Gold: Solution to Stock Market Jitters?
A “fairly priced” gold market may be just the ticket for option sellers wary of equities
If you didn’t “Sell in May and go Away,” you’re likely still keeping a wary eye on equities prices and wondering if this is a good time to diversify some of your holdings into other asset classes.
While this may be a sensible course of action, you’ll want to avoid a common mistake made by many investors in the same boat: Looking for the next big thing.
For while the other guys busy themselves looking for the next Apple or trying to outmaneuver that next big currency swing, you can take solace (and hopefully a hearty reward) from instead focusing on the quiet and mundane.
You can focus on markets that have drifted out of the headlines.
You can focus on gold.
Gold: Not the Next Big Thing
Is gold the next big thing? Well, gold is always a topic of conversation and everybody likes to own a little. But buying and selling it on the open markets is another story. Gold is neither trending, nor is it seen at extreme value or “overpriced” levels. Instead, it seems to have settled into a fairly comfortable price range held in check by nearly balanced fundamentals that could keep it there for a while. It short, it’s fairly priced. Bulls and Bears have fought to a stalemate – for now.
That’s not a headline grabbing story. But there is plenty of money to be mined from fairly priced markets, if you know how.
But before you do that, you’ll want to understand the arguments for each of these camps. That will help you to better understand the market when these balancing factors start to shift again.
First off, Don’t be Influenced by Gold Bugs.
There will always be gold bulls. Some of today’s gold bulls are actually gold bugs. What is a gold bug?
I had a client many years ago, an elderly gentleman who had lived through the depression. He liked to buy gold. He liked to buy gold because he was a gold bug. He didn’t care what it was doing. If it was up, it was going higher. Time to buy. If it was down, it was “cheap.” Time to buy. I don’t even think he cared what it did after he bought it. He just wanted to own it.
“It will always have a value,” was the wisdom he gave to me.
Of course that is true. But the same can be said for any commodity.
We got on well, this man and I. I got started in this business decades ago through my interest in buying gold and silver and they will always hold a special interest for me. So we had something in common.
That doesn’t mean I’m always bullish on gold prices.
Gold bugs are nothing short of perpetual gold bulls. And that is not really a rational way to approach the market – at least not all the time. Gold bugs are often the reason why you can sell gold calls 2-3 times further out of the money than you can sell the puts.
Gold bulls buy gold based on a current and quantifiable reasons. They can always change their minds to be bears. Gold bugs are always bullish – rain or shine. They are a class of investor unique to the gold market.
Gold bugs aside, the gold bulls of today may have a solid argument.
The Bulls Say…
Nations around the world such as Germany, the United Kingdom, even China are borrowing a page from the Fed and lowering interest rates in an attempt to spur growth in their economies. Theoretically, this course of action makes their currencies weaker. Investors in countries with lower currencies are attracted to hard assets. And there is no harder asset than gold. Thus, global QE is supporting gold prices by spurring international demand for gold.
At the same time, the US Central bank is poised to take the opposite tack by raising rates. This will theoretically strengthen the US Dollar, which could pressure gold prices. But with the US economy actually contracting in Q1 2015 (by 0.7%), odds are the Fed will wait until at least September and maybe longer before making any move. This has given the bulls more backbone – at least for a few more months.
The Bears Say….
First, Gold is priced in US dollars. And despite Fed thumb twiddling and weaker US economic data in Q1, rates rising this year still seems likely. The US economy is still expected to grow by 2.6% this year*(*source: Kiplnger). That should be supportive to the US dollar, and thus bearish for gold.
No inflation. Gold is often used as a hedge against inflation. Thus, higher inflation, or fears of higher inflation can often be supportive of gold prices. But inflation in the US is all but non existent right now. If the economy keeps growing, inflation might inch up to 1% by December. That’s up from 0.8% in December of 2014. This is not supportive to gold prices.
The New Face of Gold
This is not your father’s gold market. In the days of yesteryear, a middle east bombing, a political crisis, or a currency war could all be counted on to bring about fireworks in gold.
These days, not so much. Consider that since the beginning of 2014, Europe has embarked on an unprecedented bout of QE done on a massive scale, the Swiss left the Euro, Saudi Arabia is bombing Yemen, Russia remains entrenched in Ukraine, ISIS runs amok through the Middle East and China flexes military muscle in disputed international waters.
Where has gold moved during this time? It’s moved up a little and down a little. But on December 31, 2014, Gold traded at 1190 per ounce. At the time of this writing, gold is trading at 1190 per ounce.
What does this tell us? It tells us that gold is probably not overvalued or undervalued right now. In short, it is fairly priced.
You see, there was once a time when supply and demand for physical gold was a factor in determining its price. Analyst used to talk about things like jewelry demand and mining activity. There was also a recent time where gold was more sensitive to geopolitical events.
Both of these things are out the window now. The nature of gold has actually changed. While it remains a physical commodity, it now behaves as a currency. And that currency’s fate is pegged to that of the US dollar and the direction of the US economy.
That being said, gold now finds itself in a near perfect storm of balanced factors: Aggressive international quantitative easing and questions about the US economy supporting prices from underneath and expectations of Fed tightening later this year keeping a lid on upside breakouts.
For gold to rally $100 from it’s current price, the US economy would likely have to take flight on it’s own. Yet for the metal to fall another $100 per ounce, the global economy might have to soar, leaving the US behind. Neither is a likely scenario given the unprecedented interdependence of US and international economies in 2015.
With a move of $100 per ounce unlikely (in our opinion) over the next several months, an option strangle with a profit zone $450 wide would seem to be high probability proposition. And yet because of gold bugs and gold bears, that is exactly what is available right now.
December 2015 Gold
A gold “strangle”- selling the 950 put option and the 1400 call option. If gold is anywhere between these two strikes at expiration, both options will expire worthless.
Premium writers can sell the December Gold 950 puts and 1400 calls (strangle) for a total premium of $1,000 per strangle. Some old time option sellers also refer to this strategy as a “bracket.” By using this approach, you are in essence, putting brackets around the gold market – one at 950, one at 1400. If the market fails to reach either strike by expiration, both expire worthless and you keep both premiums.
December options expire on November 24th. However, that doesn’t mean you have to wait that long. At the very least, it’s likely you’ll be able to close at least one side months prior to expiration.
Your target on selling premium should be taking profits within 60-120 days. Even with December options, gold’s offsetting fundamentals could make this scenario a likely one.
If you are a high net worth investor and would like to learn more about selling options with OptionSellers.com’s Private Client Group, be sure to request your complimentary Investor Discovery Kit at www.OptionSellers.com/Discovery.
James Cordier is the founder of OptionSellers.com, an investment firm specializing exclusively in writing commodities options since 1999. OptionSellers.com offers managed option selling portfolios starting at $250,000 minimum investment. James’ market comments are published by several international financial publications and news services including The Wall Street Journal, Reuters World News, Forbes, Bloomberg Television, Fox News and CNBC. Michael Gross is director of Research at OptionSellers.com. Mr. Cordier’s and Mr. Gross’ book, The Complete Guide to Option Selling 3rd Edition (McGraw-Hill 2014) is available at bookstores and online retailers now or at a special discount through the OptionSellers.com website. For more information visit www.OptionSellers.com/book
Price Chart Courtesy of CQG, Inc.
***The information in this article has been carefully compiled from sources believed to be reliable, but it’s 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.