Managing Editor

Golden Opportunities?

It's important to look at commercial NET interest in a commodity to properly ascertain hedge sentiment.

For gold, net shorts topped out as prices reached their spring peak. Sellers, thus, locked in the market's highest prices through futures. Commercial net short interest has since been lightened to a level not seen in years,


On Nov 03 04:31 PM Smarty_Pants wrote:

> If commercial open interest is declining then another upleg is about
> to start shortly. Maybe it won't be the onset of the "big one" but
> prices are very likely to move higher from here.
>
> If commercials are reducing their net positions it means that the
> current prices are too low. They will be much more likely to wait
> for another rally in price back to 'realistic' levels before taking
> any more positions on the short side for future delivery.
>
> The commercials aren't stupid. They close out their short positions
> when prices get "too low" and re-establish them when prices are "too
> high". It's their business to know what they're doing. When they
> all do the same thing, it's telling you something (or it ought to
> be).
>
> Of course pinpoint timing is another story. Commercial Open interest
> figures will tell you which way the big boys are leaning though.
> Keep your eyes open.

Gold Stocks Rebound

Rebound? Yes, Paultaut, the rebound that caused the overextended GLD/GDX ratio to drop so precipitously.

Note the cautionary tone that was sounded in the piece : "...investors shouldn't forget that gold mining issues are still highly correlated to bullion. As gold goes, so goes - more or less - mining shares. The correlation of daily price returns between GDX and GLD, in fact, stands at 73%, even after counting the seemingly disparate performance records this year."




On Nov 06 05:07 PM paultaut wrote:

> Looks like gold is on its way to the low to mid $600 range, this
> appears to coincide with the last cautionary statement:
> .... have growth and can fund that growth ...
>
> What rebound? The Bear market bounce, is that what you are talking
> about?

Gold (and Gartman) Haunting Some Investors

An at-the-money option would have a delta around .50 unless you're on the eve of expiration (when delta would be zero). Delta DOES matter. Greeks DON'T disappear at expiration. An in-the-money option at expiration would have, for example, a delta of 1.

Time premium is predicated upon volatility assumptions. All of the other inputs in an option price model could be similarly perceived by all market participants; the one variable that's unique to each trader is the forecast for the asset's volatility over the option's life.

There were no other time frames to consider for DZZ's performance when the hedge presentation was made. What you saw in the example was performance from inception. An update on DZZ's post-conference performance can be found on the Hard Assets Investors site at "Did You Hedge Your Gold Stocks? (www.hardassetsinvestor...) .

The purpose of a hedge is just that ... to hedge against an unacceptable risk. If one didn't anticipate rough sailing ahead, or if one wasn't facing some other circumstance that precluded sale of an asset, one would remain unhedged. But there are times when assets must be held in tempestuous markets . An investor, for example, who's already taken a full complement of short term losses for the year might want to hold gold mining shares until they qualify for long-term capital gain/loss treatment.

There's no presumption in the presentation that alpha is positive. Excess returns can be, and as we've seen often, ARE negative. In this case, a negative alpha would be symptomatic of management's failure to beat the performance of the gold market. Beta's a matter of perspective. There are, in fact, TWO betas associated with gold mining stocks: equity risk, which can be hedged with a stock index product AND gold risk, which is addressed by DZZ. There's still plenty of beta in Hecla even after hedging with DZZ.

As for taking a "married" position (gold mining issues plus DZZ) at the outset, that's purely an alpha play. You'd be treating the mining issue as you would ANY equity issue. If you were looking for gold performance, buying gold itself would be more efficient.

Is Gold Getting Ready to Bounce?

One might say, on a comparative basis at least, that GLD has ALREADY bounced. The price ratio of GLD shares versus GDX shares hit a record high 2.4-to-1 this week.

That's certainly not what option guru Larry McMillan wanted when he recently recommended a December spread pitting long GDX calls against long GLD puts (details of the trade are outlined in the Hard Assets Investor artcile "Options As A Golden Opportunity," (www.hardassetsinvestor...).

At last look, the spread was bid at $12.50, down from the $16 limit Larry proposed as a buy point.

There's still, time, of course, for the spread to work out. The options expire December 19.

Options as a 'Gold'en Opportunity

jigs -

On the contrary, GLD puts ARE (were) cheap. The implied volatility embedded in the GLD premium was only in the 77th percentile while the the GDX calls' volatility was in the 96th percentile.

Gold (and Gartman) Haunting Some Investors

An option trader who fails to appreciate the risk factors represented by the greeks is flying blind.

Without considering delta, at least, how can you determine a hedge ratio? You won't get dollar-for-dollar price tracking between the option and the stock until the option's deep in the money.

GDX was used in the article above as a proxy, not as a trade recomenedation. Look at the examples given in the "Hedging Gold's Volatility" article and you'll see how the DZZ hedge worked against individual mining stocks and a small non-GDX portfolio. Alpha could, indeed, be stripped out.

Gold (and Gartman) Haunting Some Investors

Riskwise, owning a put against stock held long is, indeed, a synthetic long call. Diagram the risk/reward payoffs of a synthetic and a "natural" call with the same effective strike price and you'll see they're identical.

There are more unknowns embedded in options than in stocks. Each of these "greeks" (delta, gamma, kappa [vega] and rho) is a variable risk factor that influences the option's price trajectory. The only "insurance" one has is in the expiration pay-off. One pays for it through the premium. Option premium must be paid to roll the insurance forward. No premium is attached to the purchase of stock.

Don't get me wrong. I'm a big believer in options. But not everyone else is.

The hedge example presented at the Hard Asset Conference was directed at shareholders who bought gold mining shares in the belief that their stock would outperform bullion. Hedging out gold's influence with DZZ does NOT negate the upside, it merely isolates the outperformance in the stock (if any) that isn't attributable to gold's movement. You'll see this illustrated in the examples presented in the "Hedging Gold's Volatility" article. The proposed hedge, in fact, relies upon this "mismatch" to allow the stock's alpha to filter through.

There were no GLD options extant at conference time and GDX options would hedge away the very alpha stockholders wanted to preserve.

Gold (and Gartman) Haunting Some Investors

Let's go back to the focal point of the article for a moment. The fact that the DZZ-hedged position in GDX still returned a loss says one of two things (or both):

1) The hedge ratio needs to be adjusted dynamically, and/or

2) There's something "wrong" with the management of the companies making up the underlying index.

If the hedge ratio remains constant over the life of the hedge, gold's influence from GDX should be negated, allowing the underlying companies' management "alpha" to emerge

There was an 8 percent residual loss after hedging. A little number-crunching should tell you if it's the fault of the hedge or of company management.

Gold (and Gartman) Haunting Some Investors

Silveraxis -

Put options are indeed an possibility, though they come with a whole new set of considerations. DZZ offers twice the inverse return of its underlying index without an extrinsic cost. That's a degree of leverage that exceeds that of an at-the-money option.

An option is a wasting asset; if it's out of the money at expiration, the put premium is forfeit. Holding a GDX put with GDX shares, in effect, creates a long call on GDX. And, as we all know, calls can sometimes expire worthless.

There's no such cost in DZZ. Neither is there an expiration, so rolling costs are eliminated.

52-to-1 Just Right for Gold/Silver Ratio?

There may, indeed, be no predictive value of the gold/silver ratio, but that doesn't mean it doesn't get watched. The ratio is closely followed by the value investors of the metal world (see "What's Better: Gold or Silver?" at hardassetsinvestor.com...).

Gold/Silver Ratio Still Widening

Donaldo -

The green line at the bottom of the chart tracks the gold/silver ratio (gold over silver) basis the daily London AM fix. "47.1" means one ounce of gold, at market prices, could purchase 47.1 ounces of silver.

The blue and red lines, however, trace the indexed values of the DB Gold Double Short ETN (DZZ) and the iShares Silver Trust (SLV). By "indexed" I mean that each security's starting price set at "100" to make their price actions directly comparable.

Who's to Blame for the Commodities Boom?

Let's clear the air on a couple of points.

First, about deliveries through futures. Historically, only 2%-3% of futures trades are settled by delivery. In the vast majority of cases, futures trades are offset (bought or sold) before a delivery occurs.

Second, futures market making doesn't follow the securities model. Securities market makers are obliged to maintain two-way (bid/offer) quotes in their designated securities. Not so in futures. As a "local," I can bid, and bid ONLY, for contracts without an obligation to offer out any contracts.

Last, if commodity-based ETFs and ETNs are blamed for adding speculative pressure on the upside, some balance might be acheived by floating "short" or "bearish" commodity index products which have the potential to augment short open interest. Short products have other utilities as well as pointed out in the HAI feature "Where Are The Short Funds?" www.hardassetsinvestor....

The Good, the Not-So-Bad and the Ugly Commodites ETFs

No worries. UCR and DCR are novelties as far as oil ETFs/ETNs go. They're issued in tandem as complementary sides of a trust made up of credit instruments.

When you deal with the MacroShares products, you're taking on a huge tracking error risk. Tracking spot WTI can be hard enough for "old-fashioned" oil ETFs/ETN when the market's in contango.

The Good, the Not-So-Bad and the Ugly Commodites ETFs

Thanks for your insights.

Look back on the article, though. It says: "SOMEDAY (emphasis added) the commodities tower will topple leaving imprudent investors who've OVERSPENT (again, added emphasis) on commodities vulnerable ..."

Note I haven't said WHEN the reversal of fortunes will occur. To think that commodities will remain in the ascendency indefinitely denies history. Commodities prices and inflation are cyclical, to wit:

Commodity vs. Stock Bull Markets

US Stock Market Producer Price Index
Composite (All Commodities)

1898-1920 61% 228%
1920-1929 196% -38%
1929-1951* -12% -58%
1951-1965 256% 6%
1965-1981 49% 204%
1981-2001 828% 37%

*Includes anomalous effect of the Great Depression (1929 – 1940)
(Source: Legg Mason)

Without market timing, overexposure to the asset class can be deleterious to a portfolio with a date-certain horizon. And how good are any of us in the timing department?


I'm not saying one SHOULDN'T have commodity exposure, only that the allocation be prudent.