The Price of Leverage

Cash prices are the prices for which the commodity is put on the market at the various market settings. The futures price stands for the up to date market view of what the commodity will be worth at some time in the future. Under standard conditions, the price of the physical commodity for future delivery will be more or less the same to the current cash price, in addition the quantity it costs to carry or store the commodity from the present to the month of delivery. These costs, better known as carrying charges, establish the standard premium of futures over cash.

Consequently, an individual would generally look forward to to seeing an upward tendency to the prices of distant contract months. This type of market condition is known as “contango” and is distinctive of a lot of futures markets. In the majority of physical markets, the central determinant of the price differential amongst two contract months is the cost of storing the commodity over that particular amount of time. Therefore as a result, markets that reimburse a person completely for carry charges, interest rates, insurance, and storage, are known as full contango markets, or “full carrying charge” markets.

In the case regular market conditions, when supplies are satisfactory, the price of a commodity for future delivery must be equivalent to the current spot price in addition to carrying charges. The contango makeup of the futures market is kept integral due to dealers and financial institutions to take carrying charges back into line through arbitrage.

Futures markets are on average contango markets, even though seasonal aspects in energy markets have an essential role in market relationships. The reverse of contango is “backwardation”, a market condition where the close by month trades at a higher price in relation to the outer months. This type of price relationship more often than not is a sign of unease with supply; a market can in addition be in backwardation while seasonal reasons predominate.

Normally futures trading happens on a lower commission charge than the banks or leveraged dealers do, however there are some exceptions to this point. When there is an inflationary environment the money unit then loses value and this allows the borrower to pay down the loan with fewer valuable exchange units. When an inflationary situation takes place it is logical to borrow precious metals rather than buy them.

In many cases though and due to the fact that price movement is amplified to the investor in both ways, there are a lot of investors that have seen that leverage is not always the most convenient way to go. The problem is that a lot of people use too much leverage and do not have a plan set up if the market just so happens to go the other way form their purchase order, and whom do not have sufficient amount of capital to be in a leveraged condition all together.

In the case the metals market moves to a point in which the investor does not have enough stock, in this case the person that has purchased – or borrowed actually – has to ask for added money. Whenever a margin call is made the investor needs to send money in a short amount of time. If and when the money is not sent within the required amount of time, the whole amount, or a good portion of the account is liquidated. Although this would be a very disappointing event, it can be avoided when an investor chooses to use the right amount of leverage to his or her capital or to make a cash purchase.

All of this obviously is something that an investor has to choose him or herself. There are different aspects involving the situation that have to do with meeting a margin call and doing extra purchases. However, whatever decision is made needs to be well thought of beforehand.

In a lot of cases investors that go into futures lose money in the end. Remember that there are experts and professionals that know about the aspects involving it and most individuals don’t. Remember that markets constantly go up and down, and a person that chooses to use leverage needs to keep this in mind.