I've been a big fan of gold for a long time. And one of the ways I've built my gold position is through a spread bet with IG Index.
It's been a great way to glean profits during gold's bull run. But last week I had a revelation. Something that convinced me that now is a great time to buy IG itself.
And I have Ben Bernanke to thank for pointing the way.
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My double-whammy gold bet
You see as the Fed Chairman has been getting ready to flood the financial system with dollars again under quantitative easing (QE2), the greenback has been going into sharp decline in recent weeks.
And that is killing a lot of investors who own gold in dollars. Gold is going up as Ben runs the printing press. But the collapse in the dollar is wiping out some of their gains.
That's not a problem I have with my gold bet with IG. I benefit as the gold price climbs. But because my spread bet pays out in sterling rather than dollars, I'm protected from the collapse of the dollar.
And that got me thinking. How are IG giving me such a good deal? It looks too good to be true. And so I dug a bit deeper.
How a spreadbetter makes its money
It's not easy to find out exactly how a spread betting company makes its money. They don't want to give away their trade secrets. But I've been doing some digging around in their accounts. And after reading a few broker reports, I reckon I've got a pretty good handle on how theyoperate.
So here's how they make their profits. IG offers bets on everything from sports events to house prices and commodities. And it makes money on these bets by adding a small mark-up to the bid-offer spread available in the market. The bigger the volume of bets it handles, the bigger the profit.
Now here's the thing. IG doesn't actually have to place all those bets in the market. Let's take gold as an example. At any one time, some spreadbetters will be bullish on gold, others bearish. The upshot is that many positions balance out, so there's no need for IG to hedge everybet.
What they do is plug everything into a risk model and it'll tell them how much to hedge to control their risk. So let's say they've got £50m of long positions in gold, and £35m clients going short, then all they need to buy is £15m of gold in the market.
So basically, IG can choose whether to hedge its position. And in fact much of the time it doesn't have to. But, that doesn't stop them from picking up all those spreads from its clients along the way.
Meanwhile they hit betters for a host of other costs. If you go long on a future contract, you'll pay IG interest too. They also collect another commission when bets reach maturity and get rolled over.
And to top it all, IG earns interest on all the cash sitting on client accounts, as more often than not, it's not used to hedge positions.
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Making money whatever's happening
That's why IG Group has been profitable every single day during the last two years. Now bearing in mind they don't hedge every position and the market has been volatile, that's pretty impressive.
Even a well run bookie will expect to lose money some days. But not these guys. Whether markets go up, or down, they're winning.
And what a cash position - they're sitting on £678m. The banks obviously think they're a good bet. Lloyds and RBS have committed to lend them £160m should they need it. But of course they don't need the money. Typical -the banks are bending over backwards to lend to a business that doesn't need it!
Just click here to see how IG has been growing turnover and profits over the last five years.
I've been using IG for over ten years and I've generally been pretty happy. There are some things I wouldn't use them for, like punting on small stocks with large spreads. But for commodities, currencies and markets that aren't generally easy for private investors to get in on, I reckon they're great.
And now that I've had a good look at the company, it looks really good as an investment in itself, too. With a forecast yield of 4%, rising to 4.5% next year, I reckon IG makes a lot of sense.
The way they're pulling in money, I reckon it'll pay you to own this bookie's shares through the rocky months and years ahead.
My recommendation: BUY IG Group Holdings (LON:IGG)
IGG yearly performance since listed: 2005 (Apr) +44.58% | 2006 +67.44% | 2007 +39.41% | 2008 -36.73% | 2009 +48.21% | 2010 (to Nov 26th) +28.44%
This article was first published in the free investment email The Right side. Sign up to TheRightSide here.
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