold that was bought at a spot price of $1,200/oz with a wholesale markup. All in all, the dealer has 3,000 ounces of open orders from customers that were sold at a spot price of $1,200/oz plus a retail markup. In this scenario, the dealer would be left with a net long position of 2,000 ounces bought at $1,200/oz spot.
In our example scenario, if the dealer did not hedge their inventory they would have a long position of 2,000 ounces. This would mean that if the gold spot price was to move up $200/oz the dealer would make a profit of $1,000,000 on their physical inventory while losing $600,000 on open orders leaving them with a net gain of $400,000. In the opposite situation where gold moved $200/oz downwards the dealer would then have lost $400,000.
With a properly hedged inventory in this same scenario, the dealer would have shorted 20 gold futures of 100 ounces per for a total of 2,000 ounces. In this case, if spot price was to increase by $200 then the dealer would have made the same $1,000,000 on their inventory and lost the same $600,00 on open orders. The futures contracts would have then given them an additional $400,000 loss for a net profit of $0. In this way, the dealer is protecting their company from price movements while making money on the product's retail markup.
To Hedge or Not to Hedge?
By hedging their physical inventory, bullion dealers can better protect themselves against sharp decreases in spot price. This in turn means that they will be able to be more financially stable through market volatility and provide their customers with a more secure buying experience. On the other hand, dealers who do not utilize a proper hedging strategy are faced with the risk of going bankrupt and becoming wiped out by a large spot price movement.
Ordering Precious Metals From JM Bullion
At JM Bullion, we fully hedge our inventory at all times to ensure our customers can count on us through price dips and large upward movements in spot price. In this way, investors can purchase precious metals with confidence time and time again. Through our website, you can order precious metals 24/7 in a secure environment with free shipping and quick delivery.
If at any time you have questions about spot prices or any of the products on our website, we are standing by to help you. Simply give us a call at 800-276-6508 or use our live chat feature to reach a customer service representative. You can also visit our contact page to send us an email for added convenience.