“What’s the difference between Vegas and D.C.?
At least in Vegas, the drunks gamble with their own money!”
Regardless of your politics, as an investor, you have to acknowledge that with both parties spending our money like drunken sailors, the prospects for higher inflation are only a matter of when, not if, they show up in the economic data.
And no matter what the government tells you about the Consumer Price Index (CPI) or similar gauges only going up 4% a year or less, you know that any trip to the gas pump or the grocery store tells you that prices keep steadily inching up.
So, what’s an investor to do?
There’s one way to create a hedge against a higher cost of living, and that’s to consider gold as an inflation beneficiary. I’m not talking about gold stocks but, rather, a more-direct play on the price of gold itself.
For stock-market investors, rather than buying gold coins and bullion — which is not as easy to move in and out of quickly ‚Äì I‚Äôll focus on the SPDR Gold Trust (GLD), an Exchange-Traded Fund (ETF) that trades at approximately one-tenth the price of the current price per troy ounce of gold itself.
The reason not to focus on gold stocks, which are supposed to be a more-leveraged play on the swings in the price of gold is because they are STOCKS!
When money managers started to liquidate their stock holdings last fall, gold stocks fell in tandem with the overall market, with the gold-stock-oriented Market Vectors Gold ETF (GDX) down nearly 30% from September through November 2008 compared to a drop of just under 3% for the GLD.
For the full year of 2008, GLD was actually up around 5% while the major stock market averages dropped more than 30%. The only time GLD lagged in recent memory was during the sharp stock snapback off the March lows and through the April bounce. But in May, GLD regained its leadership. This is just a sign of investors preparing for the coming inflation wave, and you need to know how to cover it, too.
ETF Options: Is Way to Trade Gold Without Paying Large
Instead of buying GLD outright — which, at Friday‚Äôs mid day price of $970, would tie up $9,700 (all examples before commission costs) on each 100 shares — you could instead consider a call option purchase, with one contract controlling the same 100 shares up until a certain (expiration) date.
At the May 28 close, the GLD Jan 88 Calls (which would give you the right to buy GLD up to the third Friday in January 2010 at a fixed “strike price” of $88 per share) were trading at $12.50, or $1,250 to control that same 100-share position in GLD for roughly the next half-year. This means that if you expect GLD can rally above $100 in the next six months, this could be a profitable position. Especially if GLD mounts a 20% rally up to $115 or more, these options would gain over 100%.
This is not necessarily the most-aggressive way to play a GLD move, but it shows you how trading ETF options can meaningfully leverage your investment.
Meanwhile, if your view is way off and GLD drops by a large amount, the ETF option buyer is only on the hook for the amount invested, and no more. With the damage stock investors felt last year, the “stock substitute” strategy of using call options — with the rest of your core portfolio in low-yielding cash alternatives — could turn out to be a far better play even if you didn’t manage your call position and happened to let it expire.
The technical chart of GLD shows how powerfully this ETF can move when it starts to break out. Looking at the weekly chart back to mid-2007, GLD really started to surge when it not only cleared the technical resistance area around $69-$70, but also when it gave an Acceleration Bands buy signal Sept. 29, 2007.
Acceleration Bands serve as a trading envelope that factor in a stock’s typical volatility; they are plotted around a simple moving average as the midpoint, and the upper and lower bands are of equal distance from this midpoint. You can see usually an ETF will trade in between these bands, but when it breaks out for two-straight weeks, a serious acceleration can begin.
Weekly Chart of GLD with 20-Week Acceleration Bands
Right now, the resistance line is clearly drawn in the $99-$100 zone, but I think it’s only a matter of time before the next big surge for gold. Keep GLD on your radar — especially if the stock market endures another summer or fall correction