The Tycoon Report

Ride the Inflation Wave with Gold

Friday, May 29, 2009 | Price Headley

Editor's Note: While you may long for the days when buy-and-hold investing practically guaranteed a timely and comfortable retirement … when it seemed that stocks would keep trading up, up and away … we find ourselves in a new reality where rebuilding our nest eggs and regaining our sea legs have become essential to surviving in this shaky market.

The game has been permanently changed -- believe it or not, for the better -- because there are smarter, faster and even safer methodologies for making money in any type of market and, ultimately, reaching our financial goals.

Our mission at The Tycoon Report is to give you access to top-quality trading and investment ideas and strategies, from the savviest financial experts we can find. Today, we are pleased to announce that we are taking another step forward in helping you to add another tool to trading quiver, with the addition of Price Headley to our weekly editorial lineup.

Price is a great example of how successful someone can become simply by following his or her passions. While enrolled at Duke University, he entered a trading contest just for fun. Soon, he was daytrading with success and decided to become an analyst.

With a degree from Duke and several years' experience in the financial publishing industry, Price appears regularly on CNBC, Fox News and Bloomberg Television, and in a variety of print and online financial news outlets, including The Wall Street Journal, Barron's, Forbes, Investor's Business Daily and USA Today. He also speaks regularly to investment audiences nationwide. He is a member of the Market Technicians Association and is also a chartered financial analyst (CFA) charterholder and a chartered market technician (CMT) charterholder.

Price was inducted into the Traders' Hall of Fame in 2007 and is the founder of BigTrends.com, which provides investors with specific real-time stock and options strategies and investment education to profit from significant market trends.

One of those trends includes using his unique technical indicators to uncover opportunities in Exchange-Traded Fund (ETF) options -- an area that many of you have expressed an interest in learning more about.

He's making a special appearance in today's issue and will return as our regular Thursday contributor starting next week, on June 4. In the meantime, you can get to know him better by checking out BigTrends.com, for which Timer Digest recognized the success of Price's investment strategies by ranking him among the Top 10 Market Timers for stock market timing.

We are pleased to bring Price on board to share his insights on how to position yourself for profits with ETF options. Please join us in welcoming him to the team!

Ride the Inflation Wave with Gold

Most on-target joke overheard recently (attributed to a commentator on CNBC):

"What's the difference between Vegas and D.C.?
At least in Vegas, the drunks gamble with their own money!"

Regardless of your political persuasion, as an investor, you have to acknowledge that with both parties spending our money like drunken sailors, the prospects for higher inflation are only a matter of when, not if, they show up in the economic data.

And no matter what the government tells us about the Consumer Price Index (CPI) or similar gauges only going up 4% a year or less, you know that any trip to the gas pump or the grocery store tells you that prices keep steadily inching up.

So, what's an investor to do?

Well, there's one way to create a hedge against a higher cost of living, and that's to consider gold as an inflation beneficiary. Note that I'm not talking about gold stocks here but, rather, the more-direct play on the price of gold itself.

A 'Nugget' of Opportunity

For stock-market investors, rather than buying gold coins and bullion -- which is not as easy to move in and out of quickly -- I much prefer to focus on the SPDR Gold Trust (GLD), an Exchange-Traded Fund (ETF) that trades at roughly one-tenth the price of the current price per troy ounce of gold itself.

So, why not focus on gold stocks, which are supposed to be a more-leveraged play on the swings in the price of gold? Because they are STOCKS!

When portfolio managers started to liquidate their stock holdings last fall, gold stocks fell in tandem with the overall market, with the gold-stock-oriented Market Vectors Gold ETF (GDX) down nearly 30% from September through November 2008 compared to a drop of just under 3% for the GLD.

For the full year of 2008, GLD was actually up around 5% while the major stock market averages dropped more than 30%. The only time GLD lagged in recent memory was during the sharp stock snapback off the March lows and through the April bounce. But in May, GLD began regaining its relative leadership. I expect this is just a sign of investors preparing for the coming inflation wave, and you need to know how to play it, too.

ETF Options: The Way to Trade Gold Without Paying a King's Ransom

Rather than just buying GLD outright -- which, at Thursday's close of $94.24, would tie up $9,424 (all examples before commission costs) on each 100 shares -- you could instead consider a call option purchase, with one contract controlling the same 100 shares up until a certain (expiration) date.

At the May 28 close, the GLD Jan 88 Calls (which would give you the right to buy GLD up to the third Friday in January 2010 at a fixed "strike price" of $88 per share) were trading at $12.50, or $1,250 to control that same 100-share position in GLD for roughly the next half-year. This means that if you expect GLD can rally above $100 in the next six months, this could be a profitable position. Especially if GLD mounts a 20% rally up to $115 or more, these options would gain well over 100%.

This is not necessarily the most-aggressive way to play such a GLD move, but it shows you how trading ETF options can meaningfully leverage your investment.

Meanwhile, if your view is way off and GLD drops by a large amount, the ETF option buyer is only on the hook for the amount invested, and no more. With the damage stock investors felt last year, the "stock substitute" strategy of using call options -- with the rest of your core portfolio in low-yielding cash alternatives -- could turn out to be a far better play even if you didn't manage your call position and happened to let it expire.

The technical chart of GLD shows how powerfully this ETF can move when it starts to break out. Looking at the weekly chart back to mid-2007, GLD really started to surge when it not only cleared the technical resistance area around $69-$70, but also when it gave an Acceleration Bands buy signal Sept. 29, 2007.

Acceleration Bands serve as a trading envelope that factor in a stock's typical volatility; they are plotted around a simple moving average as the midpoint, and the upper and lower bands are of equal distance from this midpoint. You can see usually an ETF will trade in between these bands, but when it breaks out for two-straight weeks, a serious acceleration can begin.

Weekly Chart of GLD with 20-Week Acceleration Bands

So right now, the resistance line is clearly drawn in the $99-$100 zone, but I think it's only a matter of time before the next big surge for the yellow metal. I'll let my technical indicators tell me when to buy officially, but in the meantime, keep GLD on your radar -- especially if the stock market endures another summer or fall swoon.