Bruce Pile's  Instablog

Options are becoming more popular as a hedging tool against the next big turn of the market.  The next big turn of the market is, more and more these days, what you have to figure out because these big turns are dragging nearly everything along for the ride either up or down.  With options, you can limit the damage if the market turns hard the other way from your plan.  But options are expensive and take a big chunk out of your rate of return.  And they are priced per implied volatility and are thus priced per the VIX - the higher the VIX, the more expensive options become.  We are probably going to have to live with the VIX on the historical high side for awhile, so that makes using options to try to get good returns no matter what the market does a very complicated and difficult thing.

Well, put on your thinking cap and try this on for size.  Why not just buy and hold gold stocks?  It sounds too simple, but look at what gold stocks have done over a large variety of strong market disturbances - from deflation to inflation, from vicious bear to vicious bull:


With gold either steady (as in the '30s) or rising (as in the '70s and now) gold stocks do well no matter what the market does - up, down, or flat.  What complicated options strategy can average much better than that?  It's a buy and hold stock strategy where you don't have to make a directional bet on the market, freeing you from a lot a dangerous and usually self defeating week to week trading.  The investment jungle rarely offers this good of a deal.  You just have to be right on gold being in a bear or bull market. 

Since November '07, the start of our latest bear market, gold stocks as measured by the HUI Index are only about even, but that's a big outperformance of the Dow.  And if you look at this chart: (click to enlarge)

you see that the systemic failure issues of late '08 were enough of an aberration to pull gold stocks below the trend over gold's current bull market.  These credit and other problems are still a threat to gold miners as they are to any company.  But if we can avoid the end of the world, a bull or bear market may allow gold stocks to be one of the best hedging policies.

Disclosure: Long BVN, EGO, AUY, AU, ABX, GFI, RIC,NGD, NG, HL, SA, NXG, GG, RGLD, DROOY, GSS, ANV, HMY, GOLD, CGR, XRA, NEM, GRS