Is gold regaining its luster?

Yesterday on CNBC’s Fast Money show, guest investor Peter Schiff* was on with his current market predictions. Two years ago, he was dead on when he said that we were in a huge credit bubble which would be followed by a financial crisis and a “major, major recession.”

Hello! Very few listened to him then, and although nobody’s right all of the time, I thought that it might behoove me to listen to him now. So, what are his current recommendations? He says to get out of the dollar ’cause it’s going to “fall like a stone”, buy the dips in commodities, and start investing in international equities. He also predicted gold is going to go through the roof in the next couple of years, possibly hitting the $2000 an ounce mark. Yikes!

Well, investors today seemed to catch the gold bug causing a spike in the otherwise severely depressed sector with some mining stocks advancing over 40% over yesterday’s close! Technically, gold seems like it could be putting in a bottom, even if that bottom is only temporary. Mr. Schiff thinks that could drop to $600 before ultimately turning around and heck, who am I to argue? Judging from the chart of the GLD–a gold ETF that tracks the price of gold bullion and is the purest gold play out there–the $70, $65, and $60 all form major support levels (the GLD trades at roughly 1/10th the price of gold).

Even if the yellow metal does drop a little more, now isn’t a bad time to start getting hoarding a few American Buffaloes. The question is, how should we play it?

Gold ETF plays
There are two publicly traded gold ETFs—the GLD and the IAU. They are identical in nearly every respect except for two: the GLD is much more heavily traded (average daily volume is 18 million shares compared with 800,000 on the IAU) and the GLD has options. If you’re an options player, the play I like here (especially since we may not be completely confident where it’s heading in the short-term) is to sell cash-secured December puts at the $65 or $70 levels. (See Recipe #6: Put Pot Pie for further info on implementing this strategy.) The premium you take in will reduce your overall cost basis and automatically give you a downside cushion.

When gold finally does put in a convincing bottom, then buying the January 2011 LEAPS would be appropriate. The beauty of this approach is that you can write monthly covered calls against it to reduce your cost basis.

There’s also a double-long gold ETF, the DGP, that tracks twice the price of gold (divided by 50). It’s trading at $15.40, is very liquid and non-optionable–another choice if you’re very bullish on the sector. Just remember that not only are the rewards doubled, but so are the risks.

Gold stock plays
If playing options are just not you, then here are some recommendations on gold mining and exploration stocks. My selection criteria is based on technical factors (chartology), average trading volume (liquidity), and analyst recommendations of “Hold” or better. One plus that the mining stocks have over the GLD is that many of them pay dividends, albeit small ones. Most of these companies are well-established in the areas of exploration, mining, and production. The only speculative addition is Tanzanian Royalty (TRE) which is an exploration-only company. I included it because Tanzania is mineral-rich, the stock is relatively inexpensive, and I like the stock’s recent upward chart action.

You can play any of the optionable stocks the same way as the GLD using cash-secured puts or call LEAPS. If you want to buy the stock (and get the dividend), I’d suggest the fractional approach—buy a quarter position now, another quarter in a few weeks, etc.

Remember that gold is predominantly used as a hedge against inflation which I don’t think we’ll have to worry about for a while. But, if credit remains tight, the world stops investing in US Treasuries, and the dollar tanks, people could be turning to gold as one of the few remaining safe havens. In that case, $2000 an ounce isn’t that unthinkable…unless someone comes up with a cost-efficient way to manufacture it. Mr. Fusion, anyone?

*Click on this link to see the Fast Money interview with Peter Schiff.

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