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The gold futures market is one of a number of commodity futures, wherein contracts are entered into, agreeing to buy or sell gold at a certain price at a date in the future. Gold futures are used both as a way for producers and movers of gold to hedge their products against drastic fluctuations in the market, and as a way for speculators to make money off of those same movements in the market.
The gold futures market is one of the most heavily invested markets in the world, and often acts as a market people run to when the broader market is suffering. The gold futures market is very attractive for investors, in part because trading on margin allows for the relatively small movements of the gold market to translate into large financial gains.
When investing in gold futures, you are basically promising to someone that you will buy or sell a certain amount of gold to them at a settlement date in the future. For example, an investor is pretty convinced that the price of gold is going to go way up in the next three months. If he wanted to profit off of that by just buying and selling gold, and he had $1,000 US Dollars (USD) to invest, he would buy $1,000 USD worth of gold at $500 USD an ounce for a total of two ounces. If, in three months, it has gone up to $800 USD an ounce, he would have cleared a profit of $600 USD; not a bad profit, but also not terribly impressive.
By buying gold futures on margin, however, he can leverage the money he have to invest enormously. Depending on the state of the market and the size of his buy, the amount of money he has to put down on margin ranges from anywhere between 2% and 20% of the total amount that he wants to buy. In an average market, his margin on gold futures will probably be around 5%, so that same $1,000 USD can be used to buy gold futures for $20,000 USD worth of gold, or 40 ounces at $500 USD an ounce. If the price of gold increases the same amount, to $800 USD an ounce, he will have cleared a profit of $12,000 USD, even though he had only $1,000 USD to invest.
On the other hand, it is much easier to lose money quickly when trading gold futures on margin than when buying them with cash in hand. If that same 40 ounces loses only 5% of its value, going down to $475 USD an ounce, then the entire $1,000 USD initial investment will be gone. Periodically, margins will have to be topped off, as the price decreases to the point where you near expending all of your initial investment. If the investor is unable to top off his margin, then the account is closed out, and the investor loses all of his money. The temptation of gold futures is enormous, because of the huge amounts of money to be gained if it is played correctly, but the majority of people who trade gold on margin wind up losing their investments.
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