Friday, December 28, 2007

Hog Wild

"Woooooooooo, Pig! Sooie!"

- President William Jefferson Clinton (at University of Arkansas sporting events)

Similar to the grains (corn, soybeans, and wheat) discussed in the previous post, the Lean Hog contracts are very liquid and have high seasonal correlation from year to year, as do the Live Cattle contracts. Almost every year, the April contracts for both Lean Hogs and Live Cattle soar in price beginning in late-December or early-January, following dramatic plunges in price immediately prior to Christmas. Right on schedule, both hogs and heifers plunged in price this fall and early-winter, and I made some good money earlier this year shorting the hogs.

While published reports and market commentaries continue to be bearish on all of the major meat contracts (Lean Hogs, Frozen Pork Bellies, Live Cattle, and Feeder Cattle), over the last several trading days the cattle contracts have started to move upward right on schedule. Since the Live Cattle contract is the more liquid of the two, I have started watching that April 2008 contract closely, and plan to get on the train on the second consecutive close above 99. The Lean Hogs haven't started moving up yet, but I will continue to watch that April 2008 contract as well, and plan on getting onboard on the second consecutive close above 68.

The secret to trading is good money management much more than trade selection. Investors spend most of their time trying to find the next "sure thing," and not nearly enough time focusing on the mechanics of their swing. You want to search out opportunities where you have any type of edge and then take a cut. If a trade goes against you, cut it quickly, and if it goes your way, let it run with a trailing stop. As long as the amount of money you make on winners exceeds the amount of money you give back on losers, you win, even if you only "won" on 2 out of every 10 trades. The historical trends indicate that the odds are in your favor with the meats in January, but it's the mechanics of your swing - waiting patiently for the right entry point, cutting your losers quickly and letting your winners run - that will make you come out ahead in the end. Good trading!

The hagiography of Benazir Bhutto has begun in earnest, as you can see from the framing and composition of the above photograph that appeared on Time's website. While there is no doubting her bravery in returning to Pakistan, the picture of her as an earnest liberal democrat focused solely on the welfare of her people is far from the mark. My favorite description of her comes courtesy of Marty Schwartz, immortalized forever as the "Champion Trader," by Jack Schwager in his trading classic, Market Wizards: Interviews with Top Traders. While it was Michael Lewis' Liar's Poker: Rising Through the Wreckage on Wall Street that first got me interested in being a trader, it was Marty Schwartz's Pit Bull: Lessons from Wall Street's Champion Day Trader, one of the all-time classic trading books, that really made me believe it was possible to succeed at this game.

Bhutto was an early investor in an international fund managed by Marty. He met her at a lavish and opulent party in England, and described her as follows:

"This was not the woman I'd seen on TV, her body covered in drab black tentlike garb, her thin ascetic face devoid of makeup, her straight black hair pulled back under a black scarf. A gold chain hung over one shapely shoulder and attached to it was a quilted black Chanel pocketbook. Chanel beads, Chanel shoes, and Chanel fragrance all adorned Benazir - Coco in her most opulent hour had never worn as many accoutrements as Benazir Bhutto. This woman had money radiating out of every aperture."

Having worked in the intelligence field, and having visited and analyzed many third world countries, especially in Asia, I recognize Bhutto's type very clearly - someone who could not get ahead in her country's domestic politics on her own power, and therefore tried to use the United States to accomplish her goals for her. Mark Steyn, the most astute political commentator on the current scene, as usual nailed it.

Another astute analysis came from an estranged relative, Bhutto's niece Fatima. Coincidentally, I finally got around just last month to reading Ghost Wars: The Secret History of the CIA, Afghanistan, and Bin Laden, from the Soviet Invasion to September 10, 2001, a book my brother gave me as a gift several years ago. This meticulously documented book makes it clear that the Taliban was a Pakistani-funded and supported creation from its very beginnings, and that Bhutto lied directly and repeatedly to United States officials about Pakistan's activities in support of the Taliban.

In light of this history, why on earth would anyone at Foggy Bottom believe that she would really welcome "NATO boots on the ground" in the Pakistani border areas where Osama Bin Laden is hiding? Both times she was deposed as Pakistan's ruler, corruption was the excuse, but the real reason was her attempts to bring Pakistan's Islamist-infiltrated intelligence service to heel. It is quite clear she would say anything to the United States she thought they wanted to hear to gain the assistance of the CIA in regaining power - a power she was not capable of seizing unaided.

The most obvious recent similar example of someone who hoodwinked the United States this way was Ahmad Chalabi. You can read that whole sad story here.

Hopefully, Pakistan will emerge from this chaos with responsible, mature, non-Islamic fundamentalists in firm and clear command and control of Pakistan's nukes. If not, the special forces of the United States, India, Israel, or some unprecedented combined force might very well be sent in to take them out. To paraphrase H.P. Lovecroft, that scenario would indeed be "too horrible to describe," but the groundwork for it is already being laid. Note my use of the word "hopefully" at the beginning of this paragraph, and remember that hope is not a good investment strategy. As if we needed yet another reason to BUY GOLD!

Thursday, December 27, 2007

Turn, Turn, Turn

To every thing, turn, turn, turn
There is a season, turn, turn,turn
And a time to every purpose under heaven

A time to be born, a time to die
A time to plant, a time to reap

- Pete Seeger

History doesn't repeat itself, but it does rhyme.

- Mark Twain

The shapes of the annual price curves for wheat and corn follow reasonably predictable patterns based on their respective planting, growing, and harvesting seasons, as well as on seasonal fluctuations in demand for the products derived from those grains. Based on supply and demand factors in any given year, the degree to which grain prices rise or fall will change, but the basic seasonal pattern normally at least somewhat resembles those of past years. With the rising demand for grain products in China and India, price rises should continue to be in excess of the historical norm in 2008, just as they were in 2007.

As discussed in the previous post, both wheat and corn tend to rise in price between November and sometime in early-February, when prices tend to fall off sharply. Historically, the best contracts to play this seasonal rise have been the July contracts for both grains. Soybeans also tend to rise in early-January, but tend to fall again about two weeks later, and also tend to trade with more volatility than wheat and corn. Additionally, soybeans are much more affected by fluctuations in the price of oil than the other two major grains, so this discussion will focus on wheat and corn.

Both wheat and corn are already up from their November lows this year, and I am long July futures contracts of both. I started with a stop of $1,000 below my entry point on each and have now moved those stops up to lock in a $500 profit. I will continue to trail my stop up as these markets rise, and will move up those stops very tight in late-January in expectation of the "February break" frequently observed in these grains. Of note, in recent years corn has tended to "break" as early as mid-January, probably due to traders anticipating this traditional price move and getting out ahead of the pack.

Following the "February break," wheat and corn both tend to recover in price and go on to reach even higher prices, peaking sometime between May and July. If you are fairly confident this pattern will recur, another way to play this seasonal pattern that is developing right now is to buy options that are about 10-20% out of the money on the July futures contracts. Since you pay cash upfront for the options, you wouldn't have to worry about margin calls as the prices of the underlying futures contract moved against you during the "February break," as you would if you tried to hold a standard futures contract position all the way through to the summer decline in prices.

A more conservative way to play the likely agricultural commodity scenario for 2008 is to buy the corn/wheat "spread." This simply means buying the July 2008 corn contract, while simultaneously selling the July 2008 wheat contract. In 2006, corn prices went up more than wheat prices because of government subsidies for corn-based ethanol that distorted the free market (and led directly to tortilla riots in Mexico). So in 2007, lots and lots of farmers switched their wheat acreage over to corn to take advantage of the higher corn prices, which led directly to wheat prices rising more than corn prices in 2007 (to all-time highs). You can therefore expect to see farmers switch current corn acreage to wheat and soybeans in 2008, which should lead corn prices to outperform wheat prices due to the lower amount of corn harvested. By being long corn and simultaneously short wheat, you don't care anymore whether prices are going up or down - you win as long as corn becomes relatively more expensive than wheat over the holding period of the two contracts, even if both corn and wheat decline in price.

If you would like to play the agricultural commodity boom, but just can't bring yourself to trade futures contracts or options on futures contracts, probably the best way to do so is to buy some shares in an ETF with the symbol MOO that contains many agricultural-related stocks. If you want to increase your leverage on that bet, you can buy options on the ETF, the longer-dated the better. For those who prefer to play individual company stocks instead of ETFs, a personal favorite of mine that is in my wife's portfolio has the symbol POT. It's a Canadian potash mining company, and potash is a key ingredient in fertilizer. No matter how farmers decide how much of their acreage will be allocated to wheat, corn, and soybeans each season, they will still need ever more fertilizer! Again, you can increase the leverage by buying LEAPS on POT. A good friend of mine has had LEAPS on POT for more than six months and is currently up on that position in triple digit percentage terms even after the two market pullbacks that occurred this fall.

The main reason I prefer the futures to the ETF or to a single stock is that it is still not clear if we will suffer a major stock market correction in 2008 or not (regular readers know I consider this possibility to be highly likely). If we do, MOO and POT will most likely initially crash right along with the rest of the market, although I think that they will be among the first stocks to recover. I have MOO and GDX on my very short list of ETFs to buy once the crash is over.

Just a quick update on our old friends the yuan, the yen, and gold, all recommended here over the last few months.

I hope everyone had a very Merry Christmas! The upcoming year is filled with possibilities for profit, and we will be discussing them in this forum.

Sunday, December 16, 2007


It's a sad day for Navy football. As predicted here, Coach Paul Johnson was too great of a coach for us to be able to keep him. He will now be moving on to be the head coach at Georgia Tech. Unlike Roger Clemens, he's moving to a team we don't hate, so we wish him well and thank him for all those victories over Air Force and Army. Fair Winds and Following Seas, Coach Johnson!

And as for Roger, as a good friend once told me, "The Wheel of Karma always turns." Couldn't happen to a nicer guy!

We've talked a lot about financial commodities such as the yuan, the yen, and precious metals over the last few months, and those are all still looking like great places to be invested over the next few years, but today, I'd like to discuss a different group of commodities - the grains, the most liquid and widely traded of which are wheat, corn, and soybeans.

For a wide variety of reasons detailed here, agricultural commodities in general, and the grains in particular, are in the middle of what should be long-running bull markets. And the current rate cutting moves by the Fed are making the picture even rosier for grain bulls. The reason I draw your attention to this sector today is that agricultural commodities in most years have very pronounced seasonal patterns that can give a speculator an edge. For example, here are the average seasonal charts for wheat over the last 15 and 30 year periods.

You can see on these charts of the various different monthly contracts that wheat has a strong tendency to rise from early-December through mid-February, following which it suffers what commodity traders refer to as the "February Break." So far so good this year, as corn, wheat, and soybeans are all in uptrends right now as we head into mid-December. There are a number of different ways to play this trend, although as you can probably guess by now, my favorite is options on futures contracts! We will discuss some of the other ways in future posts.

Friday, December 7, 2007

Joy in Crabtown

It's official - Navy has now defeated Army six times in a row, something that neither school had ever been able to do in the more than 100 years of the greatest rivalry in college football. This picture shows Reggie Campbell scoring one of his touchdowns. He was personally involved in almost every point Navy scored, running back a kickoff for a touchdown, scoring from the run of play himself, setting two key blocks that allowed others to score, and even returning a punt 51 yards to set up a field goal with just seconds remaining in the first half. Now we go on to demolish Utah in the Poinsettia Bowl in San Diego on December 20.

Here in Japan, the game kicked off at 2:00 a.m. I managed to stay awake for all but the last five minutes of the game, when victory was already assured. 38-3 sounds like a dominating scoreline, but Army actually outplayed Navy on both sides of the line of scrimmage for much of the game. Army dropped an easy pass in the end zone, missed a 28 yard chip shot field goal attempt, and it seemed to me had at least three questionable officiating calls go against them on critical plays that either kept Navy drives going or killed promising Army drives. Hence our eternal gratitude to Reggie Campbell, the one man Army-destroying machine!

Army's strong play, plus the almost certain loss of our outstanding coach to another team that can pay him much more money sometime prior to next season, does not bode well for next year's game, but with Army-Navy, just like Red Sox-Yankees, you can always throw out the records and expect a hard fought contest. What a year so far - the Red Sox win the World Series, Navy beats Notre Dame for the first time since Roger Staubach was our quarterback, and we also beat both Army and Air Force to win the Commander-in-Chief trophy. Go Navy, Beat Utah!!!

On the not so cheery side, the world financial system continues on its inexorable path over the cliff. Citigroup, Goldman Sachs, and Morgan Stanley, among others, are all technically bankrupt. It is only a matter of time, most likely sometime early in the New Year, until even the mainstream media figures this out, and that is when gold will take off on the next leg of its bull run, if not before. If you haven't gotten some gold yet, now is a great time, as gold is in a consolidation phase that is offering a great entry point. If you haven't diversified out of dollar-based assets yet, the dollar is in the midst of a counter-trend rally that probably won't make it much higher than 80 on the US Dollar Index that offers a great chance to convert your dollars into stronger currencies like the Japanese yen, Swiss Franc, Canadian dollar, and Chinese yuan. See previous posts for the best ways to maximize your returns on these macro trends that will be with us for some time.

If you still doubt that the US dollar really is roadkill, and toxic waste in your financial portfolio, consider that the best performing currency against the dollar so far in 2007 is the Philippine Peso.

Saturday, November 24, 2007

There is Another

If you are a regular reader of this blog, you are aware of my extremely pessimistic forecast for the American dollar over the next few years. If you are still not convinced the coming collapse of the dollar is inevitable, or if you have at any time in the last four or five months looked at your brokerage account statement and thought to yourself, "Thank God for my Google (or Apple) stock, because everything else I own is going down," then please read this, this, and this before it is too late.

As a regular reader, you are also now well armed to take action to not only preserve your capital during the ongoing destruction of the standard of living of the average American family, but to also prosper as others suffer. I want to state quite clearly that I am not happy about these ongoing events of historical significance that are being ignored by the mass media in favor of the latest developments in the lives of Paris Hilton, Lindsey Lohan, Brittany Spears, OJ Simpson (again!?), and Natalee Holloway (oh wait, she's still dead), and I sincerely wish that I could instead post regularly about ways to make money by investing in America. It greatly saddens me that I cannot do so. Unfortunately, we are way past the point of no return of America's decline as a great power, and it is critical to focus on taking action now to protect you and your family from being sucked under by the coming economic hard times.

By the time Americans go to the polls next November, we will be in the midst of a protracted recession, or possibly the first actual depression since the 1930's. In economic hard times throughout American history, voters have without exception, "tossed the bums out," and handed power over to the out of power political party. This means only one thing - President Hillary Rodham Clinton. Senator Clinton's main problem is that she has no core values except for one - she truly, honestly, deep down in her soul believes that government is a force for good in the world and should be used to solve problems. Everything else is subject to negotiation or whatever the latest poll says would be popular. This means that she will not hesitate to dust off the Franklin Delano Roosevelt playbook, and try to throw money and alphabet soup government programs at the nation's problems.

Unfortunately, FDR took office in an entirely different situation in which America as a country had not run up the largest debt in the history of the universe, and individual Americans had not run up the largest collective national credit card and home equity loan debt load in history (in the 1920's and 1930's, if you wanted to buy a home, you had to have something called a "down payment"). Since there will thus be no money available for President Clinton's desired programs, the only option will be to print more - lots and lots more - which will destroy what is left of the value of the dollar, and relegate the last vestiges of America's empire to the scrap heap.

Master Yoda remarked to Obi Wan Kenobi at the end of Empire that "there is another," when all looked hopeless. He was referring, of course, to Princess Leia. Unfortunately, that was a movie, and this is real life. Of all the declared candidates for President, only one is talking about taking the necessary hard steps to restore the value of the dollar and preserve the current American standard of living - Ron Paul - and he does not currently appear to have sufficient name recognition to be able to win it all. I predict, however, that he will show surprising strength that will force the mainstream media to finally pay attention to him as the campaign wears on and the economy worsens.

Normally, I am not an advocate of voting for fringe candidates you agree with who don't have a chance to win on the grounds that you are thereby not only wasting your vote, but actually taking a vote away from the candidate of the two major parties who you dislike least. I am going to make an exception this time because, as mentioned before, America is facing its most serious existential crisis since the Civil War and not one other candidate is addressing the seeds of our coming financial implosion at all. Paul, on the other hand, is speaking directly and clearly about what needs to be done - pull our troops back from their outposts scattered all over the world that we can no longer afford, drastically slash federal taxes, spending, and regulation, and put our currency back on a modified gold standard so it has actual value. The rest of the world is in the process of taking away our national credit cards so there are no other choices available.

Many criticize Paul for his plans to withdraw from Iraq, just as it is becoming clear that our brave soldiers are finally winning the fight against the insurgency (the main indicator that we are winning the battle on the ground is that Iraq reports are vanishing from mainstream media news outlets). The way we achieved victory was to throw more resources and troops at the problem. Unfortunately, $1.8 trillion dollars into the problem, there is no more money to expend on being the policeman for Iraq, or any other country for that matter. Once the troops draw back down to their pre-surge levels, it will be up to the Iraqis to govern themselves - and they don't have a good track record on that score. Try to guess who said the following quotes:

...We rushed into the business with our usual disregard for a comprehensive political scheme. We treated Mesop[otamia] as if it were an isolated unit, instead of which it is part of Arabia.... When people talk of our muddling through it throws me into a passion. Muddle through! why yes, so we do—wading through blood and tears that need never have been shed.

...We are largely suffering from circumstances over which we couldn't have had any control. The wild drive of discontented nationalism...and of discontented Islam...might have proved too much for us however far-seeing we had been; but that doesn't excuse us for having been blind.

No, it wasn't Barrack "Audacity of Hope" Obama (what is supposed to be so audacious about hope anyway?); it was Gertrude Bell, an administrator of the British Mandate in Iraq in the 1920's, which ended about the same way as our try at civilizing Iraq will end soon. Some things never change.

Read all about Congressman Paul's economic ideas in the best of his books. Go, Ron, GO!

The Great Unwinding

I hope everyone loaded up on some gold during the recent buying opportunity mentioned two posts ago. Gold is now headed straight back up again as the dollar continues its freefall. The ongoing appreciation in the Chinese yuan often discussed in this blog also accelerated this week. But today I would like to highlight another great investment opportunity for the immediate future - the unwinding of the yen carry trade and how you can profit from it.

The yen rose against every single one of the world's 16 major traded currencies this week, primarily due to the unwinding of the yen carry trade. What is this "carry trade," and why is its unwinding such a big deal?

Following the collapse of Japanese stock market and real estate bubbles in the early-1990's, Japan's economy sank into a depression that lasted until 2004. The current economic recovery is still tentative, but slowly gaining steam as Japanese trade with China increases by leaps and bounds. During the depression, the Bank of Japan cut interest rates drastically in an attempt to stimulate the economy, and Japan's overnight bank rate of 0.5 percent is now far and away the lowest in the industrialized world. A middle class Japanese worker with a good credit rating can get a housing mortgage loan for 2.75%.

The carry trade developed as a result of the disparity between Japanese interest rates and those of foreign countries such as New Zealand, which awards 8% interest on their government bonds. Literally millions of Japanese housewives in search of greater returns on their savings have marched down to their neighborhood bank and moved their savings into foreign currency accounts denominated in New Zealand dollars, Australian dollars, Canadian dollars, Swiss Francs, and even US dollars, and paying much higher interest rates than a passbook saving account denominated in yen. Foreign hedge funds, investment banks, and even wealthy private investors have gotten into the game as well, borrowing literally billions of dollars at very low interest rates and then investing it overseas in much riskier investments.

This carry trade only works as long as the yen stays relatively stable or decreases in value in relation to other foreign currencies. Japanese housewives know that an increase in the value of the yen by just a few percentage points can wipe out their gains in interest very quickly, so they monitor the exchange rates between the yen and their chosen currency fairly closely. Since Japanese investors tend to move as a group, once the carry trade starts to unwind, that unwinding can accelerate pretty quickly.

The unwinding mechanism works like this: The level of risk begins to increase in the market due to a stock market drawdown somewhere in the world. Foreign currencies accordingly start to fluctuate in value more than usual. That fluctuation in currencies causes some carry trade investors to get nervous and unwind their positions. To do this, they sell their foreign stocks or bonds or withdraw money from their foreign currency denominated savings accounts. Then they transfer that money back to their Japanese bank account. This involves converting their foreign currency back to yen, which causes the demand for (and therefore the value of) the yen to increase, and the value of the currency they are selling to decrease an equal and opposite amount. This rise in the yen's value then causes more investors to unwind their carry trade positions, and a vicious cycle is underway.

How bad can it get? During the market turmoil caused by the Russian government defaulting on its sovereign debt in 1998, the yen soared in value by more than 20% in less than a month, as investors fled from riskier investments. The markets quickly adjusted to that crisis and were rising again smartly just a few months later. This time will be quite different. What is happening now is a massive credit crunch like the late-1980's Savings and Loan crisis, only much worse this time due to the huge numbers of adjustable-rate mortgages that will be resetting throughout the next year, and the literally trillions of dollars of credit derivatives that are based on those loans. The value of the dollar is also dropping like a stone as it slowly but surely loses its status as the world's reserve currency, as discussed in more detail in previous posts.

These two inter-related factors have foreign investors fleeing for the exits, which has precipitated the beginning of the next great carry trade unwind. The yen has gone from above 124 to below 108 so far this year, and is accelerating upward. For the reasons discussed above, this will continue on and off depending on short-term market conditions until the yen finally settles out at at least 80 yen to the dollar and quite possibly beyond that.

What's the best way to play this? All the normal choices discussed in previous posts on the yuan and gold are available. The simplest and safest way would be to convert dollars to yen at a bank, but the interest rates on your yen deposits would be very low, and of course there would be no interest at all if you held your yen in a safe deposit box or in a safe under your bed (don't laugh too quickly - one of the best-selling consumer items in Japan throughout the early-2000's was small household safes). As the number of bank failures in the US starts to increase soon, don't be surprised to see safes gain in popularity. As mentioned in a previous post, your best bet if you go the foreign currency savings account route is Everbank.

Moving along the risk spectrum, the next method is investing in FXY, a currency Exchange Traded Fund (ETF) that matches moves in the yen-dollar rate almost penny by penny. FXY has options available, but only for about nine months into the future. If you choose to buy the options to gain leverage, buy the farthest out month (currently June 2008), and every three months sell those options and buy the new ones three months farther out (this is called "rolling over" or "rolling out" your options). A friend of mine who uses this method bought 23 March 2008 options contracts three months ago and just rolled them over to June 2008. He had a nice profit of $9,600 when he sold the March options. These are the best methods for people who only have a stock brokerage account and don't have futures trading ability yet. See previous posts for more details about ETF's and options on ETF's.

For real leverage, you can use futures contracts and options on those futures contracts. As you know from previous posts, I prefer the options on the futures contracts to the futures contracts themselves, since there is no question the yen will be higher against the dollar at this time next year, but there will likely be radical swings up and down between now and then. Using options instead of the actual futures contracts will keep you from getting stopped out or worse, getting margin calls, during those swings. I'm using the March 2008 9200 strike price options right now, although I don't recommend them for someone buying now as they have moved into the money recently, and out of the money options appreciate faster. Accordingly, I'm going to be rolling them into the June 2008 9500 strike price options soon.

To give you an idea of the effects of leverage, I bought those March options on October 19, 2007, and they are now up 215% each while the yen rate itself is only up about 6% since then. In previous posts I recommended Xpresstrade as the best online broker for do it yourself futures and futures options investing. As an update, at the end of this month, they will complete their merger with optionsXpress and cease to exist. At that point, I recommend switching to optionsXpress as a great one stop shop for all your investment needs. You will be able to trade stocks, bonds, mutual funds, stock options, futures, and futures options all in the same account in a user-friendly interface. I'm not aware of any other broker, online or offline, that offers that trading convenience at anywhere near optionsXpress' commission rates.

Just to round out the total picture, World Currency Options are also traded on the Philadelphia Stock Exchange. These were the original options on currencies, and were once the only way for the small investor to gain leverage on their currency investments. With the introduction of options on futures contracts, currency ETFs, and options on these ETF's, their days are probably numbered, but you can still use them as a way to gain leverage directly on the movements of an underlying currency.

Sunday, November 18, 2007

Options, Options, Options

The market action this week provided a great demonstration of why I mentioned in my last post that options on gold futures contracts were my favorite way to play the ongoing bull market in gold. As gold continues a profit-taking pullback prior to advancing to all-time highs, my margined gold futures contracts and FOREX gold and silver positions were all stopped out, preserving some of my profits, but also meaning that if the market had turned on a dime and shot back the other way, I would have missed out on some of the move up while I was still trying to decide where and when to get back into the market. Because the vast majority of my positions in silver and gold are in options on December 2008 futures contracts, those positions are temporarily down in value, but still in play to benefit from the inevitable turnaround.

This example shows in a nutshell why options are a great choice for investing in commodities that you are sure will move either much higher or much lower in the future, but can't be sure exactly when the big move or moves will occur. As discussed in previous posts, since you pay for an option in full up front, your loss is limited to your initial investment if it expires worthless, and that can only happen if you fail to roll it over prior to its expiration date. On the other hand, since futures contracts and FOREX positions are heavily margined, investors have to close them out quickly when the market starts moving against their positions, as happened to my margined positions this week. Futures and FOREX traders who do not do so quickly become former traders.

So why does anyone trade margined positions then? Why doesn't everyone just trade options? The answer is that since you pay the full value of the option at the time you establish a position, you can't control as large of a total position size as you could in the futures, since you only have to make a small "deposit" when you establish a position in a futures contract, as discussed in more detail in previous posts. Like everywhere else in the market, taking greater risk creates the possibility of greater returns.

Options on stocks and Exchange Traded Funds (ETF's) were discussed in detail in my November 8, 2007 post. The main difference between options on stocks and options on futures is that a futures option gives you the right to buy or sell one futures contract at a set price at a set future date, instead of 100 shares of an underlying stock. Other than that difference, the underlying concept is basically the same. A speculator looking for the maximum leverage would purchase a futures contract on a given commodity, and would consequently assume the risk of greater losses than his or her initial investment if their margined position moved against them far enough before they closed it out. A speculator looking for high leverage, but also looking to avoid margin calls, would instead purchase options on a futures contract.

Let's look specifically at some examples for each method. As of this writing, with gold trading at $787 per troy ounce, a speculator with $10,000 could choose to control two full size 100 troy ounce gold futures contracts (leaving a $1,900 cash cushion), or 10 e-mini 33.2 troy ounce gold futures contracts (leaving a $2,300 cash cushion). The speculator could also choose to buy two call options that would give him or her the right to purchase two full size 100 troy ounce gold futures contracts at a price of $800 per troy ounce on November 20, 2008 (leaving a $180 cash balance). If the price of gold moved from $787 to $887 per troy ounce sometime in that period and the speculator decided to take profits at that point, the respective profits would be $20,000 for the two full size contract choice, $33,200 for the 10 e-mini contract choice, and $12,700 for the two call options.

The $12,700 profit on the call options represents a gain of just under 160%, but was achieved without having to worry about margin calls or getting stopped out of the position at a loss. True to the concept of greater risk taking opening up the possibility of greater gains, the margined futures contract positions were up 247% and 431%, respectively, but if at any time following the opening of the position the price of gold had gone down by just $4 to $783, the futures contract holders would have received margin calls asking them to deposit more money, at which point most futures traders would have closed out their positions. There is also the ongoing mental stress associated with holding heavily margined positions to consider.

Options on futures should only be considered by a speculator who has a very firm view of the future direction of a particular commodities market, as options can expire worthless if they are not rolled over. So the obvious question at this point in time is whether or not gold is certain to move significantly higher in the next few years. Since nothing is certain in this world except for death and taxes, a better question is what it would take for gold NOT to move significantly higher. The only scenario that derails the ongoing gold bull market is one in which: (1) the Fed embarks on an aggresive campaign to raise interest rates to protect the dollar, thereby throwing millions more homeowners out on the street than are headed out on the street already; and (2) the politicians in Washington embark on an aggressive campaign to cut federal spending on defense, Social Security, Medicare, etc. enough to generate huge annual budget surpluses for at least the next generation. Each speculator or investor will have to make up their own mind as to whether or not they see the above scenario coming to fruition anytime soon.

Monday, November 12, 2007

Soaring Asian Currencies

Previous posts discussed in detail the ongoing appreciation of the yuan and described how to take advantage of it for financial gain. Hopefully you took some action, because last week the yuan had its largest weekly gain since it was allowed to float in a limited range against a basket of currencies in 2005. Not to be outdone, the Japanese yen also broke up and out of a trading range and cracked the 110 yen to the dollar level, as increased risk aversion among investors caused an unwinding of yen carry trades. Once we finish our ongoing series on how to play the bull market in gold, we will discuss why the yen should appreciate in value over the next few years, as well as the best ways to profit from that opportunity.

Today's topic is how to trade gold futures contracts. We have already discussed how to buy physical gold, gold-related Exchange Traded Funds (ETF's), and stock options on ETF's. The next level up the risk/reward ladder is gold futures contracts and options on those contracts. In a previous post on how to trade yuan futures, we discussed what a futures contract is in detail, and why yuan futures are still not robust enough to provide a good trading vehicle to play the ongoing appreciation in the yuan. Gold, on the other hand, has a variety of futures contracts that have high daily trading volumes, as well as options on those contracts.

If you are not clear about what a futures contract is, dig back into the archives and re-read the October 30, 2007 post on Trading Yuan Futures before reading further. The main gold futures contract trades on the New York Commodity Exchange (COMEX), and is for 100 troy ounces of gold. It has an initial margin of $4,050 and a maintenance margin of $3,000, which means you would have to have an uncommitted $4,050 in your trading account to use as your "deposit" to purchase one full size gold futures contract, and would have to maintain $3,000 in your account until you closed out your position.

For most investors, that's a very high initial margin, and because the contract is so large, the big price swings that come with even very small changes in the price of gold may be too much for the small investor to be able to handle and also sleep well at night. Luckily, there is another option, the e-Mini gold contract that trades at the Chicago Board of Trade.

The e-Mini gold contract is for 33.2 troy ounces of gold, and has an initial margin of $770 and a maintenance margin of $570. So for an initial deposit of $770, you can control a contract worth more than $26,000 of gold. The e-Mini contracts generally have lots of volume in the "forward month" (the one closest to expiration) and very little in the other months, so to get a good fill price, you should always try to buy the forward month contract.

At the time of this writing, December is the forward month. The trading symbol for the gold e-Mini contract is XK, and the symbol for the month of December is always "Z" no matter what commodity you are trading, so the symbol for the forward month December 2007 gold e-Mini contract is XKZ07. Since the forward month has heavy trading volume, it is safe to use market orders to enter and exit your trade. If you trade online, you just have to enter the symbol and place a market order good for the day. If you trade through a human broker, you would just tell them you want to "buy one XKZ07 contract at the market good for the day."

As mentioned in the previous post about yuan futures, the advantage of directly trading futures contracts is that you maximize leverage, and the disadvantage is that because you are using so much leverage, even small changes in the price of the underlying commodity can cause big swings in the value of your position, and you will be held liable for losses that exceed your initial deposit. In the next post, we will discuss my personal favorite way to play the current gold bull market, options on gold futures contracts. With options, you still enjoy high leverage, but your risk is limited to your initial investment. You will never get a "margin call" asking you to put more money into your account to cover large swings in price that temporarily move against you.

If you haven't gotten onboard the gold bull market yet, it's not too late. As a matter of fact, there is an ongoing pullback in gold that will provide better entry points to establish or add to gold positions than you would have enjoyed as recently as last week.

Thursday, November 8, 2007

Options and Okinawa

Before we get into discussing options, I would like to publicly announce that my daughter and her partner came in second place in the mixed doubles competition of the season-ending Far East High School Tennis Tournament, and following the tournament she was named to the All Far East team. In the championship match against a team from Seoul American High School, she and her partner won the first set 6-2, but then unfortunately dropped the next two sets. Congratulations!

My daughter's championship match was very similar to the attempt by the world's central banks to hold down the price of gold earlier this week when it was approaching the psychologically important $800 mark. The central banks, in cahoots with large commercial speculators who hold large short positions in gold, were able to hold the gold price down below $800 for about a day, but ran out of ammunition on the second day and were completely overwhelmed as gold soared to close to a price of $850 per ounce within 48 hours of breaking past the wall of resistance at the $800 mark. Expect something similar to happen around $850 and $900 as well.

In the last post, we discussed ways to buy Exchange Traded Funds (ETF's) that would profit from the rise in gold. Today we will discuss how to juice up the returns from ETF's using the leverage of stock options. An option is just what it sounds like - it is a contract that gives you the "option" of purchasing 100 shares of the ETF or stock in question at a set price on a set date in the future. The set price is referred to as the "strike price," and the set date is referred to as the "expiration date." Options that are purchased to bet on a rise in the price of the stock are referred to as "call" options, and options that are purchased to bet on a fall in the price of a stock are referred to as "put" options.

For example, the best option to purchase if you believe that GDX, an ETF composed of a wide variety of unhedged gold mining companies, will be going up in value would be the January 2010 $60 strike price call option. That sounds complicated, but it is not hard to figure out if you translate it word by word. This option gives you the right to purchase 100 shares of GDX at a price of $60 per share on a set date in January 2010.

Let's say you purchase such an option, and a year later want to get out of the position. If GDX stock is trading for $60 per share on that date, you could "exercise" your option by purchasing 100 shares of GDX at $60 per share, and then turn right around and sell the stock back into the market at the current price of $60 per share. No speculator in their right mind would ever do that at that price because the purchase and sale would cancel each other out, and they would lose money due to the transaction costs (brokerage commissions) involved in executing those trades. For the same reasons, you would not want to exercise the option if GDX stock was trading below $60 per share, since you would lose money if you bought 100 shares at $60 each and then sold them at the lower current market price. That is why the majority of options expire worthless and are never exercised.

That brings us to the profitable case - when GDX shares are trading above the strike price of the option when you exercise it. For example, if GDX shares are trading at $70 per share, you can exercise your option and buy 100 shares at $60 each for a total cost to you of $6,000. You can then turn right around and immediately sell those shares in the open market for $70 per share (the current market price) for a total of $7,000, giving you a quick $1,000 profit.

So how does the potential profit from buying options compare to the potential profit from just buying regular shares in an ETF or stock? Let's look at an example.

If an investor purchased $10,000 of GDX shares at $50 per share in 2007 and then sold them when the price of GDX stock increased to $60 per share in 2008, he would make a profit of $2,000 (excluding transaction costs). But if the same investor instead purchased $10,000 of GDX call options when GDX was trading at $50 per share, and then sold or exercised them when the price of the common stock increased to $60 per share, he would have a profit of approximately $10,000 instead, a result five times better than just buying shares of the common stock. This is the power of leverage in action.

So what's the downside - why doesn't everybody just buy options instead of stocks?

There are two reasons. First, stocks do not have expiration dates. If a stock moves against you, you could hold it for literally years waiting for it to come back to your break even point. If you hold an option to its expiration date and it expires at or below its strike price, it expires worthless and you lose your entire purchase price. Most investors do not realize that there are two simple solutions to this dilemma - either sell the option to another investor in the market if its value falls to your mental stop loss position (that way you only lose as much of your investment as you decide prior to the trade you are willing to risk on that one position), or "roll" the option. Rolling over an option means that you sell an option that is about to expire while there is still some profit that can be extracted from it, and then immediately turn around and purchase an option at the same strike price that expires at a later date. In this manner, you never have to reach an expiration date unless you want to.

The second reason most investors purchase stocks instead of options is that they are unfamiliar with options and if they know about them at all consider them to be too exotic and risky for normal investors to trade. As discussed in the preceding paragraph, there are loss mitigation strategies that can make trading options no more risky than trading common stocks - and options have far more profit potential than shares of common stock.

In the last post, we talked about two ETF's to play the ongoing appreciation of the gold price - GLD and GDX. GLD unfortunately does not have any listed options, so you have to purchase common shares. But GDX does offer options, and as mentioned previously, if you'd like to dip your toe in the water and experience the superior profit potential that comes from trading options, your best bet is most likely the January 2010 $60 call option. This option has lots of time left on it until it expires, and I can think of no scenario in which the price of gold will not be significantly higher at sometime in the next two years.

If you have never traded options before, getting started is easy. Most brokers just ask you to fill out a form and mail it in to them and then they give you permission to trade options. Some online brokers will even allow you to apply online and save the cost of the envelope and stamp if you already have a brokerage account with them. Good luck!

Wednesday, November 7, 2007

The Demise of the Dollar

The last few posts have discussed the ongoing bull market in gold. That bull market picked up steam in a big way in the overnight markets in Asia, with gold rising from $824 to $845 dollars per ounce. My FOREX positions in gold and silver more than doubled again today. The cause of this tremendous rise in the precious metals was simple - the dollar fell off a cliff all last night, losing ground steadily with hardly a pause against all of the 16 major currencies, including the yen. This of course led buyers to rush to the precious metals, the traditional store of value during inflationary times.

The cause of the dollar's slide was simple: Taking their cue from supermodel Gisele Bundchen, China announced they would diversify out of their dollar holdings into "stronger currencies." Since China currently holds several trillion dollars of the US national debt, this is not good news for our country. Lenin once remarked that, "The last remaining capitalist will sell you the rope you need to hang him." This is precisely what our government has done with its profligate spending and reckless rush into unprecedented indebtedness - an indebtedness that is primarily owed to Japan and China. Sun Tzu said several thousand years ago that, "The best general wins without having to fire a shot." By selling China the rope they needed to hang us, there is no need for a geopolitical or military confrontation with us; they merely need to sell their enormous stash of dollars into the open market. They have now announced that they have begun that process, leading directly to today's drastic increase in the speed of our dollar's inevitable descent into worthlessness. Hence the huge rally that is continuing even now in the precious metals.

In yesterday's post we talked about how to buy physical gold. Today we will discuss the next most conservative way to invest in the gold bull market - Exchange Traded Funds (ETF's). An ETF is very similar to a mutual fund, except that it trades on a major stock exchange so that you can buy and sell shares of it through your broker, just like shares of common stock. To invest directly in gold itself, just buy shares of the ETF with the stock symbol GLD. The fund's managers place more gold in a vault in London every time people buy more shares of GLD, and the fund's value moves almost in lockstep with the movements of the spot price for gold. Since the gold is held in London, it should be safe from confiscation by President Clinton a few years from now, but there are a few conspiracy theorists on the Internet who have meticulously examined the fund's prospectus and who have their doubts. In general, though, this is a safe and easy way to share 1 for 1 in the rise in the gold price without having to deal with the inconveniences of holding and storing physical gold.

In past gold bull markets in history, there is a discernable pattern. First gold rises, then the shares of leading gold mining companies go up even more than gold, and finally, tiny junior explorer gold companies soar in value the most of all. We are at the point in this bull market when the leading gold companies are just starting to make their move to catch up with the increasing price of gold itself. To avoid single company risk, the best ETF to play the rise in the stock prices of gold companies has the stock symbol GDX. The companies in this ETF are unhedged, which means they benefit the most from a rise in the price of gold. Some gold companies are hedged, which means they have entered contracts in which they agreed to sell some of their future gold production at lower prices than gold is currently trading. Of course, you want to avoid investing in these companies. Therefore, GDX provides a way to make one stock trade that gives you shares in a large group of unhedged companies, including both leading companies and junior explorers. GDX will soar in value during the next phase of gold's bull run.

In tomorrow's post, we will discuss the riskier process of how to buy stock options on gold ETF's to get more leverage. If you are not comfortable trading options and desire to use the ETF method discussed here today, a good way to do so would be to purchase equal dollar amounts of both GLD and GDX.

Tuesday, November 6, 2007

The Golden Bull

I don't know what it is about my posts lately, but the day after I posted recently that the Chinese yuan would be increasing in value, it made it's largest gain since it was allowed to float a small amount against a basket of currencies. Then in yesterday's post, I made the case for the coming bull market in gold. Sure enough, gold then shot up today to $824 per ounce as of the time this post is being written.

It's also interesting that after writing a post a few days ago that was fairly critical of FOREX trading, my FOREX trading account (which is equally divided among gold, silver and Canadian dollar positions) was up by more than 125% just today. I quickly moved up all my stops since what 50:1 leverage gives, 50:1 leverage frequently takes right back!

So what is the best way to play the bull market in gold? I'll save my opinion on that subject for a future post. Today, as promised, we will start by taking a look at the most conservative way to invest in gold - buying physical gold. Then in future posts, we will discuss progressively riskier (and potentially more rewarding) methods of investing in gold.

The easiest way to buy physical gold is at a reputable coin shop or dealer. Some people like to purchase rare coins that are made of gold in an attempt to increase the return on their investment, but for most people it is better to just purchase one ounce national gold bullion coins, unless you are a coin collector or hobbyist who really knows what you are doing. The most popular such coins are the South African Krugerrand, Canadian Maple Leaf, American Gold Eagle, and Australian Nugget. These coins are very portable, easily hidden, and instantly recognized as a store of value worldwide. Of the three, the Krugerrand is your best bet because it has the lowest dealer markup for obscure reasons that date back to apartheid days. If there is no coin shop or dealer in your area, it is possible to order gold coins online as well, although if you choose to go that route, be sure to thoroughly check out any prospective sites before you send them any payment.

As mentioned in yesterday's post, for American citizens, you might want to go a different route in case President Clinton at some point takes away the right of American citizens to own gold again. If this possibility concerns you, I recommend a unique entity known as the Perth Mint, which is run by the Government of Western Australia. They run the only government-operated gold and silver bullion certificate program in the world. You can purchase any amount of gold that you desire through their website. You receive a certificate in the mail, and they store the gold in their vaults in one of the safest and most politically and economically stable countries in the world. For an extra annual fee, you can choose segregated, allocated storage under your name. Otherwise your gold and silver is stored together with everyone else's.

Tomorrow we will take a look at how to invest in a gold Exchange Traded Fund (ETF).

Monday, November 5, 2007

The New Gold Rush

Gold closed above $800 per ounce on Friday for the first time in more than 27 years. It's now just a short distance to gold's all time nominal high of $850 per ounce that was reached in January 1980. In inflation-adjusted terms, though, gold is still well below its all time high of more than $2,200, so it still has plenty of room to run - and run it will.

The conditions that led to gold's last monster run were stagflation and a plunging dollar, coupled with all-time high oil prices due to a tense standoff between America and Iran. Sound familiar? I was in high school then, and I remember very clearly that at the peak of gold's run there were stores in every shopping mall selling gold coins, television commercials extolling the merits of investing in precious metals, and investing in gold was a popular conversation topic at parties, much as Internet stocks were in 1999. My father told me recently that he bought some one ounce South African Krugerrand coins in 1979 that are just now becoming worth more than what he paid for them again. Until we see this type of activity again, it will still be safe to buy more gold.

Gold is traditionally bought as a hedge against inflation. When governments print excessive amounts of paper money, each existing dollar becomes worth less than it was the day before the new paper money was printed and added to the money supply. Governments worldwide are currently printing new batches of paper money like it's going out of style in a desperate but futile attempt to bail out the big banks which are sitting on large piles of now worthless securities that were backed by pools of subprime mortgage loans that are being foreclosed on right and left as Adjustable Rate Mortgages reset beyond the ability of cash-strapped homeowners to pay. Last Thursday alone, the Federal Reserve pumped an additional $41 billion new dollars into the world monetary system.

It's simple supply and demand - as the value of each dollar becomes less, the amount of stuff you can buy with it goes down. The result - rising prices of everything from bread to automobiles to gasoline to heating oil. Throughout human history, at such times people have turned to gold as a store of value to protect them against the drop in value of their rapidly becoming worthless paper money.

This is a worldwide phenomenon, but is particularly acute for the United States, since unlike in the late-1970s, we now have the largest accumulated debt of any kind in the history of the universe, more than $9 trillion and growing ever larger as you read this. There is no possible way the United States can ever pay this debt back in full. Just servicing the interest on this mountain of debt will cost American taxpayers more than $400 billion dollars in the next fiscal year.

There is only one way out of this mess - to deflate the value of the dollar so we can pay back the nations (primarily Japan and China) that lent us this money with dollars that are worth much less than the ones they originally lent us. This is the exact strategy that was used by the Weimar Republic in Germany in the 1930's. They could not afford to repay the excessive war reparations that were thrust upon them by England and France at the end of World War I, so they devalued their currency and paid the reparations back with worthless money. At the height of the ensuing hyperinflation, people were actually burning stacks of German money in their furnaces to keep warm because firewood was more valuable than the paper money - and everyone has heard the stories about needing a wheelbarrow full of money to buy a loaf of bread then.

So why hasn't this happened in America yet, when our national debt has been off the historical scale for quite some time now? The answer is simple. For the last 75 years or so, the other nations of the world have allowed the dollar to function as the world's reserve currency, and therefore helped to prop it up. Oil, gold, wheat, etc. are all priced in dollars. That is now changing. Many nations, including China and Kuwait, have dropped their currency pegs to the dollar. Iran will no longer accept dollars as payment for their oil. There are reports that at OPEC's next meeting they will vote to no longer price oil in dollars, but rather against a basket of other currencies. Most tellingly, there is this story.

History tells us what happens when a nation's currency ceases to act as a reserve currency. When the British pound was replaced by the dollar as the world's reserve currency, it lost more than 70% of its value. In this inflationary environment, gold will do what it has always done throughout human history in similar situations - soar in value. Fair warning, though - the governments of the world will do their best to hold gold down in a vain attempt to preserve the values of their paper currencies. They will lose, but they will put up a heck of a fight. Before this is all over, we will see gold moving up and down as much as a $100 per ounce in a single day. And don't be too surprised if President Clinton takes away the right of Americans to own gold around 2010 or so to protect the dollar, just like President Franklin Roosevelt did. So fasten your seat belts and climb onboard the gold train now!

The next few posts will detail the best ways to play the rise in gold, starting with the most conservative methods, and working up to the high risk-high reward strategies.

Wednesday, October 31, 2007

Riverboat Gambling

Two previous posts have discussed methods of investing or speculating in the ongoing appreciation of the Chinese yuan (or renminbi). The remaining method is foreign exchange trading, also referred to as FOREX or FX trading. FOREX is the Wild West of trading since it has high leverage, is lightly regulated, and mostly takes place "off exchange," which means that unlike when trading stocks, options, or futures contracts, there is normally no central clearinghouse to protect speculators. Since it is a lightly regulated area, numerous shady, fly-by-night FOREX trading web sites have separated gullible would-be investors from their money over the last few years, giving the FOREX market a slightly sleazy reputation in many quarters.

So why do people trade FOREX instead of futures? Three reasons: leverage, leverage and leverage. Trading FOREX is like playing a video game, can be highly addictive, and some sites offer up to 200:1 leverage. Even with the more common 50:1 or 20:1 leverage, you can still make or lose a lot of money very quickly. The FOREX markets are also open almost around the clock from Sunday evening through Friday, since FOREX is also traded in Tokyo and London, meaning that the "sun never sets " on FOREX trading. And finally, trading currencies is the purest way to play macro trends, since there is no possibility of a company or commodity-specific problem suddenly adversely affecting you, as occasionally happens when trading stocks or futures.

When trading FOREX, you see a live streaming chart of the movements of one currency against another on your computer monitor. There are many different "currency pairs" to choose from, with the two most heavily traded being EUR-USD and USD-JPY (the Euro against the dollar, and the dollar against the yen, respectively). With just a few clicks of the mouse, you can go long or short depending on which way you believe the lead currency of the pair will move against the other.

There are no trading commissions at the vast majority of FOREX dealers, who make their money on the "bid-ask spread" instead. The "bid" is the price that someone who wants to buy a currency pair is willing to pay to get in, and the "ask" is the price that someone who wants to sell a currency pair is willing to pay to get out. The difference between those two prices is the "bid-ask spread." The FOREX dealer acts in a manner very similar to the "house" in a gambling casino, and makes money by buying from another speculator at the ask price, selling to you at the bid price, and pocketing the difference for themselves. This means that when shopping around for a good FOREX dealer, all other factors being equal, the dealer with the tightest spreads is the one to go with, as you will start out each trade a little closer to making a profit than you would with a dealer with larger spreads.

A unique aspect of FOREX trading is that since it involves trading one currency against another, each day interest is credited to the accounts of traders who are long a currency that has a higher interest rate than its pair currency, and deducted from the accounts of traders who are short a currency with a higher interest rate than its pair currency. This means that if you chose to go short the USD-TRY (dollar against Turkish lira) currency pair, you would gain 16% or more annual interest if the currencies remained stable against each other, since Turkey has much higher interest rates than in the United States, and conversely, you would have to pay 16% interest for the privilege of going long the USD-TRY currency pair. In fact, many traders trade a basket of currencies against the yen, which has the lowest interest rates in the industrial world, just to capture the interest payments. Of course, if the currencies start moving against each other more than expected, this "carry trade" system can quickly lead to losses due to the change in the exchange rates.

There are numerous web sites and books that offer various strategies for how to make money at FOREX trading. But be forewarned that the vast majority of FOREX traders lose money because they focus too much on trying to pick the next winning trade, and not enough on money management of their trading stake, and because they underestimate the powerful negative effects of the tremendous leverage they are using and fail to get out early enough when a trade starts moving against them.

The best site to learn about FOREX, which I highly recommend, is: It is designed as a comprehensive, easy to understand course for beginners who know nothing about FOREX, but also includes tips that would benefit even experienced FOREX traders. Also, beware of companies selling systems that promise automatic profits. If a company really had such a foolproof system for predicting FOREX movements, they wouldn't be selling it to you - they would be using it to make money for themselves.

The FOREX broker I use, which I also highly recommend, is Oanda, which is located at: They are a legitimate broker with over $43 million dollars in assets backing their firm, and two large Wall Street firms just bought an equity stake in their parent company, which offers additional stability. They also offer the tightest spreads of any FOREX broker, and are the only broker to offer the Turkish lira, Indian rupee, and Chinese yuan currency pairs. In addition to a very extensive list of currency pairs, they also allow you to trade gold and silver against the dollar. They are ideal for beginning traders because they allow very small initial size trading accounts, and there is no minimum trade size. My only criticisms are that their customer service is not the friendliest, and they don't offer trailing stop orders.

The obvious problem for Oanda in offering the USD-CNY (dollar against the yuan) currency pair is that everyone knows that the yuan is slowly but steadily gaining against the dollar and will continue to do so for quite some time. If 90% of the speculators chose to trade the yuan side of the currency pair, there wouldn't be anyone to take the other side of those trades. So Oanda has established a high negative interest rate for those going long the yuan against the dollar. The yuan is advancing so slowly now, that even with 50:1 leverage, the interest charged frequently equals or betters the gains experienced by the currency's appreciation. One solution to this problem is to establish an equal position in a high-yielding currency such as the Turkish lira. The interest gained for being short the USD-TRY currency pair would more than offset the interest charged for being short the USD-CNY pair. The problem with this approach is that you now no longer have a pure play on the yuan appreciation, which was the point of the exercise in the first place, and higher yielding currency pairs are notoriously volatile.

The best move if the FOREX approach to trading the yuan appeals to you is to open an FXGame account with Oanda. This allows you to "paper trade" a $100,000 simulated account and learn the ins and outs of the Oanda FXTrade platform at the same time. If you are satisfied with the results, then you can open an Oanda FXTrade account and start trading with real money. I would encourage anyone interested in this approach to dip their toe in the water now so you will be ready when the yuan begins appreciating at an accelerated rate.

Tuesday, October 30, 2007

Trading Yuan Futures

I had heard of the "power of the blogosphere," but hadn't experienced it first hand until now. In a post two days ago, I explained why the yuan was a "sure thing" to appreciate against the dollar for years to come, and introduced readers to the most conservative method to take advantage of that appreciation. Imagine how surprised I was yesterday to see that the yuan had just made its biggest ever advance against the dollar since China first abandoned its "dollar peg" in 2005.

For more details, you can read the entire story here:

I can only assume that my many readers rushed to buy the yuan yesterday after reading my post, causing this big rise in the yuan's value. Just kidding!

Two days ago we discussed the most conservative method to play the ongoing rise of the yuan - how to deposit money into a yuan account. Today we will discuss a more risky, but potentially much more profitable, method - buying yuan futures contracts. The above picture shows the trading pits of the Chicago Mercantile Exchange, the rough and tumble arena where the only yuan futures contracts in the world trade.

Futures contracts are exactly what they sound like - a contract to deliver a certain quantity of a specific commodity (in this case, Chinese yuan) at a set price at a specified contract expiration date in the future. You can go "long" or "short" a futures contract, depending on whether you think the yuan-dollar rate will go up or down in the period of time between when you buy a contract and when it expires or is sold to another investor, whichever comes first.

For example, if you had a futures brokerage account, you could go online or call your broker today and buy a futures contract that entitles you to receive 1,000,000 Chinese yuan on March 18, 2008. At the time of this writing, the market price for that contract is quoted at $137,860, which works out to an approximate exchange rate of 7.25 yuan per dollar. The actual exchange rate in the cash market (what you would get if you went to a bank in China and exchanged cash money) is 7.47 yuan per dollar today, so futures traders are currently betting that the yuan will rise in value by approximately 3% against the dollar between October 2007 and March 2008.

So far so good. Now comes the best part. A key difference between stocks and futures contracts is that you pay for the value of a stock in cash at the time you buy it and don't get paid back until you sell that stock at some point in the future. This would not be practical for futures contracts because most investors and speculators would not want to tie up $137,860 of their hard earned money on just one investment for five months. So futures markets like the Chicago Mercantile Exchange do not require investors to pay for a futures contract at the time they buy it. Instead they are only required to put down a good faith deposit called a margin payment at the time they buy the contract.

For the Chinese yuan contract, the required initial margin is $1,350 and the maintenance margin is $1,000. This means that a speculator must have $1,350 of uncommitted cash or interest-bearing Treasury bills in their account to control one yuan futures contract, and once they have purchased the contract, they have to maintain at least $1,000 in cash or interest-bearing Treasury bills in their account at all times until they sell the contract to someone else.

Think about that for a minute - in the futures market, you can control 1,000,000 Chinese yuan for the life of a contract by merely posting a $1,350 deposit, and if your deposit is in the form of Treasury bills, you're earning interest on your deposit while you wait for the contract to move in your favor! If you bought a contract at today's price of $137,860, and then held it for six months during which the yuan rose against the dollar by just 3%, you could sell it for $141,996. That's an increase in value of $4,136, which when compared to your initial deposit of $1,350 equates to a gain of 306% in six months on an investment that only actually went up by 3% in value!

So what's the catch - why isn't everyone doing this and becoming rich? There are two reasons, one applicable to all futures contracts, and another that is specific to the yuan contract. The first reason is that "leverage is a double-edged sword." If the dollar was to rise against the yuan by more than the $1,000 in maintenance margin in your account, you would receive a "margin call," and have to either liquidate the position at a loss or put enough extra money into your account to maintain the required $1,000 dollar maintenance margin. It's actually possible to lose more than your original investment this way. This not so friendly downside of futures trading is the origin of those stories about everyone's apocryphal uncle who "lost his shirt in soybeans."

The second reason is that the yuan contract has very low trading volumes, which makes it hard to get a buy or sell order filled at a price close to the actual market price. Bad fill prices on both ends of a transaction can greatly reduce the size of your profit on a given trade. The low volumes are due to the fact that the yuan contract is still very new and unfamiliar to long-time pit traders, and because the yuan's appreciation is still slow - steady but slow. Futures traders want contracts that make larger and quicker moves so they can take advantage of the huge leverage inherent to futures trading to make outsize profits.

Once the Chinese government makes the yuan fully convertible, however, all that will change. As the yuan starts making bigger and bigger leaps forward against the dollar, currency futures traders will come streaming into the market and create much larger daily trading volumes, which will enable traders to get better fill prices on their trades. Right now, as traders wait for those greater volume days to arrive, many speculators trade the Japanese yen instead as a far-from-perfect substitute for the yuan, due to the tremendous liquidity of the yen futures contracts. We will discuss investment opportunities in the yen in future posts.

The bottom line is that while most investors prefer to stay away from futures trading due to their concern about the high leverage involved and the potential to lose more than their initial investment, the yuan futures contract provides an almost unique opportunity to exploit the high leverage of futures with a much greater margin of safety due to the extreme rarity of the ultimate rise of its underlying commodity being a near certainty. I would open a futures account if I didn't already have one, and use this "calm before the storm" period to dip your toes into the water and get comfortable with the mechanics of futures trading so that you will be ready to hit the decks running when the yuan becomes fully convertible.

(I have found XpressTrade to be a great choice for a commodities brokerage for those interested in saving money on commissions by doing all their trading online. They have great customer service and very low commissions. They can be found at this link:

Monday, October 29, 2007

Joy in Beantown

As promised we will talk some more about the Chinese yuan, but first we must pause to honor a momentous occasion - the second World Series victory by the Red Sox in the last four years (that's two more than the New York Yankees in that time span, in case anyone was wondering).

Ever since elementary school, the Red Sox have contrived to regularly break my heart. While older and quite a bit more jaded now, I still have fond memories of Yaz, Rico Petrocelli, George "Boomer" Scott, Fred Lynn, Dewey Evans, Carlton Fisk, Luis Aparicio, who shares a birthday with me, and the rest of the rag tag Red Sox of the 1970s. The TV jingle that preceded Red Sox games on local TV in New England went like this back then:

Take your shoes off
Put your feet up
And you'll meet up...
with the Boston Red Sox
Boston-born and Boston-bred Sox
And be a Sox watcher!

As a true Red Sox fan, I automatically change the channel when Joe Morgan is commentating on a game, I refuse to think of the name Mookie as cute, I have not yet brought myself to be able to forgive Bill Buckner, and I have started to believe that perhaps our most hated Yankee nemesis of all was born Bucky F*****g Dent, since that is the only way I have heard him referred to since October 2, 1978.

Having lived in Chicago for a year, I have firsthand knowledge that during our long years in the wilderness together with Cubs fans, we were not like them in a very important way. Cubs fans deep down don't really want to win the World Series. They want to preserve their snakebit status as some twisted kind of badge of honor, like the ivy on the walls of Wrigley Field, or their tradition of throwing home run balls by opposing teams back onto the field.

Boston fans, on the other hand, have always really wanted to win the World Series, and that was why our pain was so much deeper and purer than that of Cubs fans. And unlike the Cubs, who seem to just have incredibly bad luck, our hurt has always run deeper because it was primarily self-inflicted. Boston "managers" sent Bill "Spaceman" Lee back out on the mound for the seventh inning of Game 7 of the 1975 Series after he had just been shelled in the sixth, left Mike Torrez on the mound in the seventh inning of the one game playoff to determine the American League East champion in 1978 after he had just given up two hits, sent Bruce Hurst back out for the seventh inning of Game 7 of the 1986 Series after he had barely pitched his way out of a bases loaded jam in the sixth, and most inexplicably, left Pedro Martinez on the mound in an almost identical situation in Game 7 of the 2003 ALCS against the Yankees.

The worst part of being a Red Sox fan was the fatalism that you developed. Watching a Red Sox Game 7 was like watching a train wreck. True story - on that fateful day in 2003 when Grady Little forgot that the reason that his job title was "manager" was because he was expected to "manage," I was watching the game on a TV set in my office while doing some work. A contractor was doing some kind of construction work in and around our office that day and he came in to announce that he was off to lunch. He glanced over at the TV and asked who was winning. I told him Boston was, but not for long, because it was the fifth inning. When he asked what I meant, I told him that Martinez would get tired in the sixth and pitch his way out of a jam. Then the village idiot Grady Little would send him back out to the mound for the seventh inning and allow him to blow it once again for Red Sox fans worldwide. He commented that was a pretty detailed prediction, and I told him it was not a prediction, it was exactly what would happen, using the same tone as the Waterboy's girlfriend talking to Lynn Swann. When Martinez came back out on the mound for the seventh inning, I beseeched Grady Little through the TV to re-think his non-decision. When he walked out to the mound later in the inning as Martinez was in the middle of being shelled mercilessly, and then left him in the game, I cursed Grady Little and all of his ancestors.

That is why today we must give praise to Terry Francona, who in both the 2004 and 2007 playoff runs managed his bullpen exquisitely, which made all the difference in the world. When Matsuzaka started crumbling in the fifth inning of Game 7 of the ALCS, I almost cried in gratitude as I saw Francona stride purposefully to the mound, a place he never ventures to tread without a good reason and a well thought out plan. When Okajima gave up two hits in a row in the eighth inning of today's Game 4, Francona again did not hesitate. We must also give praise to Theo Epstein, who used sabermetrics to assemble a roster of sound team players, and to John Henry, who opened the purse strings and gave Theo the monetary ammunition he needed. No Barry Bonds or A-Rod on this team!

I think what I enjoy most is that for the first time in more than 30 years of watching the Red Sox, I never doubted this year that they would somehow find a way to win either the ALCS or World Series, or for that matter any of the individual World Series games. Even in 2004, there was a vague feeling of foreboding and dread as you waited to see how the Sox would choose to choke once again on baseball's biggest stage. I hate to put it this way, but this year for the first time ever Red Sox Nation got to experience what it must have felt like to be a Yankees fan growing up. It's a pleasant feeling -and what makes it sweetest of all is that for the first time ever Yankees fans now know what it felt like to be a Red Sox fan for all of those years. They had better get used to that feeling, because the Wheel of Karma has turned.

Sunday, October 28, 2007

Converting Dollars to Yuan

There are very few sure things in the investment world. The ongoing appreciation of the Chinese yuan (or renminbi) against the dollar is one of them. The yuan is currently allowed to float in a carefully controlled range against a basket of foreign currencies, and this range is periodically increased by the Chinese government as they baby step their way toward eventual full convertability of their currency. Some observers believe that full convertability will happen sometime in 2008, possibly in conjunction with the Beijing Summer Olympic Games.

Long-time currency trader and investment advisor Jack Crooks said this about the yuan last month:

"Without a doubt, the Chinese yuan looks poised to appreciate most in the years to come.
China has been suppressing their currency for many years. They believe a weak currency is the key to driving and maintaining export growth. Export growth is critical for them as it creates jobs. And jobs are critical for the ruling elite in China because they are extremely concerned about the potential for social unrest.

But pressure is building for a change in China's currency policy. It will change, and when it does, this currency promises to soar. Eventually, the domestic consumer market will evolve in China, so Chinese will buy the cheap goods they create themselves (rather than importing them to the west).

When that happens, China will no longer have a need to suppress their currency, and the yuan should move dramatically higher to its true value.

Most economists believe the yuan is at least 40-60% undervalued against the dollar. I think it could be much more. Back in the late 80's, the Japanese yen and Japan were in a similar place as China now. Western nations forced the yen higher in value. And it soared around 80-90% in just a few years.

Plus, just in the past few days, China has threatened to use their estimated US$1.33 trillion in U.S. dollar reserves as a political weapon. They're threatening to dump their reserves and deal a deathblow to the U.S. dollar, to retaliate for any trade sanctions imposed by Congress. The fact that they're starting to use their reserves as a bargaining chip is just another bullish factor in favor of the yuan!"

I was living in Japan in the years immediately following the 1985 Plaza Accord, and vividly remember lines of people stretching around the block at banks changing as many dollars for yen as possible on a daily basis as the yen soared from around 240 yen per dollar to well below 200 yen per dollar in a very short period of time. In fits and starts it has continued appreciating since then to the current 114 yen per dollar. That trade was a sure thing since the yen appreciation had been publicly coordinated among several governments, and I did not make nearly as much money on it as I should have. I have been searching ever since then for the next "sure thing," and the coming full convertability of the yuan is it. I do not plan to let this one pass me by - and you shouldn't either.

In the next few posts, I will discuss several simple ways a normal investor or speculator with minimal capital can invest in this next sure thing, starting with the most conservative and moving to more highly leveraged strategies.

Today we will talk about the most conservative - converting dollars to yuan and depositing them in a savings account. Obviously, opening a bank account in China is the most direct way to accomplish this. But aside from the obvious expense involved in traveling there if you do not live and work there already, this is not a wise strategy for large amounts of cash since China is still run by a Communist government that could impose foreign exchange controls at any time. Also, China still makes it very difficult for foreigners to open yuan accounts. Even in Hong Kong, you have to show proof of residency to open a yuan account at a bank, and Bank of China branches located in countries around the world still do not offer yuan accounts to foreigners.

The simplest and easiest way to convert dollar savings accounts to yuan (and the only way as of this writing that I am aware of for non-Chinese investors) is to open an account with Everbank, an online bank that offers many different types of foreign currency accounts, as well as precious metals-based certificates of deposit. They are extremely well capitalized, and as safe as possible considering that it is an online bank. Yuan accounts require a minimum deposit of $10,000 and do not accrue interest. Accounts can be opened at the Everbank web site at:

Future postings will explore more leveraged ways to play the ongoing appreciation of the yuan. Warren Buffett once said that an investor only needed two or three really good investment ideas in a lifetime to achieve life-changing investment results. Famed international investor Jim Rogers (co-founder along with George Soros of the Quantum Fund) recently announced that he is moving to Shanghai and converting ALL of his dollar holdings to the yuan, yen, and Swiss franc, stating that he expected the yuan to triple or even quadruple over the coming decades. The appreciation of the yuan is definitely one of Buffet's "life-changing" ideas.