GOLD IS POWER / BARRON´S

Tuesday, August 25, 2009

THE STRIKING PRICE DAILY

Gold Is Power

By STEVEN M. SEARS

Aurum est potestas in any language may come down to option trades on SPDR Gold.

IT'S ALWAYS HELPFUL to know a little Latin.
Illegitimus non carborundum -- which is really pig Latin -- means, "don't let the bastards grind you down," and is everyday good counsel for anyone who makes their living in the markets.

At certain market moments, including now, res ipsa loquitur, or "the thing speaks for itself," sums things up perfectly. Investors may read one thing in data, and another thing in the market.

What to do? Listen to the market.

Sure, it doesn't know Latin, or English, but it speaks very loudly in the voices of all investors combined.

So as we sit here on a Turnaround Tuesday, wondering, "Do I dare buy at these levels?" the market is leaving clues if you know where to look. The view is not intuitive, and will be invisible to most individual investors, which is ironic in a way because professional investors are looking to them for clues about the health of the economy.

In essence, the consensus in large swaths of the investment community is that corporate profits may have already experienced a V-shaped recovery. That means a sharp decline, followed by a sharp recovery. But consumer spending, which drives 70% of the U.S. economy, and 20% of the global economy, remains the wild card. The cognoscenti are debating if the shape of the economy's recovery will be W-shaped.
Even though the stock market is a discounting mechanism, reflecting all known information about securities and economies at any given moment, there is only so far that it can lead the economy before it gets nervous.

Traders, investors and other full-time practitioners whose lives depend on their trading results are mindful of this. On Monday, when the price of gold fell sharply, many traders took nervous note.

''When gold falls $10 per ounce in the course of a very few moments, we are always on the lookout for rumors concerning IMF [International Monetary Fund] sales or massive legacy bank sales or margin liquidity or any number of explanations,'' Dennis Gartman, publisher of the influential Gartman Letter, told clients in Tuesday's note.

He found no reasons and chalked up the dramatic bear raid to the illiquidity of summer trading.

But the answer to the bearish trading emerged rather quietly in the options market. It appears that investors are deciding to maintain their exposure to gold even though they are selling gold in the stock and commodities market.

How do they accomplish such legerdemain?

As we detailed in a previous column, (see Striking Price Daily, "The Third Dimension of Investing," Aug. 18, 2009), institutional investors are selling positions in cash markets, such as the New York Stock Exchange where SPDR Gold Trust (GLD) trades, and using a portion of the proceeds to maintain bullish exposure in the options market.

Trading in GLD options has been bullish. On Monday, investors bought about 15,000 March 100/120 call spreads, which entails buying March 100 calls and selling the March 120 calls. In recent weeks, Susquehanna Financial Group said investors also have initiated "1x2" spreads in the March 100/130 calls, which entails buying one March 100 call and selling two March 130 calls.

With GLD at about $93, the options trades offer investors a leveraged position in case gold prices skyrocket. The consensus among many traders is that September and October will likely be volatile, as all the market's worst events from broad-market crashes to the dissolution of major firms tend to happen in the fall.

If the past repeats itself, demand for gold, the feel-good asset in times of woe, will increase prices.

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