A review of Trade Opportunities in Gold/Silver and Copper (calendar) spreads – Where Are They Now? In the June/July issue of AHA we provided a detailed look at an investment or trading strategy called spread trading. Here we challenged the traditional strategy of “buy and hold” with a more sophisticated approach whereby no cash purchase of either metal is actually made nor did we need to have an outright view of whether either metal was going up or down in value. Review of the long Gold / short Silver trade for May 2011: In all cases, spread trading attempts to capture the price difference between two contracts whereby one will outpace the other. As a spread trader we might have the view or speculate that when gold and silver reach a ratio of around 32:1 the spread price is too narrow (historically) and that we anticipate it should widen out to say 38:1. We look to sell silver the “expensive” commodity (as it relates to gold) and buy gold the “cheap” commodity (as it relates to silver). To benefit financially a trader can buy gold and sell silver in equal dollar amounts, so long as the price/ratio widens out. Let’s take a close look at the spread history of long gold and short silver during early May through to the end of June. This spread has been profitable 87% of the time over the last 15 years, when you enter on May 8th and exit the trade on June 30th. At the time of this report (early April) gold was $1500/oz and silver was $45/oz (33:1). If you are interested in a rare trading opportunity that features capital preservation, low costs, and prudent risk management using spreads, then consider these approaches. Two strategies for the Gold/Silver spread: Scenario #1 - OTC trade using spot metals - 33:1 ratio Our example is based on Gold at $1500/Silver at $45 ounce. - Customized to your risk appetite - Margin account let’s you choose the dollar amount - E.G. $30,000 to each leg (long gold/short silver) - 20 ounces of gold/660 ounces of silver - Holding cost is around $5.00/day (not including commissions) - Requires less than $5,000 - 5 weeks later spread moves out to 37:1 - Gold is now $1400/oz; Silver is $38/oz - We lose $2,000 on the Gold and profit $4700 in Silver Approximate profit is $2700 USD

Scenario #2 – Futures contracts at COMEX (Commodity Metals Exchange in New York) Our example is based on Gold at $1500/Silver at $45 ounce. - Long 3 100/oz AUG Gold/short 2 5,000/oz SEP Silver - Spread margin is excess of $17,000 - No holding charges - 5 weeks later spread moves out to 37:1 - Gold is now $1400/oz; Silver is $38/oz - We lose $30,000 on the Gold and profit $70,000 in Silver Approximate profit is $40,000 USD We look to sell silver the “expensive” commodity (as it relates to gold) and buy gold the “cheap” commodity (as it relates to silver). Timing Your Trade Seasonality suggests that a change in direction (gold/silver) to the upside (widens) occurs in late April or early May. The chart below represents the last 15 years for the gold/silver spread. The monthly spread charts below tells us that the price of silver has outpaced the price of gold regardless of the outright direction of either metal during this time frame. We have seen that history itself offers an edge (with seasonal statistics) and can by itself be the sole basis for your trading decision as long as you determine your risk before you take on the trade. You will need to establish your plan of action before undertaking this spread. You’ll need to have your profit and your loss levels determined before you apply either (spot or futures) trading approach. You will need to determine your risk to reward so that you remain within your comfort zone. The monthly chart below ranges from 1995 till April 2011. Close examination will show the seasonal tendencies for this spread to widen during the suggested time frame of early May through the end of June. The seasonal strategy calendar indicates that silver drops in value during mid-May through to mid-June around 64% of time over the last 15 years. Perhaps this is further indication that silver might outpace gold. The example here (4 point variation 33:1 to 37:1) shows that even a small change in the ratio can produce significant profits or losses, so it is advisable to proceed with a plan that is well within your comfort zone based on affordable risk and emotional fortitude.

Where Are They Now? This spread has moved out to 56:1 since this spread trade opportunity was first presented in the June/July issue of AHA. Even with a minimum of $30,000 applied to each leg (long/short) as is the example for scenario #2, the profits would be over $16,000 for a $5,000 margined account. I’ll let your imagination and math skills calculate what the profits might be for using the minimum contracts of 2 silver / 3 gold contracts for a futures position – astronomical! Again there was no view taken on being bullish or bearish either metal.

Review of calendar spread trade for Copper 2011: Similar to but not as complicated as the Gold/Silver strategy is a calendar spread in Copper. This is where we seek a (spread) trading opportunity to profit from the price discrepancy or variation between the different expiry/delivery months in the same metal (copper). And just like our Gold/Silver we look to history and copper’s own seasonality for a trading edge, so we can develop a trading plan. We are neither bullish nor bearish copper, rather we take the view that the spread price relationship will either widen or narrow between the two months. To benefit financially a trader can sell one month (September) in copper futures and buy a different month (December) and create an entirely new trading entity called an intracommodity or calendar spread. Since they are identical contracts (same contract value) but have different expiry dates we have a simplified the trade and allowed for advantages unique to calendar spreads, namely reduced volatility and margins. Simple Strategy in Review Over the last 15 years around late May or very early June is when the (spread) price of September copper begins to move higher or widen relative to the price of December copper regardless of the outright direction of copper. The time to exit this trade is in the third week of August. This has been profitable 100% of the time in the last 15 years simply by entering at a specific date and exiting by a specific date. The period for the entire trade was less than 10 weeks. So, the strategy was to be short September and long December copper futures at the COMEX (Commodity Metals Exchange in New York). This trade was characterized by low margin which was $304 USD with low volatility as illustrated by the weekly chart below:

Where Are They Now? This spread proceeded lower and widened out to lower levels i.e. -235 before closing out the position in early August. A small 6 lot position which required $1900 USD for margin, delivered a tidy profit of $675 USD. Since then, the follow-on calendar spread in copper has emerged (you guessed it) for being short December 11 and long March 12 copper using a seasonal entry and exit date. It has the same margin and has gone on to produce a similar return as illustrated by the chart below. Again there was no view taken on being bullish or bearish either metal.

Summary It is not the intention of this article to ‘fly our flag’ over the successes of these spreads but rather to raise awareness as to the various investment opportunities beyond the same old ‘buy and hold’ strategy which has left many investors holding non-performing investments and tying-up much needed capital. As well, it is still wise to diversify within any investment portfolio. Jay Richards is a licensed Trading Adviser specializing in spread trading. Aliom Financial Markets and Just Spreads offer an investment product called a Managed Discretionary Account (MDA) for spread trade opportunities. Visit www.justspreads.com.au or www.aliom.com.au to learn more.