Tom Szabo

Crude Oil and Gold: Not Worth Worrying Over

An alternate theory gaining a bit of credibility compared to "first a slight correction, then to da moon!" is that commodities, oil and gold will trade in a wide consolidation pattern during the next few years. There is no fundamental reason why oil couldn't be trading at $50 today just like there is no fundamental reason that it is trading at $80. Similarly, I think the idea that gold cannot trade for an extended period in a price range of perhaps $700-$1100, but instead must inevitably trade much higher in the short run, is a sign of groupthink. I have a large exposure to precious metals in the form of physical holdings and stocks so I would love for gold to explode in price but at the same time I believe it's important not to drink the market's Kool Aid.

Commodities: Brief Correction or Bursting Bubble?

There are quite a few small "commodity stocks" where the project economics are now underwater. If commodity prices slide far enough, the same thing could happen to some of the majors. Over time, the price of a given commodity (absent a monopoly like diamonds) will be slightly higher than the marginal cost of production. This is a reality that most current (sophisticated) investors recognize by awarding P/E ratios that are subpar to the market as a whole. If we do have confirmed peak production in a particular commodity, the paradigm may very well change but this is not something we will be able to confirm until several years of declining production in spite of higher prices. I agree that if and when the mom and pops buy up this sector, there could be other new paradigms to explain the overvaluations. Investing on that basis, however, is an application of the greater fools theory and not the way any billionaire got to be that way. Instead, if you have enough patience to wait for the type of absolute proof that is required to borrow every last penny you can to buy commodity stocks, you might be rewarded in the years ahead. And I don't think it will be too late if you just chill out now and wait for it. Remember the new paradigm: several years of rising commodity prices in spite of declining annual production. If it happens, that would be true alpha.

Gold (and Gartman) Haunting Some Investors

Brad, you don't need delta when AT THE MONEY. You receive one dollar of insurance for each dollar move against the underlying position. The cost of that insurance is the time value and it is directly related to volatility. We can ignore the greeks completely as they all disappear at expiration of the option, which is the time period we are seeking to insure. In other words, you wouldn't pay more in time premium than you would expect the underlying could move between now and expiration of the option.

I understand this wasn't the point of your article and I did read Hedging Gold's Volatility. I also understand how one could try to strip out alpha using such a method. But there are problems with the method as presented. I'll pick just three. First, you chose a "convenient" timeframe where DZZ was generating returns, not dragging on them. This made the return and risk-to-reward of the hedged portfolio artificially high compared to real world results. Second, I don't see where you took into account the fact that it took about $20,000 to acquire the hedge. In other words, $20,000 Hecla with a $20,000 DZZ hedge should be compared to $40,000 Hecla. I presume this would make the hedged returns when gold is climbing (which is most of the time in a bull market) even more pathetic. Third, you've created alpha but that doesn't mean it will always be positive. That's because you don't have ANY beta in the hedged portfolio at all. So, when beta is large and positive, you are going to have a large and negative alpha. And that would buy you exactly one calendar quarter as head of a hedge fund.

Options as a 'Gold'en Opportunity

Brad, I see total upside of 50% on this trade with a maximum downside of 33% (the time premium on the put and call option). There is virtually no leverage to higher gold prices unless gold stocks significantly outperform. The 50% gain would come around a gold price of $600 by end of December (how likely is that). I'd grade this trade a B-. For 1/3rd the cost (the amount at risk), you can strangle Dec. GLD with an 87 call and a 75 put. At $600 gold, that's a 200% profit and you have unlimited upside. What am I missing?

The Bedrock Case for the Return of the Gold Bull

There is no such thing as volume for the forex markets as a whole, that is why there is no volume on the USD chart.

As for gold being used as money, nobody is going to spend gold in a grocery store. Even when money was based on a gold standard, gold itself rarely ever changed hands in everyday transactions. It was used to store and transport wealth and in large transactions. Most of it was used to back gold certificates. And there was silver or other metal coins and also trade bills for everyday trade (but not all of these forms had to be accepted for payment of debt, one could demand gold). So when we say "gold is money" we don't literally mean it will replace the penny, nickel, dime, quarter, one dollar bill, ten dollar bill, etc. Instead we mean that gold serves as the most liquid, immutable and internationally recognized store of wealth and means of exchange. Gold's value soars in relation to other forms of money when wealth seeks absolute safety. Even the IMF, BIS and most central banks recognize these facts, so it is a bit surprising that some of the posters have doubts here.

The Disconnect Between Supply and Demand in Gold & Silver Markets

slugbait and others who can only bee-yatch here: why don't you start your own assay shop and mint? That's what a lot of people did in the 70's when there wasn't enough bullion around either! It's not very expensive to get going--a furnace, a 1000 oz. bar, some molds, a brand and you're in business. Stop bugging the people trying to mint more product and get crackin' on your own.

The Disconnect Between Supply and Demand in Gold & Silver Markets

Bron, I don't believe GoldMoney or Bullion Vault have liabilities against their gold (other than the customers' fractional share).

User244350 & James Conrad & others: SLV and GLD both publish bar lists including serial numbers and they are also audited annually by a Big 4 accounting firm. The bars are held in London metal warehouses (subcontractors) that have never had a major loss of silver or gold over the years including 2 world wars. Morgan Stanley did not admit the allegations against it were true. Here is what they said:

Defendants believe that the record demonstrates that they handled their customers’ precious metals accounts properly in all respects and that if the case were not settled, they would be entitled to summary judgment dismissing all claims. Defendants believe that the evidence shows that the documents provided by Defendants to Class members contained no misrepresentations regarding the purchase or storage of precious metals from and through MSDW. At no time did Defendants make any promises to purchase or store metals on an “allocated” basis, unless specifically requested for by the customer, nor to segregate metal on a customer-by-customer basis. Defendants also assert that MSDW purchased actual, physical metals for its retail customers and that no client sustained any economic injury whatsoever. <u>The undisputed evidence shows that all of the precious metals held on behalf of Defendants’ customers are present and accounted for, purchased pursuant to each and every customer order. Defendants also arranged for the storage of metals at secure, credit-worthy depositories. Defendants were also contractually entitled to charge their customers storage fees for the services they facilitated, pursuant to the CDS that customers signed. These fees were not inconsistent with the fees charged by other brokerage firms.</u> Defendants also assert that all members of the Class were beneficial owners of their precious metals and that the metals were not subject to lien by Morgan Stanley or its creditors.

www.gardencitygroup.co...

This Gold Correction Has Further To Run

I'd largely agree that large specs haven't reached a bearish extreme, but it's very possible most of those left are sitting on positions built last Sept-Oct in the $700 range. They may not go for a while, or perhaps not at all during the gold bottom. Thus, I'd say we might actually be closer to a bottom than your COT chart shows. A final spike down to around the $740-750 range with a recovery to around $775-780 during the same session would probably do it.

Gold (and Gartman) Haunting Some Investors

Yes, riskwise they are the same.

No, we don't need to examine the unknowns when buying an at-the-money put against a long position. We know everything we need to know: the premium and the term. We can divide the premum into the price of the underlying and annualize the term, and voila we have the annual cost of the put insurance expressed as a percentage of our position. That pretty much boils everything down to volatility.

Aha, now I get what you were trying to achieve! The fabled, non-existent (positive) alpha in gold stocks as a group! Too bad nobody has seen that in years, and even when it did exist, it always seems to "outperform" on the way down. In other words, gold stock volatility is skewed. Have you checked that for both GDX and DZZ?

If the goal is to seek alpha in gold stocks, you probably want to put together your own porfolio and not use GDX. Ideally, you would pick stocks that have a skew profile that is inverse to DZZ and obviously have good fundamental prospects.

Gold (and Gartman) Haunting Some Investors

Brad, my point was that DZZ neuters the upside, which is a real cost you must consider.

A call option is not the same as a long position combined with a put option. For one, the call option will generate capital gains if you sell for a gain or it expires in the money. Meanwhile, the long position hedged with a put remains tax free as long as you hold it. There are other very fundamental reasons why you cannot equate the two.

Even then, a call option is still better than your long GDX short DZZ strategy. As I already stated, the option will let you keep the entire upside while DZZ neuters it. The cost of capital is also much lower with the put; you fail to consider the time value of money tied up in GDX and DZZ. Worse, one really can't know how good a hedge DZZ is going to be up front, as you reminded us. This causes you to allocate too much to the short leg or else suffer losses related to poor correlation.

With an at-the-money option, you know precisely your loss up front--it is the option premium. In fact, buying a put to hedge a long position should be viewed as a tradeoff -- taking a known loss in exchange for an unknown one. You might know this by another term: insurance.

As for your suggestion we should do some math to figure out why the long GDX short DZZ are not perfectly correlated, that would be a waste of time. Everybody knows gold and gold stocks don't move in perfect unison. It has nothing to do with company management. But even if they were perfectly correlated, you couldn't exactly offset a loss since the correlation is not a flat line along every price point. The easiest way to see this is to realize that the long leg can go to infinity but the short leg can only go to zero. That means if you think GDX is going up 1000% in the next few months but might also go down 50%, then DZZ might be an okay tool (still not as good as a put option) since it could only go to zero which still gives you 900% overall gains. The reason is simple: an option gives you more leverage along the entire price curve. This works in inverse as well but to a much lesser extent. Thus the math is a bit more complicated than you imply: it is not linear math but rather logarithmic math (looking for my high school math textbook as I write this)

Gold (and Gartman) Haunting Some Investors

Hello! Hello? I don't hear anybody discussing PUT OPTIONS here! You know, they have them for both GDX and GLD (just introduced). An attempted offset like DZZ & GDX is not really an investment hedge, it's a waste of time. You want to keep exposure in at least one direction! In April, you could have bought Dec GDX put options at the money for about 5. That's an automatic loss of 10% but you would have no further downside exposure, would get to keep all the upside on GDX, and would still have the money left over from not having to buy DZZ. Of course, there hasn't been any upside so far but next time could be different.

Bob Moriarty: Gold is Safe Haven for Looming Crash

Given all the gold detractors that still appear to dispense their "can't eat Gold" wisdom in these forums, I'd say the bull market in the Midas metal has a ways to go. Well, guess what, you CAN eat gold (as many a Vietnamese or Cambodian refuge found out the hard way when they had to literally eat their entire wealth--I'm talking about gold jewelry--in order to hide it as they fled their countries in rickety boats launched into the ocean).

What's Wrong With Gold Stocks?

First, spiraling production costs are due to (1) higher energy, equipment and labor costs and (2) miners going after lower grades (even within "first tier" deposits) as justified by the higher gold price. The equipment and labor costs are high in part due to shortages caused by the unprecedented fast pace of new mining activity after a long period of industry contraction. The shortage issues will be resolved in due course. Gold (and silver) prices will continue to outperform inflation (in particular, the rise in energy, labor and equipment costs). This is a plus, not minus, for gold stocks.

Second, ETF demand has not deprived gold stocks of positive investment flow. ETF investors are not reformed gold stock investors fleeing from high risk behavior. Rather, the sheer number of gold stocks and the tremendous amount of financing raised to fund exploration and development have sucked up whatever cash investors have thrown at the sector. Add all the base metal and uranium exploration plays, and you are talking about a huge pile of money that has gone "poof". It takes a while to pay penance for these necessary sins.

Third, as another commenter has pointed out, gold stocks actually thrive in a climate of poor stock market conditions. They actually prefer a bear market in general equities but will get along well if there is just a malaise hanging over Wall Street. History provides plenty of evidence, such as 1929-1936, 1973-1981, 1987 and 1996-7.

So, what's really "wrong" with gold stocks? Nothing. They are just fine, reacting to the ebb and flow of the market and patiently waiting for the next opportunity to dash higher. The wait could be a few more months or even a year or two. But when they next move, it should be a beauty to behold.