BullionVault definitions

Futures/spread bet contango

Have you ever heard a futures salesman explaining that you don't have to pay a financing cost on a future because you only pay a small amount up front in the margin.

It's not true.

The price of the future includes the full financing cost on the whole size of the deal. And exactly the same cost is in a spread bet too.

If US Dollar interest rates are 4.65% and gold lease rates are 1% (not far wrong, but you'll see the numbers are chosen carefully) then there are 365 basis points between the two rates.

That's one basis point per day during the year.

The result is that the future you buy with 90 days to settlement will lose 90 basis points against the spot - that's 1 basis point a day - during the course of its 90 day life. So it will start with a 90 basis point premium to the spot, and bleed it out slowly. This is why buying that gold future is fine for the short term but an uphill struggle for you in the long term.

The 90 basis point difference is called the contango, and if it is not there the world's computers come in and arbitrage the futures markets against the spot market to earn the missing basis points for some big bank somewhere. They do this by borrowing gold at 1%, selling the gold at spot, depositing the cash proceeds for 4.65%, and buying the gold future to balance the position.

This forces the contango up to its fair value.

So as a futures buyer you end up paying the financing cost on the whole un-margined amount of your futures purchase or spread bet.

Contango costs arise on any delayed settlement - which is all a futures contract is. BullionVault settles instantaneously at the point of trade, and there are no contango costs.