The markets have done something that I have never! It’s possible that it’s happened before, but I don’t recall a time in the 35 years I’ve studied the markets that I have seen it happen.
This week, everything went up! Stocks, bonds, oil and gold! What? It makes no sense, but then again very little has made sense in the past year. Over the last couple weeks I’ve written about the reverse correlation between stocks and bonds. Stocks are risky assets, and when investors don’t perceive risks in the economy they buy stocks and sell bonds. When risk in the market exists, investors will move out of risky assets like gold and into the safety of government bonds. Makes sense right? Well, for the last couple weeks, both stocks and bonds are rallying side by side.
Ok, now let’s introduce oil to the equation. Historically when oil rises, investors fear inflation and jump out of bonds. Inflation is the arch enemy of bonds for this reason. This week things were different; and, while oil spiked, bond prices also climbed. Weird! It gets weirder when you think about why oil spiked. Oil spiked in response to rising conflict in Iran. Iran appears to be trying to control the Hormuz Strait which is where the vast percentage of oil tankers travel. As if that’s not enough, last week Iran attacked two oil tankers. This puts supply concerns in the minds of most investors because everyone knows that when you restrict supply of anything prices will rise.
The law of supply and demand is literally the first thing I learned about while studying economics in college. Let’s add in an additional oddity to this picture. The stock market has historically hated conflict. Conflict creates uncertainty, and uncertainty is the enemy of the stock market. So, in this case, what made oil prices rise should have tanked (no pun intended) the stock market. To be clear, oil rose based on the conflict in Iran which led to supply concerns. Increasing oil should have caused a sell off in bonds, but the oppositie happened. The same conflict that drove oil prices up, should have taken the stock market down, and yet the stock market made a new record high. What?!
Next, let's talk about gold. Gold behaved as I would have expected. Gold is considered a safe haven by investors and a great place to “hide out” when the markets are uncertain. Especially when this uncertainty is caused by world conflict which we have all around us. China has quickly become an overt enemy, however in my opinion they have been a covert enemy for many years. The difference is that now the gloves are off and neither side is pretending. We are one bad conversation away with Iran from having a full blown war breakout. Gold is the friend of conflict and uncertainty and all of these things are the enemy of stocks. Yet again, gold went up for all the right reasons but somehow stocks also made new record highs. Are you seeing a pattern here?
You already know how I feel about the stock market, but lately, I look like a fool. That is fine, I am ok being a fool right now and missing the top of the stock market by a couple thousand points, as long as I am safe and ready to pounce when the market falls. I will bet anybody that our strategy will make a lot more money on the way down than theirs will by hanging on to the last drops of gains that they can squeeze out. I say that statistically, people who exit before the peak fare much better than people that try and catch the top and end up exiting on the way down. Their exit point will be much lower than mine and their money will be lost on the way down while my powder stays dry. Drop a tennis ball from your roof and then try to take a picture of it just as it reaches the apex of its climb back up. You won't catch the top. You will either be late or early and I prefer early because it gives me certainty!
Gold Ran Up This Week!
If you think about it, gold, oil and bonds performed pretty much as you'd expect. Stocks were the odd man out. Bonds look very tired and I believe we called the temporary top on Thursday. Also, if oil continues its climb (and considering what is happening with Iran, it probably will), this will take a toll on the already tired bond market. So, now I have ruled out investing in bonds and stocks this week, which leaves oil futures and gold. I will pass on oil futures because the Iran conflict will hopefully pass without incident, and oil can reverse its upward movement and resume the down trend it was on before all of this happened.
So, we are left with gold and I am VERY bullish on gold right now. A lot of people think that gold drops when rates drop and this is true. A lot of other people think that gold will rise when rates go up which is also true. Still, others think gold will go up when supply diminishes which is also of course true. Finallly, there are those that think gold will rise when there is world conflict and these folks are also right. What the heck? Does gold go up no matter what? Nope! Gold likes rapid change which leads to uncertainty. Better said, gold loves excitement. Gold does not like ho-hum markets! Gold hates to be bored and will fall during boring times. Does anyone think we are headed toward boring? If you do, can I please have a hit of what you are smoking?
Lets analyze each reason that drives gold up.
1. Rates Rise- Rates rise when there is inflation and gold has forever been a key hedge against inflation. I don’t see inflation or high rates, so let's talk about what happens when rates fall.
2. Rates Fall- Investors are always on the hunt for yield. When rates drop, of course yields drop. I would rather sit on gold with the hope it will rise and the comfort that I am safe than jump into a 0-1% bond.
3. World conflict- World conflict provides nothing but surprises and gold loves surprises. Conflict drives down stocks and rates. Certain conflicts that hurt our dollar can also lead to inflation. All of these things point to justification for owning gold.
4. Supply and demand- China has been stocking up on gold for the last 6 months. Other countries are doing the same. As world banks beef up their gold storage, supply goes down and prices spike as they did this week.
Sneaky, sneaky! Look who's quietly stocking up on Gold!
Clearly, I think the timing to buy gold is right. In fact, our options trading group is currently long two separate gold stock’s. There are three ways to place a bet on gold. The first is actually buy the precious metal, but this is cumbersome and requires that you take physical delivery or have the gold delivered to a storage vault. This setup makes it harder to liquidate your investment. The next way to own gold is to buy stock in gold mining companies. The third way to own gold is to invest in gold ETF’s.
ETF’s are Electronically Traded Funds and they invest in a number of different mining companies which allow you to spread your risk between a number of gold companies with a single investment.
Here are some gold funds and mining companies we like:
Barrick Gold's (GOLD)
Newmont Mining's (NEM)
Royal Gold (RGLD)
Some interesting background; Barrick has recently announced their intention to purchase Rand Gold, while Newport Mining has an impending acquisition of Goldcorp. If this is not interesting enough for you, Barrick has now announced its interest in purchasing Newmont mining. Oh man!
We also like JNUG and NUGT. Both are liquid ETF’s that we actively trade options in. There are three ways you can play if you want to invest in gold. The first and most simple, (yet has the most risk) is to simply buy shares. If you buy shares, we like Barrick Gold (GOLD). In the last quarter, 10 major funds and billionaires increased their holdings in this company. In the fourth quarter of last year, company insiders also purchased shares. The stock is currently trading for $15.60. If you buy it, you may also want to consider buying a $13 Sept PUT for a measly .15 cents a share. This purchase will protect you in the event that the stock falls until September. The most you could lose is $2.60 per share, as opposed to what can happen if the stock were to fall hard.
ETF's are Stocking up on Gold!
The next thing you can do is to make an options play. This limits your upside but also limits your risk. We like Newmont Mining company for this strategy. You can sell the August $36 put and get paid a credit of .83 cents a share and then for protection, you can buy the August $33 put. This trade has an 85% probability of winning and the stock can drop from its current price of $37.49 down to $35.38 and you still make money! I love options! This trade has a max gain of $62 per contract but each contract only costs $215 to purchase. This is a huge ROI!
Here is a screen shot of the options play
Lastly, you can do a covered call. We have developed a trade that works if the stock goes up, down or sideways. A covered call, quite simply, is when you buy the stock and then sell a call against the stock. For this trade we also like Barrick Gold (GOLD). We would buy the stock and then sell the July 12, $16 call for .32 cents a share. If the stock goes up to $16, you make .72 cents a share. If the stock stays the same or goes down, you still keep the .32 cents per share you earned for selling your call. Think about it, if you buy 1000 shares of the stock and sell 10 call contracts you earn $320 in just 19 days. Annually, this equates to $6100 against a $7540 investment. This happens even if the stock stays the same.
Here is where our strategy gets interesting. We also buy the $14 Put for protection. This means the most we can possibly lose is $1300. BUT, (and this is big!) if we continue to sell calls and buy puts each month on this stock, then based on the current environment, we continue to earn $500 per month in option income. Well, if the stock plummets and you lose the max amount of $1300, but you are making $500 per month in option income, you break even from the loss of the stock price in just 2.7 months! You can keep selling options as described and continue to earn an 80% plus return on your $7500 investment. A quick disclaimer… option prices vary and the income could go down by as much as 50%. So what! You still earn $3000 per year from your $7500 investment. How many places can you do this. I know it sounds complicated but at University of Options (www.universityofoptions.com), we make it simple and lay these opportunities out for you every week.
Screenshot of Covered Call with Protective PUT