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Old 04-21-2011, 10:00 AM
GraniteHillsInvestments GraniteHillsInvestments is offline
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Default Gold Price – A Short Term Correction on the Cards?

Got a long gold position and wondering what to do given the current sharp rise in the price? Below, there are some thoughts regarding the some scenarios for the short term gold price.

Fundamentally the Bull Run in the gold price remains solid. Sentiment is very strong towards the price with many investors still piling into gold. This can be seen particularly with the inflow into Exchange Traded Funds (ETF’s) which hold the underlying commodity. So far in April there has been the largest amount of purchases in gold since August 2010. There have also been reports of some investment funds actually purchasing the physical asset rather than any gold related security. Also in the options markets for gold futures the open interest in particular for call options with a strike of USD1500 has increased dramatically in recent sessions. This all indicates a very positive picture, for further increases in the price of gold.

However, as we all know markets do not move up in nice smooth upward sloping lines. There are always bumps along the way. With the recent surge in the price of gold to new all time highs (however still below the inflation adjusted highs of the 1980’s) there is a real possibility of a short term correction in the price of gold. This is quite likely to be driven by short term investors who have made a good return recently and now want to take the profit. Another reason for a short term correction is the new lease of life which equities have got in the past few sessions. Gold is often seen as a prime investment when there is uncertainty in markets regarding geo political tensions, economic uncertainty etc. With market seemingly having disregarded all such thoughts equities are on the march up again.

Any correction I believe will not be severe. As the price of gold falls investors will again focus on the long term positive factors for investing in gold which include weaker USD and growing inflation concerns among others.

To either hedge a long portfolio holding of gold or just speculate on a short term fall in the price. Looking at the gold chart there appears to be some good support at firstly 1447 and then 1326 which should hold in any short term correction. One way of capturing a short term downward move is to implement a put spread with the strike prices around these levels. Currently a 1450/1350 put spread on the June 2011 gold future will cost around USD640 or just under 0.5% premium.

I believe this is a good strategy to capture a correction and if it comes about there will be some more cash available to go long gold at lower prices. If the market does not correct the cost of implementing such a put spread is not too high.

In February 2011 implemented a long gold strategy using options buying the August 2011 expiry of the 1370 call, selling the 1370 put and buying the 1325 put. At this stage I’m buying back the short 1370 put selling the 1325 put and buying a new 1450 put with June expiry to cover an expected short term correction.
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