Mini Futures and the appeal of physical Gold

Futures contracts aren’t as arcane or complicated as they seem, but you should keep a few things in mind before investing, says Jennifer Ropiak, vice president at NYSE Liffe US, NYSE Euronext’s US futures exchange.

Since 2008, Ropiak has managed business and product development for the exchange’s gold and silver futures and mini futures contracts. Prior to joining NYSE Liffe, Ropiak worked at a CTA and at a small hedge fund specializing in gold. She has over 20 years’ experience trading and marketing precious metals, including stints at Morgan Stanley, AIG and Dresdner Bank.

Recently, HAI Associate Editor Lara Crigger sat down with Ropiak to get her perspective on the mini futures market, including why silver mini futures have seen a bump in open interest, what new investors should consider before buying a mini futures contract, and whether proposed government regulations would send derivatives business overseas.

Crigger: Given gold’s trajectory over the past several months, how has volume or open interest changed in the gold mini futures market? Or, for that matter, the silver mini futures market?

Ropiak: We’re seeing a lot of active trader and retail trader flow. I think that is because the sharp rise in price has made the full-sized contracts less appealing to some traders. But people still want to have some exposure to precious metals prices, so they’re using our mini gold contract [which is 33.2 ounces], as opposed to the 100-ounce gold contract. Our mini gold contract volume is up 71 percent from this time last year, and our open interest is up 75 percent. Average daily volume in June is about 10,000 contracts.

We have also seen much more interest in mini silver: Our mini silver contract is 1000 ounces, versus a standard contract, which is 5,000 ounces. Mini silver has averaged a daily volume in 2010 of 3,200 contracts, which is up 25 percent from 2009.

Crigger: Are the increased inflows a direct result of gold’s price rise? Or are investors judging silver’s fundamentals separately from those of gold, and moving into the metal accordingly?

Ropiak: Many people view silver as “poor man’s gold,” and as a cheaper item, I think silver is benefiting from the interest in the precious metals complex in general.

But on the other hand, silver is an industrial metal, too. So at certain times, depending on economic sentiment and the fundamentals, silver prices can move on the back of either gold prices or copper prices.

Crigger: So six of column A, half a dozen of column B.

Ropiak: Exactly. If you feel the economy will recover strongly, you might want to be long in silver, because it’s an industrial metal. Also, silver prices are more volatile than gold prices, so if you think precious metals prices are going up, you might choose to buy silver, because you would expect it to have greater percentage gains than gold prices. But you might choose the reverse, and buy gold if you believe the economy’s still going to have difficult times ahead.

Crigger: Certainly what happens next is still up in the air, given the eurozone crisis overseas. How do you think inflows into both silver and gold futures will reflect this uncertainty over the next couple of months?

Ropiak: What we have read from many analysts is that people who hadGLD [the SPDR Gold Trust] in their portfolio since its launch five years ago definitely saw a diversification benefit. People looked into their portfolios and realized, “This works.”

So as more and more Americans learn about gold and silver’s portfolio diversification benefit, and the market looks for different ways to participate, I think that our mini gold and mini silver futures contracts will only benefit. A lot of analysts say that you should have 5 or 10 percent in precious metals in your portfolio, and of course, mini gold and mini silver futures are a great way to achieve that.

Crigger: But many investors are warned away from trading mini futures, either because they’re too difficult for novices, or because of liquidity or risk concerns. Should only sophisticated investors be dealing in these contracts?

Ropiak: Certainly brokers should have strict standards they’ll follow before they let a client open a futures account. And when someone starts to trade, they usually first start in equities, and then learn about options and futures.

It is important that the investor has a solid understanding of the power of leverage. For example, to take a position in mini gold futures, you only have to put up about 6 percent of the current value of the contract. The current value of the contract is about $40,000. The initial margin is $2,248. Then every day after that, you reap the full benefit or full consequence of the movement in prices. So if the price moves $2, depending on your position, you will have a positive or negative mark-to-market of 33.2 ounces, multiplied by $2, or $66.40. That leverage is something that a lot of active traders appreciate. With a mini futures contract you can get that exposure to gold, and the balance of the value of the contract — that 94 percent — you can put into an interest-bearing vehicle or another investment. Leverage is powerful, but you definitely do have to understand how it works.

Anotther advantage of these futures is that it’s possible to actually take physical delivery. If you’re long three mini gold contracts, you can stand for delivery and receive three Warehouse Depository Receipts. You can then swap these WDRs for a vault receipt, which allows you to remove the 100-ounce gold bar from the exchange-approved vault. The same is true for mini silver, but you need to have 5 WDRs to remove silver from an exchange-approved vault.

If you are long less than 3 mini gold (or 5 mini silver) futures and stand for delivery, you will receive WDRs that are backed by the real metal stored in exchange-approved vaults, but you won’t be able to remove the metal. There are other futures exchanges with precious metals mini futures, but their volume is negligible in comparison to ours. I think the reason that we [NYSE Liffe US] have the most volume and open interest is that our contracts are actually backed by physical metal.

Crigger: Certainly there’s been increased desire from precious metals investors to be able to take that physical delivery.

Ropiak: I think Americans are genuinely concerned about their future, and gold is considered by many as a store of value. But prior to the launch of GLD, if you were interested in owning precious metals in the US, outside of being a coin collector, it was almost un-American. But in Asia, India and Europe, it is common to be invested in gold and silver, and it has been the case for a long time. Silver for Indian dowries is a classic example, but globally, individual investors have been very comfortable with precious metals for a very long time. We as Americans are simply catching up.

Crigger: We’re behind the curve.

Ropiak: Indeed. If you look at some of the numbers of the physical trade of gold over the past couple of years you’d see that, ironically, while there’s been a rise in Western investments, the Chinese, Japanese and Indians have been selling some of their holdings into this rally. The East has been selling into this rally to the West.

Crigger: Of course, the World Gold Council said that China and India will remain the real heavyweights of gold demand for the foreseeable future. Rising demand in the States won’t really make a dent, not compared to the level the Chinese and Indians are buying at.

Ropiak: Well, there’s lots of levels that could contribute to the buy side. There’s the individual level, the institutional level and the level of the central banks. For a long time, the central banks were only concerned about the amount of dollars they had in their reserves. Now they’re concerned about the amount of euros they have in their reserves. So what can they do to diversify? One option over time is to buy gold.

Crigger: So do you have any plans at the NYSE Liffe to launch any other precious metals futures contracts? For example, we’ve seen a major rise in investor interest in the platinum group metals, especially since the launch of the platinum and palladium ETFs.

Ropiak: We are absolutely looking at that market. But the regulatory authorities — in this case, the CFTC — would want to be assured that the deliverable supply is plentiful enough. When you start contracts, the first thing that’s always asked is about the deliverable supply. So before anything happens, the CFTC would have to feel absolutely comfortable that there would not be a squeeze in the market.

Crigger: In a recent interview, Jim Rogers said when it comes to the new proposed regulations for the derivatives market, the US is “shooting itself in the foot,” and that we’re essentially just “giving business away” to the rest of the world. Do you agree? If the government imposes new regulations, will the market just shift overseas?

Ropiak: That’s the great dilemma, of course. In the precious metals ETF universe, GLD has all the volume. Why? People all over the world, whether they’re in Europe or Asia, use the United States’ ETF, because they like the regulatory framework that’s in place for securities.

But if there are going to be a lot of changes to the rules governing the futures and over-the-counter markets, there could be a risk of volume fleeing to more opaque markets. In other parts of the world, banks feel strongly about protecting their clients’ privacy, and they may not welcome the ability for an American regulatory body to inspect their books. Our role at NYSE Liffe US is to offer a transparent market. We look forward to our continued growth, as more volume looks to go on exchange.

Disclosure: No positions