Oil and the Dollar Drive Precious Metals Market

April 1, 2008 | By | Reply More

Gold continues its see sawing between $900-950 an ounce in Far Eastern and European trading this Monday. The principle drivers are a stronger dollar (the market never ceases to surprise!), weaker oil prices, and quarter end book balancing and profit taking when gold challenges $950.

May be the demand from the approaching Indian wedding season when it is traditional to give gold to the newly weds will bring some stability to the price.

Some readers of the runes, otherwise known as chartists/technical analysts see a retracement to around $850 an oz., others see support at the $900 level before the longer term bull run gets back into its stride.

Fundamentalists expect that the gold price should begin to recover within 4.5 months if not sooner as South African production continues lower and demand from India, the Gulf States and China are likely to increase.

Silver looks promising at under $18 an oz with reports of shortages in the bullion retail market while platinum is still in demand.

In the current investment climate there are so many uncertainties to take into consideration and balance against each other to have any confidence in the short-term outlook at least.

Whether there will be more bad news to drive the markets lower or whether that has already been discounted is anybodies guess. Is this bargain hunting time or is it prudent to wait and see and risk missing out on some profit opportunities?

There is only one certainty if the past is any guide and that is that the market will spring a surprise at the expense of the unwary.

Our view is that we have sufficient exposure to precious metals and their producers for now, and we are showing a nice profit, but then we got in early. If gold does retrace to 850 we will be adding to our positions unless there is an unexpected development.

In the meantime we are looking to make our money work for us by generating income reasonably risk free, at least in the medium to long term. Keeping cash anywhere is certain loser as inflation runs amok unless you are a currency specialist.

Our strategy is to pick out top performing established producer companies paying a dividend. They must be trading globally in materials likely to continue to be in demand despite a world wide economic downturn. We buy the stock and sell the call option at a strike rate that gives more or less a 20 % profit if the call is exercised.

Usually somewhere between 6.8 months ahead will provide the necessary percentage, bearing in mind the price you get for the call will depend on the general market outlook. In the `prevailing volatile climate we look to buy the stock on a down day and sell the call when the optimists are in a buying mood.

The outcome is either your stock is called away in which case you have made circa 20% plus any dividends paid in the meantime plus you will have trousered the option premium you gained from the sale, less of course dealing charges. A fair return after 6 or so months when interest rates are falling.

If your stock does not reach the strike price then obviously you retain the stock while the call option expires worthless to the buyer and represents your profit. It should be possible to repeat the process twice within 12.15 months.

Timing is important to maximize the profit from selling the call option but it is possible to get a return nearing 20% p.a. taking into account dividends received.

There is another factor that appeals to us but hopefully not to any of our readers and that is that it commits us to our profit expectation when we enter a trade.

When you see your stock on a roll it is so easy to think that it will continue ever upwards and all your good and sensible intentions give way to greed.

That is when the market can strike back, almost always unexpectedly, to turn that lovely profit into a naked loss and leave you kicking yourself for not sticking to your principles but knowing the temptation will still be hard to resist the next time. Selling at the top and buying at the bottom is an expertise that no man has ever successfully conquered in the history of investing!

If you like this strategy then a current trade that we like the look of is Alcoa (AA:NYSE) at around $36 and selling the October $42.50 call ($2 plus) but, as always, think it through, do the research and make your own mind up, we could be wrong.

We were in this trade at $36.19 earlier in March; the price went to over $39 the following day when we were able to sell the July 45 call for 1.70. Do this twice a year would return circa 10% plus divis, better still have the option exercised and bank better than a 25% in six months.

Just a reminder that one option contract represents 100 shares so keep to buying in units of 100. Be safe, invest wisely and beware of false stock market dawns.

 

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