Gold: The Play of 2007

By Richard Ilczyszyn and Phillip Streible

November 2006

With 2007 approaching and the stock market testing all-time highs, many investors are getting ready to rebalance their portfolios and diversify their assets. We believe the metals markets are one sector of the commodities universe that every investor should consider having some exposure to. Historically, the long-term gold outlook has been heavily dependent on the U.S. economy, inflationary pressures (especially from energy), geopolitical events (such as the war on terrorism), and the value of the U.S. dollar. With record trade deficits and an anticipated collapse in the housing market, investors have been searching for viable investment alternatives to stocks, bonds and currencies. That puts precious metals in the spotlight.

Looking at the precious metals markets just after the Thanksgiving holiday, silver prices are retesting their September highs and trading near $13.50 per ounce, copper has held the $3 per-pound level and looking to retest $3.50, platinum is trading at $1,170 per ounce, and gold has held long-term support of $560 per ounce. The yellow metal looks to be forging a run, and we believe that with strong physical demand, central bank buying and concerns about inflation, there is enough momentum to push gold well above $650 per ounce. We'll first outline an options trading strategy you can consider in the gold market, and briefly outline reasons for our bullish stance.

An Options Strategy

We believe the gold market will continue to move in the path of least resistance (higher), and you therefore might consider buying bull call spreads in the April contract. For example, if you have a bullish outlook on gold futures and feel April futures will go up to $700 from their current level of near $650, then you can buy an April $650/$700 bull call spread. The cost for the $650 call is currently $2,800 and the sale of the $700 call is $1,500, excluding commissions. The difference is around $1,300 maximum risk per spread, plus commissions. If, at the time of option expiration (March 27, 2006), April gold futures are trading at or above $700 an ounce, the spread would be worth approximately $5,000. If gold were trading below $650, the most you would lose would be your $1,300 cost, plus commissions. The same type of strategy would apply if you are bearish gold, but you would use puts instead of calls.

Please keep in mind, options strategies can be complex and involve significant risk, so I encourage you to contact our desk for details on this type of strategy, particularly if you are a novice investor.

Looking Back Long Term

When looking at a weekly continuous gold chart since late 1996, you can see that the gold market was once in a deep bear market that had lasted nearly three years. Prices declined from $385 in 1996 to $252.50 in 1999. Shortly after posting that low, the gold market was red hot again, running up to $327 in October. The market then backed off to $275 in December before making another run up to $322 in February 2000. For the next year, gold went back into a bear market, posting a double-bottom of $255. Since that double-bottom was posted in early 2001, front-month gold futures prices have yet to look back on those levels, and are knocking at the door of $650.

Long-Term Technical Buy Signals

When examining long-term trends in the market, one classic approach I like to take is to look at the 100-day and 200-day moving averages, and most importantly, the crossovers of the two. One can see that back in April 1997, the 100-day moving average had crossed over the 200-day moving average to kick off a bear market in the gold market that would last little over five years before it produced another crossover. In August 2002, the 100-day moving average crossed back over the 200-day moving average, producing a buy signal at $313.70 that has yet to have been retested.

This long-term example gives a brief outline of a trading method that we favor in showing you how to participate in a rally in the gold market, which we believe is about to kick off. If you have any questions about gold, or this trading method, please don't hesitate to contact me via phone or email. If you are a Lind-Waldock client, be sure to check out our "Strictly Options" and "Inside the Markets" hotlines, updated each trading day. Contact our desk and we will be happy to provide the numbers to you.

Richard Ilczyszyn is a Senior Market Strategist with Lind Plus. He can be reached at 800-605-0095 or via email at rilczyszyn@lind-waldock.com if you would like to discuss this strategy or others.

Phillip Streible is a Senior Market Strategist with Lind Plus. He can be reached at 800-803-8037 or via email at pstreible@lind-waldock.com if you would like to discuss this strategy or others.

Kristina Zurla Landgraf is editor of Lind eWire. She can be reached by email at editor@lind-waldock.com.

Futures trading involves substantial risk of loss and is not suitable for all investors.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

© 2006 Lind-Waldock, a division of Man Financial Inc. All Rights Reserved.