Of all the commodities, few are more complex or difficult to diagnose fundamentally than gold. Perhaps because of its widespread appeal to investors of all classes, gold has an emotional appeal to it. It has been this way for centuries.
The problem is few investors or even professional traders have a clear understanding of what actually does move gold prices and thus are often willing to listen to what the self-proclaimed “gurus” and gold bugs have to say about gold prices “blasting off” as they have been telling us since 1982.
While we generally disregard apocalyptic scenarios as rubbish, gold is in the midst of an impressive uptrend and appears to have a number of bullish fundamentals in its corner as we work our way through the first quarter of 2007. And while we’re not about to make a projection on where gold prices might go, we do believe there are enough bullish factors supporting gold to make a substantial sell-off unlikely in the coming months. And that’s why gold put sales look so enticing at this point.
Gold is not so much an industrial or commercial metal as it is an economic instrument. While gold’s primary commercial use is in jewelry, the typical supply/demand balance that drives the price of most other commodities does not apply as much to gold. Longer term, gold prices are largely driven by macroeconomic factors including currency values, interest rates, inflation, strength or weakness in world economies and geopolitical events.
With the exception of a dramatic geopolitical event, these factors are broad and vague. They tend to help establish long-term trends in gold rather than short-term price spikes. Granted, an economic report can push gold prices one way or the other in the course of a day or two, but to move more than that requires a blend of congruent economic data. This makes gold much more vulnerable to technical trading in the short term.
While there is a plethora of factors that affect gold prices over the long term, there are three key fundamentals that are driving, and will continue to drive, the current uptrend:
The falling U.S. dollar. The United States is still the world’s largest economy, which means fluctuations in the U.S. dollar can have a major affect on the gold market. Despite some recent strength, the U.S. dollar is still very entrenched in a long-term downtrend that few expect to change anytime soon. Massive trade deficits, record debt and a lingering fear foreign governments will soon stop financing that debt, by lightening up on investments in US Treasuries, has us agreeing with the likes of Warren Buffet and George Soros. We see the dollar decline continuing, which should be long-term supportive to gold. A lower valued dollar means it takes more dollars to buy an ounce of gold.
Substantial new investment interest in gold. While traditionally seen as a hedge against souring equity markets or political turmoil, gold has more recently become an investment in and of its own. Gold ETF’s have become a popular investment vehicle to the average investor and the growth of these vehicles should continue to offer firm support to gold prices. In addition, the continuing flow of capital into the commodities markets should be a major boon to gold. It is estimated that $25 billion in new capital will flow into commodity funds this year. As funds are almost always long the market, this influx should not only benefit gold directly, but indirectly as gold tends to key on other commodities, such as oil, for direction. World governments are also showing more interest in gold investments. China recently stated its intention to diversify its currency reserves, and a significant portion is expected to go into gold.
A stronger than projected U.S. and global economy. With the release of each new financial report, it is becoming ever more apparent that the United States has experienced a “soft landing” and may be back on the upswing. Despite lingering concerns over the housing market, most other major economic indicators such as the CPI and unemployment look encouraging. The Chinese economy never slowed down and in fact is expected to grow by another 14% in 2007. But strong economies mean inflation is always a threat and this big picture fundamental should not be overlooked in its single-handed ability to drive gold prices. In addition to inflation, strong economies typically mean increased demand for physical gold, which adds to the bullish psychology.
While we see these three factors driving gold steadily higher in 2007, there always exists the possibility of a global geopolitical event that could cause a sharp spike in gold prices. In times of trouble or uncertainty, investors will often flock to gold as a safe haven. However, a move of this magnitude would almost certainly be to the upside and we see very few factors that could cause gold prices to simply collapse in a rapid spiral downward.
It is for this reason that the strategy of put selling becomes so attractive. For while there are many factors that could drive gold prices higher, we cannot say with any certainty that they will do so. Nonetheless, with so many factors supporting gold prices at this time, we feel it’s unlikely the market will abruptly reverse trend and move substantially lower. In other words, we see potential on the upside with a somewhat limited downside. This is the optimal scenario for put selling.
With put selling, an investor selects a price level below the market that the market is unlikely to attain and sells a put option at that strike price. He collects a premium when he executes this trade. If the market falls below that strike price by expiration, the investor incurs a loss. However, if the market remains anywhere above that strike price at option expiration, the option expires worthless and the premium becomes the investor’s profit. Therefore, put selling allows an investor to take a neutral to bullish position in gold and be able to profit whether the market continues higher, moves sideways or even suffers a limited correction. It is an approach that currently has a high probability of success.
James Cordier and Michael Gross
Liberty Trading Group
401 East Jackson Street
Suite 2340
Tampa, FL 33602
(800) 346-1949
www.optionsellers.com
We will be looking for opportunities to position managed portfolios in the gold market in the next 10-14 days. If you would like more information on selling puts in gold or an option selling approach to your portfolio, feel free to call or visit us on the web at www.optionsellers.com .
Watch CNBC’s live interview with Liberty Trading’s James Cordier as James gives his outlook for 2007 gold prices, Feb. 22, 2007. Now available on our website at www.libertytradinggroup.com/news.html
James Cordier is head trader and president of Liberty Trading Group, a futures brokerage firm specializing in option writing on commodities. James’ market comments are published by several international financial publications and worldwide news services including The Wall Street Journal, Reuters World News and Bloomberg Television News. Michael Gross is an analyst with Liberty Trading Group. Cordier and Gross’ book, The Complete Guide to Option Selling (McGraw-Hill 2005) is available at bookstores and online retailers now.
***The information in this article has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.
