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.