On Monday, I mentioned the rise in commodity prices, and I also predicted a bit of a pullback. I said that this might be a good opportunity for investors to look into commodities.
And we sure have seen a bit of a drop today in gold, but as today’s guest editor Adam Lass will tell you, you might not want to close the door on this precious metal just yet.
Over the past few hours, the price of gold has taken a rather magnificent drubbing. As I sit to write to you, the “best investment of the past decade” is down some 3.24% on the year! Of course the year has barely begun, so perhaps announcements of the shiny stuff’s demise are a tad premature.
Let’s review the broad picture for a moment: All during the great tech boom, when companies with business plans scrawled on the back of napkins were king and every corporate lunch room had its own foosball table, gold could be bought for some 25 bucks an ounce. We’re basically talking pretty paperweights here. Bowling trophies.
Then came the first chapter in “the great unraveling,” when the public at large saw for the first time in a generation that it wasn’t “different this time,” history was not over, the naysayers did indeed “get it,” and stupid was indeed stupid.
(I was one of those naysayers back then, a semi-retired micro-cap exec hired by a Baltimore financial publisher specifically to examine the books of some of those “wunderkinds” who were building ladders to the moon. So to a certain extent, I felt quite vindicated when the whole ball of wax melted down. Still, it wasn’t a lot of fun telling folks about how their retirement “savings” were pretty toast.)
You Can’t “Invent” Value
This was the deal back then, and it’s pretty much still the deal today: “Invented” money just doesn’t work.
Back then they tried to get around a paucity of capital by printing their own money in the form of massively proliferating stock shares and screwy backdated stock option plans. The new form of the trick didn’t change a damn thing. In the end it was still too much specie chasing too few real goods. In other words, the classic recipe for massive inflation.
The cycle is by now quite familiar: prices went up, paychecks couldn’t keep up, folks got poor, and the market crashed. Problem is, no one on Wall Street or in Washington has figured out anything different to do since, so we have simply seen the same cycle repeat under fresh new names. So the next time around, it was real estate that drove the bubble, it was still an excess specie-driven bubble never the less.
But there was one important difference: Now most every wise guy in the biz knew exactly what was going on. This led to a critical reversal in one particular asset. For decades, the price of gold moved contrapuntally to stocks. When they went up, it went down, and when things were scary, folks sold stocks and sought out gold’s safe harbor.
But post the 2000 crash, the price of gold began to move in lockstep with stocks. The wise guys knew damn well how the con worked, so they bought and sold gold in tandem with their share purchases. The end result has been quite well heralded: By the time the dust settled come the end of the most recent boom, crash, boom cycle, the shiny stuff was trading for more than $1,400 an ounce, an amazing increase of some 5,390% over the course of a decade for an “asset” whose chief attribute is that it never changes.
Now it’s easy to forget that this run was not a straight line of any sort. Even during a trending run, the price of gold can hop, skip, dive and pop 5% or 10% as Wall Street attempts to correct its cash and leverage imbalances.
(Investing doesn’t have to be complicated. Sign up for Smart Investing Daily and let editors Jared Levy and Sara Nunnally simplify the stock market for you with their easy-to-understand investment articles.)
And when the second leg of the “great unraveling” in 2008 came upon us, when it looked like the entire financial system might collapse in upon itself, the wise guys sold enough of their hoard to drop the price of gold more than 34% an ounce over the course of some seven months.
In other words, this stuff is tradable, if you know how to find the key to its movements and the leverage to convert those intramural moves into viable plays. This is exactly what I set out to do just prior to the winter holidays. And to do it, I asked for a tad of help from this column’s regular contributor, your own Jared Levy.
Now you should know that I am primarily a chart guy, with a particular eye toward broad historical trends. But I saw what looked to my eye to be a rather sweet short-term opportunity brewing in the chart for the Market Vectors Gold Miners ETF (NYSE:GDX).
I bounced this chart off Jared, and here’s what he had to say:
“Looking at the GDX chart above, I have to say that I agree with you here. The current downdraft in gold and the GDX is providing us with a nice entry point into that bullish ascending channel you mapped out.
“In simple terms, a stock or index that is in a bullish trend needs to take breaks from time to time. Those breaks provide us with advantageous entry points.
“The gold miners tend to have an acceleration effect when it comes to the price of gold. They can move much faster and because of that, I wanted to select an option that gives us both value and allows us to participate in as much of that acceleration as possible, while keeping risk low.”
The Right Way to Play
Jared suggested that the readers of my WaveStrength PowerSignal column might benefit from GDX March 57 calls (GDX1119C57) for several reasons:
- “Time: Even though this may be a shorter-term play, it’s never a bad idea to have more time than you need in an option, there is nothing worse than having your option expire before your trade works out. Also remember that options decay the most in the last three weeks before they expire!
- “Delta: The delta of the March 57 call is about .68, which means this option will move about 68 cents for every dollar the GDX moves and give us the movement that we want to make profit.
- “Price: At a current price as I sit to write of $5.20, this call is less than 1/10 the price of the stock, but it has the potential to gain 13% if the GDX only moves up $1. (Please: when you are buying, don’t pay more than $5.30, or it screws up our ratios).”
“With that said, I want us to be prepared to sell the call option if the GDX moves back to around the $62 level. Why $62? While the chart shows the potential for a real home run perhaps as high as 100%, all that skittishness in the master OEX chart puts me into a real “see gains-take gains” frame of mind. At that GDX $62, we can expect to sell the option for about $6.30, yielding conservative traders a 21% return in the trade in a matter of days.”
Snatching 22% From the Dragon’s Mouth
In the end, the play worked out to a “T.” WSP readers were put out 12 days later when these calls reached $6.01 on Dec. 28 for automatic gains of 22%. Over the ensuing days, the exact drop we warned readers of came to pass, with the GDX ripping through its support line at the 50-day average.
Is gold done for? Will the $1,500 dollar-an-ounce mark turn out to be yet another ladder to the moon? Hard to say right now. That abrogation of support may very well indicate that we are in for one of gold’s steeper declines, but I strongly doubt that this is the end of the overall rise.
That won’t happen until those old Keynesian dogs on Washington and Wall Street learn some new tricks.
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