We Called Gold’s Tumble… Here’s How to Play the Precious Metal’s Next Move

by Karim Rahemtulla, Options Expert
Tuesday, December 8, 2009: Issue #1153

Amid all the media hoopla and rampant running of the bulls, not many people saw the shock lurking around the corner.

So when it happened last Friday, many people got a nasty surprise.

I’m talking about the huge decline for gold, as traders shaved around $50 an ounce off the price – one of the biggest daily drops in recent memory.

Fortunately, I tipped you off about gold prices falling right here just two weeks ago.

I did so by simply looking at the options activity among gold stocks, noting that volatility had increased and the market was indicating a series of large moves for gold shares.

The question now is: Does this signal the end of the party for gold? Here’s what my latest analysis suggests…

Is Gold’s Run Over? Why $900 Is a Key Level

In short, I don’t believe that Friday’s big drop means it’s the end of gold’s run. Not at all.

However, it doesn’t mean that you should use the decline to load up on the metal either. While buying on dips is often a very good strategy, keep in mind that the gold market has shot straight up for months now, so a correction of some magnitude was inevitable – and still is to some extent.

Friday’s move was either a sharp, one-day reaction to the threat of higher interest rates (gold’s near-term nemesis), or merely profit-taking in a crowded, overheated market.

But regardless of the reason, gold still remains in a definite bull uptrend and the technicals suggest that it would have to slide below the mid $900 level for the upward trendline to be broken (over the short-term anyway).

So what do you do? Sell your gold shares and hope for a chance to buy back lower? Or hold on tight for the next rally?

Trying to Time the Market is a Fool’s Game… Do This Instead

Sensible investors know that hiccups like this happen all the time – especially in markets that launch straight upwards. There are always moments when prices correct.

That makes trying to time the market a very dangerous and unpredictable exercise.

There are two strategies that can help you combat such events – and profit:

• Sell covered call options against your gold share positions.
• Sell put options in order for you to buy gold shares at lower prices – and gain passive income, too.

And here’s the best part about both those strategies at the moment: The increased volatility in gold shares means you can collect a tidy amount in options premiums.

Last month, for example, I sold some puts on Yamana Gold (NYSE: AUY) for about $1.05 per contract. Last week, I bought them back for about $0.65 – not a bad haul. The worst case would have forced me to think about buying Yamana for $7.50 – not a bad option either.

And if you’re really worried that you’re overweight in gold shares, you could take put options and “marry” them to your gold shares…

How to “Get Married” and Reduce Your Risk

When you buy a “married put,” you buy put options equal to the shares that you own.

This means that even as the share price declines, your puts will increase. So while you’ll likely lose some money because of the premium that you pay for the option, you’ll also limit your downside risk.

Now, if you think gold shares will correct significantly (and they do react much more than the price of the metal itself), you could dump some of your shares outright and buy some LEAP options. These are long-term options that will keep you in the game, but take 80% to 90% of your capital off the table.

Of course, if you’re a long-term gold investor, rather than a more active trader, you need to do nothing. Gold will continue to react favorably to the massive worldwide stimulus efforts, which are forcing governments to print cash and erode currencies’ purchasing power. Each dollar/yen/pound/euro printed is like an extra flake of gold added to your holdings.

Good investing,

Karim Rahemtulla

P.S: Before I go, a quick word about guns. Not a political-style speech, but from an investment angle. Gold may be grabbing the bulk of the headlines at the moment, but gun manufacturers like Smith and Wesson (Nasdaq: SWHC) have fared well this year, as people stock up on their second favorite metal. For numerous reasons (some logical and some not), people have bought guns and ammunition in record numbers since the economic crisis began (and coincidentally, since the Democrats came to power, too).

But also coincidentally, SWHC’s share price slumped by 15% last Friday when the firm said that sales, while robust, wouldn’t notch the same growth as prior quarters. Interesting that the price of gold and one of America’s top gun manufacturers suffered the same fate on the same day.

3 Responses to “We Called Gold’s Tumble… Here’s How to Play the Precious Metal’s Next Move”

1. Alan Says:
   
   December 8th, 2009 at 3:10 pm

   900 would be the worst case for gold, overall i don’t think it can down that far, and once it up again, it’ll up to new high.

   Reply

2. Dawna Says:
   
   December 8th, 2009 at 3:11 pm

   Kudos – I remember reading your article and you got it right. Credit where credit is due. Do you have a subscription offering this strategy outside the gold market, but not options?

   Reply

3. Fritz Laistner Says:
   
   January 13th, 2010 at 7:22 am

   u r wrong

   Reply

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