by: James Cordier
November 26, 2009
Anyone remotely familiar with the financial markets knows that precious metals were the place to be in 2009. Gold has soared to all time highs on the back of spiraling U.S. deficit spending, a still unresolved portfolio of toxic assets, and a general investor fear of paper currency.
Indeed, it would seem the current administration’s hope would be to inflate the country out of debt. And thus, despite government denials to the contrary, a weaker dollar seems to be the logical solution to exploding debt.
Thus, as the U.S. dollar continues to decline, Gold and it’s less glamorous cousin Silver, have continued to appreciate in price.
The question is, is it too late to buy now? Are gold and silver prices near a top or is this rally just getting started?
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The good news is that as an option seller, you won’t have to answer this question. You rarely do. In fact, your objective is only to select price points where the market won’t go. You are trading options, not futures contracts. This means you can study a variety of likely scenarios and then position for all of them. Picking outright market direction isn’t necessarily a requirement for success.
For the purpose of this week’s letter, we will focus on the silver market as a candidate for premium collection opportunities. Gold has been leading all commodities in the current bull market and has taken on a life of it’s own in regard to investor buying. While there may still be opportunities for option writers here, the irrational nature so common to equities price movement may be spilling over into gold for the time being.
Silver on the other hand, may have just enough bearish headwinds to slow it to a desirable speed for option sellers. The argument that gold has rallied by a higher percentage than silver and thus silver will have to “catch up” does not hold water with us. The argument that silver’s all time high was near $50 back in the early 80’s and thus still has “a long way to go” are utter ridiculum. Silver rallied for an isolated, specific reason back in 1980 that has nothing to do with today’s inflated prices.
Fundamentals are taking a back seat at this point and are currently not what is driving price. But we must not forget that silver also shares some qualities with industrial metals and unlike gold at the present time, tends to derive at least some of it’s price direction from the commercial sector.
As we have discussed for months, demand for a variety of commodities from gasoline to copper have not kept pace with price. In fact, demand for many industrial commodities is well below levels for last year. At the same time, speculative long positions remain very high in these same markets. The latest Commitment of Traders with options shows speculative positions in silver at a net long 65,588 contracts – not a record long position as many bulls like to point out. But, comparatively high by historical standards and certainly what most would consider “overbought.”
Because of the aspect of industrial as well as investor demand, silver prices will remain more subject to corrections than will gold. Any bearish economic news could have a two pronged effect on higher silver prices.
A. Silver could react more as an industrial metal and experience selling due to anxiety over future commercial demand
B. Bearish news that jars the market could bring flight to quality buying back to the dollar, which would almost certainly result in liquidation of long silver positions
However, if you are one of the many who is bearish the U.S. dollar, you must invest on the assumption that silver prices may continue to rise over the near term. With the latest comments from the Fed deeming the dollar decline “orderly,” one has to assume that the Fed is content to let the dollar value continue a steady trek lower.
And that is the key word – steady. A steady trek lower in the dollar would most likely mean steady to higher silver prices. Translation – a lower likelihood of price spikes in either direction. These types of markets have historically been good to option sellers.
Yet, with investor interest in silver high, option values are at some of their best levels in years. One can sell puts in this market with expectations of steady to higher prices in 2010. But one can also sell calls, simply because of the stupendous strikes that are available above the market. Contrary to most investors instincts, selling calls in a bull market can be a profitable play, especially if the trend is “orderly.”
We continue to feel that the silver market offers good opportunities for selling strangles. We suggest call sellers look for strikes at least double the price of silver and put strikes at close to 50% out of the money.
We will be working closely with client investors prior to the holidays in establishing these positions.
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