Carry Trade

For traders, carry trade can yield profits even if the prices do not move for a period of time, but rather stay the same.

This strategy can be achieved by borrowing/selling a financial instrument with a low yield and then using it to buy a financial instrument with a higher yield. This trade is popular in the medium and long-term positions in the FX market.

How does this work? Speculators buy high-interest-rate currencies and enhance their return by selling currencies with low interest rates. The rollover-interest will be posted to the trader’s account. The selection of the currencies and market conditions plays a vital role in the carry trade. Traders will be interested to buy a currency that has a relatively high interest rate and sell a currency that has a comparatively lover interest rate. Also, currency selection depends on the health of a particular economy, i.e., the pairing of a stronger currency and a weaker one. Commonly selected currency pairs for a carry trade include GBP/JPY, GBP/CHF, AUD/JPY, EUR/JPY, CAD/JPY, and USD/JPY.

Gold Carry Trade

It is a little known fact about the gold market, but gold can also be used in a carry trade strategy. How does it work? In short, traders borrow gold at the gold lease rate, which is usually very low, sell it and invest the proceeds in other assets at a higher rate (for example, at LIBOR or risk-free Treasuries). The profit from this strategy is the return on the purchased assets less the gold lease rate. In case of investing in U.S. dollars at LIBOR, the investors’ return amounts to the GOFO. The gold carry trade was very popular in the 1990s, as gold prices were decreasing. As long as the bear market lasts, the gold carry trade (and gold leasing) is profitable, because traders repay their leases with cheaper gold in the future. However, this strategy may be risky. First, the risk-free interest rates may decline. This is one reason why the carry trade was unwinding in the 2000s, when the U.S. interest rates plunged after 2001. Second, if the price of gold rises, the traders will have to go into the market and buy more expensive gold. In other words, a bull market in gold reduces the profitability of the gold carry trade. However, there is some positive feedback here, as the carry trade (it entails gold sales) could push the price of gold even lower, while unwinding the carry trade could drive the price of gold even higher.

We encourage you to learn more about gold – not only how it is affected by the carry trade, but also how to successfully use gold as an investment and how to profitably trade it. A great way to start is to sign up for our gold newsletter today. It's free and if you don't like it, you can easily unsubscribe.