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: http://www.babypips.com/school/. 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: http://www.oanda.com/. 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.

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: http://www.bloomberg.com/apps/news?pid=20601087&sid=aJRdZS_2FxtM&refer=worldwide.

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:
http://www.xpresstrade.com/why_trade_here.php.)

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

Relax...relax...relax...

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.

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: https://www.everbank.com/.

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.

A Dark Destiny Draws Near

This blog will primarily comment on ways to profit from the coming transition to a new world financial system following the impending collapse of the post-Bretton Woods fiat currency regime. Over the next few years, being long precious metals and natural resources should pay off handsomely as the East slowly but inexorably supplants the West in world leadership and the dollar accordingly loses its status as the world's reserve currency. The blog will also touch on other subjects at the whim of the author. While the author does have more than 10 years of reasonably successful experience trading stocks, options, bonds, real estate, FX, futures, and options on futures, he is not a registered investment advisor and holds no securities licenses of any type, and none of his comments should be construed as investment advice. Readers acting on any of the information in this blog do so at their own risk.