The market drop this week has not been kind but at least it gave us a unique opportunity to buy the precious metals on a dip.
Gold has fallen -$200 over the last week as the dollar spiked and the euro collapsed. Silver collapsed back to $28 and very close to the low for the year.
These metals are simply reacting to the debt crisis events overseas and the fluctuation in the currencies. There is only one way for these metals to move. They may be volatile while Europe sorts out the final resolution to its problem but the end result is clear.
The only way for Europe and the U.S. to escape their debt problems is by printing more money, a lot more money. Both groups need inflation to reduce the value of their currency and allow them to pay off the current debts with cheaper dollars and euros. It is the only way Europe is going to solve its problems other than a sovereign default. Those countries in trouble can't stimulate their economy to create taxes and pay down debt if every budget cycle contains more austerity measures. Austerity slows the economy, reduces taxes and forces more austerity. This is not going to work as a solution unless you have a couple decades to wait. In the short term the increased austerity will create either a recession or a depression or both.
In the U.S. we have the same problem. We have a mountain of debt so high it would reach to the moon if piled in a stack of dollars. We can't cut the budget enough to make any meaningful impact on the debt. We are not going to restructure so the only option is to continue to print money.
As Europe's austerity pushes it into a recession the U.S. multinational corporations will begin to suffer. Many get more than 50% of their earnings from overseas. If nothing is done the European mess will drag us under as well.
Bernanke is a student of the Great Depression. He is not going to let another recession/depression of any magnitude happen on his watch. He is not called helicopter Ben for no reason. In January I believe we will see the Fed launch QE3 in an effort to force mortgage rates even lower and re-inflate the housing sector.
Printing dollars will force the value of gold and silver higher. Since the ECB has no other choice than printing euros to keep Europe from imploding it will be a race to see which central bank can print the fastest. Basically the cheapest currency will win in the global trade war. A cheap currency makes your products more attractive on the global markets.
Europe is not going to sit around and watch the euro climb to 1.50 on the dollar and see their troubled exports dry up. Both central banks will race each other to the bottom.
This cheapening of the currencies is going to push the precious metals higher. Citigroup expects gold to move substantially higher. A Citi analyst said they would not be surprised to see a move in 2012 that was equivalent to the move in 1978 when gold rallied +50% from 1977 levels. A move of that intensity would see it trade in the $2300-$2400 range. "On a long term basis we can expect higher levels with a move towards $3400." I want some of whatever he is drinking.
Fortunately the Citi analyst is not the only one making those predictions. Goldman Sachs expects gold to hit $2500 over the next couple years. Bonds and treasuries are not going to return more than pocket change and stocks could be risky because of the earnings hit as a result of the growing global austerity. Gold and silver will return as safe haven investments.
I believe the dip in prices over the last week is somehow related to the European crisis. Banks have been told to raise another 115 billion euros in capital and they are selling assets as fast as possible. That includes loan portfolios, real estate, noncore businesses and more than likely their reserves of gold and silver. The rate of decline over the last week suggests it was not simple profit taking. There was a big seller in the market that triggered technical sell stops and created the market flush.
I am going to recommend a couple of long term plays for Friday. You can take them both or just execute one. These are long term because we have to get past this short term volatility surrounding the crisis.
Send Jim an email
Long Term Recommendations
GLD - Gold ETF (Short Put)
The gold ETF (GLD) crashed back to $152 on Friday after a -200 point decline in gold over the last week. The GLD was over $185 in September. Long term support if the 50-week moving average at $153. This average was broken back in 2008 but has not been touched since April of 2009. The 2008 recession was the force that broke that support on a temporary basis.
I am going to recommend shorting the Jan-2013 $160 Put. The premium is $22 and if we were put the GLD in 2013 our cost would be $138 and the rough equivalent of gold at $1,380. That is a long way from the Citi forecast of $2300-$2400.
The problem with shorting the put is that it limits our profit. However, making $22 on a security at $153 today is a pretty good profit. It would be the equivalent of buying the GLD today and selling it when it returned to $175 but the cost of entry on the play would be a lot higher.
If you want to be more aggressive you could use part of the proceeds from the put sale to buy a call but the long term premiums are so high I think you would be wasting your money.
Sell Short GLD Jan-2013 $160 Put, currently $23.40, NO STOP.
This is a long term hold and worst case we will hold the GLD in Jan 2013 so no stop.
New Aggressive Recommendations
SLV - Silver ETF (Combination Play)
Silver has been a much better performer than gold over the last couple years but gold gets all the glory. I believe that is going to change. Silver ownership by individuals is surging and at multi-decade highs. Older investors remember the hyper inflation of the late 1970s and they want to put something in their portfolio as a hedge against the inflation we know is coming.
Gold has rocketed out of sight as an investment for the common man. Even at today's $1550 price just owning one ounce of gold is more than most people can afford, much less a sizeable investment in the actual gold. Fortunately there are multiple ETFs for that purpose.
Silver is still affordable. Silver rocketed to nearly $50 earlier in 2011 before the commodity exchanges took it upon themselves to raise the margin rate five times over the course of several weeks. This took all the speculation out of silver and caused the price to collapse. After several months of consolidation it appeared poised to move higher but the euro games and the spike in the dollar knocked it back to $29.
This is a major buying opportunity. Silver production is lagging silver consumption. Over the next several years we could see an actual shortage of production and supply. Couple this with the demand for investment silver as an inflation hedge and we could see a major short squeeze.
I personally believe silver will trade over $50 in the next couple years. If inflation does pickup as expected it could be well over $50. I am going to recommend a long term short put using the Jan 2014 $40 strike, currently $15.25. While a $15 return on a $30 security would be a very nice return I am going to recommend we use a portion of the proceeds to buy a Jan 2014 $35 call for $4.90. If silver really does catch fire we have unlimited upside for two full years and basically a free play using the premium from the short put. If you really want to get aggressive you could buy two calls and still have change from the put sale.
Sell short SLV Jan 2014 $40 Put, currently $15.25, NO STOP
Buy SLV Jan 2014 $35 Call, currently $4.90, NO STOP
There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.
Here is the most common margin calculation for naked puts.
100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))
For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)
Prices Quoted in Newsletter
At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.
The prices quoted in the newsletter are the end of day prices in most cases.
When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.
For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time the readers are able to get a better fill than the opening print because of market maker bias at the open.
For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.
All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.