 Not Your Grandfather's Commodities
Market
Kevin Kerr
The Daily
Reckoning
Mar 12, 2007
The Daily Reckoning PRESENTS: With the age of electronics, everything
changed - even the stodgy old commodities market. Kevin Kerr
explains how these innovations have changed - and advanced -
the world of trading. Read on...
Over the last decade the commodity
markets have changed to the point that to some they may be unrecognizable.
Since 1848, the open outcry and hand signal method of trading
on commodity exchange floors was the only way to go. Enter electronic
trading in the early 1990s, and soon the old auction method looked
as if it were about to die any minute. Add the Internet and easier
access to these markets by individuals, and it was bye-bye trading
floor, hello computer screen.
We all know that didn't happen,
and I personally believe it won't happen. But we can't deny that
the electronic era is here to stay.
Today's trading methods aren't
your grandfather's, and neither are today's markets. The markets
we see actively trading today may not be the only ones we will
see trading five years down the road. We may see alternative
energy commodities such as ethanol take off from their infancy.
We may see markets like corn and sugar explode because of ethanol
demand. We may see new contracts for such things as water. We've
seen commodity exchange seat prices jump, and we've seen the
world scramble for resources. The explosion in commodities and
natural resources over the last few years has been remarkable.
As a nearly 20-year veteran of these markets, I have never seen
anything like it- and it's showing little sign of slowing.
There are certain commodities
that are staples of trading and most all investors should know
these sectors and be very comfortable with them...one of them
being, of course, gold.
"All That Glitters"-
that's what the old COMEX marketing line was. Back when I started
trading, the COMEX was the top exchange in New York, the crème
de la crème. The badge was green in color, and it took
a lot of "green" to get one. At the time, a seat on
the COMEX also was the most expensive seat on the New York exchanges,
of which there were really four: the Coffee Sugar and Cocoa Exchange
(CSCE), the New York Mercantile Exchange (NYMEX), the New York
Cotton Exchange (NYCTN), and the Commodities Exchange (COMEX).
Chicago markets like the Chicago
Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME)
were viewed as being on an even higher plane, and most Chicago
traders considered the New York markets to be second-class citizens.
Now much of that has changed. But as I arrived on the scene,
a pivotal shift was happening: As the NYMEX began to grow in
stature, the COMEX became a bit more tarnished.
The Hunt brothers' silver debacle,
after their attempt to corner the world silver market in early
1980, drove many investors away from the metals, and some never
returned. Today, however, the metals have come full circle, and
silver, which for most of my career traded in the $5 to $7 range,
is now busting out to new highs almost monthly. For many years,
gold was simply a hedge against inflation, but not anymore; today,
the shiny yellow metal is being sought as a flight to a quality
instrument but also for its uses in jewelry on a large scale.
The new gold exchange-traded funds also have helped to drive
the price of gold higher, as these new instruments are backed
by physical gold.
E-gold is another phenomenon
that is not just fantasy anymore. Gone are the ideas of returning
to barter using gold nuggets. Today's modern commerce allows
the exchange of electronic gold credits between parties all around
the world. This virtually eliminates currency risk and opts for
one currency: gold!
The metals markets can be very
volatile, and one strategy for capitalizing on the long-term
rise in gold is to use options- specifically, long-dated gold
options that may seem very far out of the money. FYI: An option
is the right, but not the obligation, to buy or sell something
(called the underlying- in this case, gold futures contracts)
at a specific price, before the expiration date of the option.
A long-dated option is one that expires a long time into the
future. For example, as I write this, gold is trading in the
low $600s but had been over $700 an ounce. It's quite possible
gold could surge to $1,000 an ounce, and any traders worth their
badges would want to be in on it! So to play this right now (with
gold at $623), we would add the $950 call options.
They would be considered quite
far out of the money. There's one of those pesky trader terms
again. Let me clarify. In dealing with options, when you buy
an option and the current futures price is below your option's
price, it is called buying an out-of-the money option. When the
futures trade up to the price of your option, it is called an
at-the-money option, and when the futures price is above your
option's price, it is called an in-the-money option. As I was
saying, a $950 call option would be considered way out of the
money if gold was currently trading at $623, but all that could
change if gold rallies to new highs.
Meanwhile, by buying gold options,
my risk potential is limited to the premium (price) I pay; I
can't lose any more than I initially invested. It is one of the
safest ways to invest in gold.
On to silver...
For years the silver market
has languished in a narrow range with little momentum and not
much of a bright future. Unlike its golden counterpart, silver
has been more like the redheaded stepchild of precious metals.
Not anymore.
This often maligned metal is
up a whopping 60 percent since the beginning of 2005, and so
far 2006 is looking good, too. There are many ways to play silver,
just as there are for gold: silver bars, ingots, coins, jewelry,
certificates, stocks, futures, and options. All have advantages
and disadvantages, but the one we want to add to our portfolio
is silver options.
Silver closed at its highest
level in more than 22 years recently on hopeful expectations
that the Securities and Exchange Commission would soon approve
a silver-backed exchange-traded fund. This silver ETF is similar
to the gold futures-based funds, streetTracks Gold and IShares
Comex Gold Trust. According to reports, investors hold more than
14 million ounces of gold in the ETFs- that's significant because
it's equivalent to about a fourth of last year's worldwide supplies.
In 2006, silver had an incredible
performance in my portfolios and those of my readers. The launch
of the silver ETF drove silver prices up several cents, and seemingly
out-of-the-money options were tripling and quadrupling in price.
In less than a two-month period, our positions were returning
unheard-of 400 percent profits and went even beyond that.
Regards,
Kevin Kerr
for The Daily Reckoning
Editor's Note: Kevin Kerr is
the editor of two highly successful and acclaimed financial advisory
newsletters, Resource Trader Alert and Outstanding Investments.
A veteran commodities trader, Kevin uses his irreplaceable experience
to advise his readers on a variety of commodities investments
on a daily basis. Widely considered one of the nation's top commodities
gurus, Kevin's expert opinions are routinely featured in the
country's premier media outlets.
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The above was taken from Kevin's
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