Buying Airlines as a Gold and Silver Hedge

I've written previously about using financial stocks as a hedge against the falling price of gold and silver equities. Gold and silver stocks are currently rising over an unstable global financial climate, rising inflation and a falling dollar. As the financial environment attempts to stabilize, we have seen the recovery of many bank stocks and the fall of most precious metal stocks.

While financial stocks are a great way to hedge a portfolio of gold and silver stocks, I believe I have found another sector that can be used as a more efficient hedge. When we look at creating hedges, I believe looking at volatility is very important. When your hedge moves up 8%, you want your gold and silver positions to move down by a similar amount and vice versa.

One of the primary factors behind the runaway inflation we are experiencing is the rise in oil prices. The inflationary effect of rising oil is positive for gold and silver investors, but negative for sectors like airlines where on average 1/3 of the cost of operating an airline is tied to the price of jet fuel. Oil has been on a tear recently, with some analysts expecting the price of oil to reach $200 by the end of the year. As speculation grows over the price of oil, airline stocks have come under pressure and have approached heavily oversold territory.

The airline sector is very cyclical and prone to high volatility. Airlines have been so oversold, that any good news that comes out can cause the entire sector to rally. In the event that oil continues to rise we should see major positive performance from gold and silver stocks. This may be especially true going into the fall which is the traditional  high season for physical gold and silver prices. I’ve posted in the past about the historical 10:1 oil to gold ratio and here is the chart again.

I believe oil may trade in the $150-$160 range by the end of 2008. This isn’t a far stretch since oil is now at $139 and another 10 percent move would put the price of oil in the $150-$160 range. The Fed again would have to boost the number of dollars in the economy in order to help people absorb the inflationary effect of rising oil prices. With everything in favor of a falling dollar and an inflationary environment, I would be surprised not to see gold over $1000 again and silver over $20. My own price target for gold is $1100 and silver at $19 by the end of 2008.

If the opposite trend were to occur and oil prices were to drop, easing inflation, I would expect airline stocks to experience a major rally due to the oversold conditions in the entire sector.

The performance of  AMR Corporation (AMR), better known as American Airlines, Inc., and Continental Airlines Inc.(CAL) accurately paints the picture.

American Airlines has dropped from a one year high of $29.32 to the current price of $7.13, a drop of 75.68%. Continental Airlines has dropped from a one year high of $38.79 to the current price of $13.87, a drop of 64.24%. In the short-term as you build a hedge using either financial stocks or airlines, there is likely additional room to drop. In the long-term the likelihood of a rally and making money from buying into today’s prices is higher than the probability of sustained lower prices. Looking at the historical charts for C, Citigroup Inc., UBS, UBS AG, AMR and CAL confirms this. The resulting rally out of all the recessions the U.S. has faced has resulted in higher prices.

Having patience is key to buying into a falling market. No one knows when we will reach a bottom, but picking and sticking with your entry prices is key to earning a long-term gain. Very few people can become wealthy overnight, so I always stress buying quality companies at a price you believe is fair. For me I have a chance to begin building a hedge using airlines at a 70% or greater discount on average for an entire sector.

I always keep a practical piece of advice from my parents in mind, “nothing goes up forever”. Having a hedge doesn’t mean you won’t make money, quite the contrary. Either your hedge or main portfolio investment will produce gains. In the stock market, nothing is a true loss until you sell. This is why picking quality companies with long-term sustainability is key to seeing an entire sector go through a fall and rise. No one can be right all the time, it’s more a game of who’s turn is it to be right. No matter what angle you look at it from, certain sectors are down 70% or more. The same oversold conditions that formed in 1999-2001 are forming again in different sectors in 2007-2009.

In today’s market I am reminded of a quote from kitco’s Doug Casey for successful investing, “be bold when everyone else is timid and timid when everyone else is bold”.

*Disclaimer: The author does not own a position in any of the stocks mentioned above.

Comments

[User 206834]

but will oil come down anywhere near $60/bbl again

[notsosmart]

what would cause oil to come down to $60 a barrel?

[User 78990]

It seems as a good personal expenriance with the author. I like this article and its hedge ideal by sector.

Lili

[rlac]

Are you crazy? The Airlines are so far in debt that the likelyhood of bankruptcy is very high. You could loose everything with this strategy. You're betting that OIL will top out before they file. That's a very high risk bet IMHO.

[willieb]

I think that 2 airlines are positioned well.. 1 airline will be out of business before fall 2008 (Frontier), Several others will file for protection, JetBlue, AirTran and possibly, AMR. Of course if we see 200.00 OIL, the government will probably have to step in and give the airlines the same tax breaks that they are still giving the OIL companies.

[guri]

good contrarian move

[secmaven]

Bottom fishing is usually non productive. Many of the airline bullheads will only come to the surface upside down.

[notsosmart]

who said if you want to be a millionaire start as a billionaire & invest in airlines?

[rawgreed]

$60 Oil would mean airlines would likely return to 2007 prices, the gain would be 300% or greater for the entire sector. If oil were to rise to $200 it would be extremely inflationary and bullish for gold and silver. Your precious metal investments would likely double or more. Long-term you are buying into a sector that is down on average 70%. In this sense you can afford to be wrong about one carrier, as long as the sector returns to historical norms at some point. History has shown that as we emerge from a recession the stock market and individual sectors will end up higher than previously set levels.

You are staring at an opportunity to buy travel infrastructure starting at .30 on the dollar.

A few years ago CAL was under $9 and shot to $40 in about a year, giving some investors a few hundred percent gains. The same was true for AMR and basically all airlines. This is the cyclical nature of the sector.

[IndependentE.G.]

What you see on surface is not what things really are under deep water. You are right in realising nothing last forever. What goes up has to go down! Same for gold and oil especially when you check the volume traded under the price jump. The volume is not there to indicate a demand. "The demand is not there." The OPEC spokesperson is saying that over and over when denying the need to raise production. George Soro and Warren Buffet are calling this oil price a "bubble", would that ring a bell? So the question is how long will this bubble last? It's easy to say nobody knows. But if it affects our economy, we need to take action to end it sooner. From the surface, we can see airlines use a lot of fuel. But we know it doesn't stop there. People pump gas into their cars everyday. So the auto industry. Actually, the whole transportation industry as whole. So why Mr. Buffet is betting on railroads? Because railroads use less oil or no oil-dependent energy. What about trucking companies, and shipping companies? They're hurt but not many got into headlines like the airlines. Cars made are getting smaller and with alternative energies. Airlines are merging and getting smaller. Is that the force behind the volatility? You bet! There's a deadline for the mergers to go through. Some has a shot, some don't. The new administration will have new procedures. The lame-duck's clock is ticking. Those merger-hopefuls don't want to pay a high price and don't really mind low share prices (and they all pay hedged fuel price anyway.) Those who cannot meet the deadline (six months at least) are making whatever they can to make it harder for their merging competitors but it seems that there're too many downward pressure since people who are leaving airlines general sell their shares which drives stocks down and many claim-holders cash in their shares plus shorters who are betting that the oil bubble will last longer. That's the danger for the shorters who are betting on bubble. Right now G8+3 is being held in St. Petersburg. Together the World's major nations/consumers will focus on OIL price issue and act together. Last time, it was Reagan's administration alone. This time: It's the WORLD acting together! Be aware: whoever is cooking the oil price.

[Strider]

In my way of thinking now is not the time to try and catch a falling knife. Stay sidelined and watch, if anything increase your gold/silver positions as they are investings ultimate hedge against chaos, which is only going to increase whether its oil surges or more war globally... Grab a seat before the music stops !

[Umm, yeah]

Clarification requested, please. And an observation.

It appears that you're gambling that either of your long positions (either in Gold/Silver or your Hedges) outgain your losses on the other side of the hedge?

I think there's significant risk if you were to buy your Airline hedge, and the commodities stay at the current levels (or even if they go up a smallish %). Also, as rlac points out, what happens to the valuation of the airline sector if airlines start to go bankrupt? Would the subsequent rise in price of your Gold/Silver holdings cancel that out? It doesn't "feel" right.

[User 206834]

is it a good time to buy a years worth of travel now or do you see ticket prices going any lower.