Jim Lytle, a financial adviser, recommends that his clients invest in gold. Specifically, he is advising a client to invest $100,000 to purchase 175 ounces of gold bullion, with the expectation of holding the gold for a period of one year before selling it. The client points out that the futures price for 175 ounces of gold to be delivered in one year is $104,000, which represents a 4% return on the $100,000 investment, while the one-year Treasury yield is currently 5%. “Wouldn’t it be better,” the client asks, “if I sold 175 ounces of gold today for $100,000, while purchasing a forward contract to purchase the gold in one year at a price of $104,000? I could then invest the $100,000 in 5% Treasury bonds maturing in one year.”
Analyze the returns for the client’s proposed strategy. What is your recommendation?
Why might the two alternatives offer different returns?