Karim Rahemtulla (Investment U):
Of all the great investments you could have made in 2009, gold is right up there among the best of them.

The price of gold has surged this year, taking gold shares upwards with it. Readers of my Xcelerated Profits Report have rung the register with 45% profits on Goldcorp (NYSE: GG) and a triple-digit winner on Golden Star Resources (NYSE: GSS). We’re also up big on Yamana Gold (NYSE: AUY) at the moment.

All is good, right?

On the surface, perhaps. But not if you believe what the options market is saying…

Yamana Options Signal a Share Price Drop

Using Yamana as an example, the options market is betting that over the next 12 months or so, Yamana may fall from current levels of around $13 back into the single digits again.

Just take a look at the January 2011 $7.50 put options (the right to sell Yamana shares at $7.50), currently trading at $0.70 cents per contract. This means the put buyer thinks Yamana’s price will fall to $6.80 – almost 50% below current levels – in order to be in the money. The $6.80 price is derived from subtracting the price of the option from the strike price ($7.50 minus $0.70 = $6.80). This tale is similar across other gold shares, too.

These put options are expensive relative to Yamana’s share price – the result of gold prices moving sharply in previous weeks and causing the volatility in gold stocks to increase.

As a quick refresher, the price of an option is based on four major factors:

The price of the underlying shares
The options strike price
The time to expiration
The volatility of the underlying shares
Two Ways to Play Gold Prices… But Only One Viable Option

So if you’re a gold investor looking to participate in the market, what can you do to protect your profits, or buy shares at a lower price? Here are two potential ways…

Click here for the rest of Mr. Rahemtulla’s Analysis at Investment U.

This issue is entirely in the contrarian spirit of playing devil’s advocate. So put your pitchforks down. Take a deep breath. There is plenty of space to poke holes in (or rant) about our thesis by writing to notes@todaysfinancialnews.com

So here it goes. The four reasons you shouldn’t buy gold today…

Reason 1: Did you know that the seventh largest holder of gold in the world is not a country, but an exchange traded fund? Yes, gold ETF SPDR Gold Shares (GLD) has amassed the seventh largest gold reserve in the world. This fund holds more gold than China, Switzerland, Japan, the United Kingdom or the European Central Bank.

So why does this matter? Because should big investors (hedge funds, pension funds) who hold this fund (and many due), decide to dump their shares or are forced to liquidate their holdings because of investor redemptions, who will buy up the excess slack? This excess supply would surely drive the price of gold down making for some unhappy gold bugs.

Reason 2: Gold is overbought at today’s price level. When anything becomes overbought quickly, as gold has in recent months, it has a habit of correcting just as quickly. According to Bob Prechter, CEO of Elliot Wave International, the precious metals are “heavily overbought” and the “path of least resistance” will be to the downside for many months. “[Gold's] going to go much further [down] than people think.”

While gold stocks have recently pushed their 200 and 50 day moving averages higher, which is a bullish indicator, the threat that speculators are leading the way is ever present. And if the current recession takes a double dip, which we think is highly possibly (and so does Nouriel Roubini), investors around the world will flee to the dollar again. When the dollar gets propped up, gold falls. And when it starts to fall, you can bet these speculators will be abandoning ship just as fast as they boarded. This could leave you, dear reader, with a sinking boatload of gold in the middle of the vast and hopeless ocean.

Reason 3: More inflation hedges are available today. In the past, gold served as the best inflation hedge out there. In the 1970s when inflation started taking off, so did gold. People piled into the precious metal at rates never before seen, driving the price up to historic highs.

Fast forward to today, and you have a much different investing environment. Gold’s monopoly as the only inflation hedge is over. Now, investors have a wealth of options such as currency ETFs, TIPS, short US Treasury ETFs, other baskets of commodities, and stock in companies that can raise prices on pace with inflation. While none of these vehicles is the perfect inflation hedge, each attracts money away from gold. And the less demand for gold, the less upward price pressure there will be.

Reason 4: The run up in gold is based on fear, not on increased demand. Right now, owning gold is a “fear trade.” The price of gold is not up because people are buying more jewelry or Indian saris. It’s up because people are scared of hyperinflation taking over, the mountain of debt crushing the US, and the fiat money system collapsing. But what if Chairman Ben, and all his merry henchmen, are actually doing the right thing? While it is hard to say this with a straight face, what if everything returns to normal and we experience a nice V-shaped recovery? Or, more plausibly, what if deflation wins the day? Both these scenarios will have serious downward consequences on the price of gold.

So, dear readers, what do you think? Are any of these scenarios possible? Write to us at info@contrarianprofits.com

The Great Depression Speaks

The most notable example of what happens to gold stocks in a prolonged deflationary environment is the Great Depression. However, the United States was on a gold standard at the time, so miners had a guaranteed selling price – which was a good thing for them, because their operating costs were plummeting. So the comparability isn’t perfect, but let’s see what we can learn.

When the stock market crashed in 1929, gold stocks were part of the general wreckage (sound familiar?). The market then rallied and recovered almost 50% of its losses by April 1930, with gold shares again tagging along. It’s what happened next that gives us our first clue about deflation’s effect.

When the bear market resumed in the summer of 1930, all securities sold off again – except gold stocks. Gold shares stayed basically flat until early 1931, when they boarded the elevator and headed for the penthouse.

Let’s look at how shares of Homestake Mining, the largest gold miner in the U.S. at the time, and Dome Mines, Canada’s senior producer, performed during the Great Depression.

And the chart doesn’t show that you could have bought both stocks at half their 1929 price five years earlier, which would have led to gains of around 1,000%. And get this: both companies paid healthy and rising dividends as the depression wore on; Homestake’s dividend went from $7 to $15 per share, and Dome’s from $1 to $1.80.

Yes, volatility was high in the gold stocks throughout the depression, with occasional wild price swings, but after the 1929 crash most of the volatility was to the upside.

The bottom line is that the two largest gold producers – during a time of soup lines and falling standards of living – handed investors five and six times their money in four years.

From Homestake’s chart, you get a clear picture of what the stock did compared to the market as a whole:

You’ll notice the large spike down in both Homestake and the Dow during the 1929 crash… but then look at Homestake’s recovery immediately afterward, returning close to its old high. This is eerily similar to our recent pattern: our stocks sold off violently last October but have since doubled or more from their bottoms.

You’ll then notice that Homestake took almost two years to exceed its old high, but once it broke out, it was off to the races. The stock doubled four times in five years during a seven-year run to its peak after the ’29 crash.

The conclusion? If history is any guide, gold stocks can hold their own against deflation. And they could profit tremendously if the demand for gold as a safe haven continues to grow.

Gold vs. Deflation

On April 5, 1933, President Roosevelt issued an executive order forcing delivery (confiscation) of gold owned by private citizens to the government in exchange for compensation at the fixed price of $20.67/oz. And less than nine months later, he raised the gold price to $35, effectively diluting the dollar in every wallet 41% overnight and swindling everyone who had turned in his gold.

We don’t know exactly what an untethered gold price would have done during the depression, but given its distinction in history as a store of value, it’s likely to retain its purchasing power in a deflationary setting regardless of its nominal price. In other words, while the price of gold might not rise, or could even fall, your best protection is still gold.

But with this said, the overriding concern is that in a fiat system, any deflation will be met with an inflationary overreaction (as we’re seeing). And the worse the deflation, the more extreme the overreaction will be.

It’s for this reason that the editors of BIG GOLD urge you to own physical gold, in your possession and under your control, given its reliability as a store of value in both inflationary and deflationary environments. If you have less than our recommended one-third of your investable assets in some form of gold, check around for places to buy gold coins and bars at good premiums.

The Silver Lining

For those with an inclination toward silver, our research points to clear signs that silver is increasingly being viewed as a store of value and not just as an industrial metal.

Here’s a comparison of silver’s performance vs. base metals over the past six months (10-1-08 through 3-31-09), which includes last fall’s meltdown:

Silver               +6.7%
Copper            -36%
Lead                -18%
Aluminum        -35%
Nickel              -25%
Zinc                 -13%
GFMS Index*  -54%

[*Based on the average equally weighted settlement price for aluminum, copper, lead, nickel, tin, and zinc.]

If silver were viewed solely as an industrial metal, the price would be off sharply.

This doesn’t mean we think silver or silver stocks can’t go temporarily lower from here, but rather that the demand for silver as a store of value metal will be growing.

Bottom line: Whether we’re served debilitating deflation or insidious inflation, holding gold (and silver), along with an appropriate allocation of precious metals stocks, offers us both a fort for protection and a canon for profit.

Buying physical gold and silver as safe-harbor assets is for many investors a no-brainer at this point. But only a few have heard of another prudent gold investment – one that has gone up more than 50% in 2008, at the exact same time when the overall stock market bombed. You don’t want to miss out on owning this “48 Karat Gold” stock… click here to learn more.

Source:  Gold Stocks in a Depression

This from Ted:

As you know, I’m a gold bug. I’m quite bullish on the yellow metal. I have been recommending gold since 2001 and I expect gold to run much higher. You should own some gold in your portfolio as an insurance policy, just in case the economy gets worse.

Gold is a safe haven in times of financial and geopolitical instability. Gold has often been nicknamed the “crisis commodity” since it tends to outperform other investments during periods of market distress and world tensions.

I mentioned in previous articles that a great way to own gold in your portfolio is to buy the SPDR Gold Shares (GLD).

You can even generate some income on your holdings in GLD by selling covered calls against it.

This simply means selling the right for someone else to buy your GLD shares at a specific price (strike price) until an exact date (expiration date).

Therefore, if GLD were to go up in price – exceeding the specific price (strike) and the buyer of the call exercises their option, you have to hand over your GLD, but you still make a nice profit.

The investor pays you money (premium) upfront no matter what happens with GLD.

If your GLD shares never trade for more than the strike price, then you keep the premium and your shares in GLD.

You want to get lots of cash (premium) upfront and still be able to profit if gold heads higher. So I suggest selling covered calls with a strike price about 15 to 20 percent above the current price of GLD. I also suggest options that expire 4 to 6 months out.

The drawbacks are that you cap the amount you can make in the position, but you can buy GLD back if your position is taken away from you, allowing you to maintain your exposure to gold. Also, if gold goes lower you will lose money but you will still keep the premium that you received by selling the covered calls. Please consult with your broker before acting on this strategy to see if it’s right for your financial situation. I want you to fully understand how covered calls work before you proceed.

Covered call selling can be a great way to reduce the average cost for your GLD position and boost your overall performance.

You can even earn more income using this strategy than from some of the highest dividend paying stocks around. This strategy is very attractive because option premiums are high right now.

Source: Earn Income on Your Gold

I am always looking for some extra money with which to buy gold, and if I am ever successful without actually getting a job, I intend to buy some right away, as Bob Moriarty at 321Gold.com has taken a look at the XAU gold equities index compared to gold, and finds that a recent ratio of 0.182 means that today “is the most negative ratio of gold shares to gold in the last five years. This week the ratio got even more negative with the ratio plunging to 0.176. People simply hate gold shares.”

As a result, he says, “Since most profitable investors use contrarian opinion, the ratio is a screaming buy signal for both gold and gold shares.”

Mark O’Byrne, Executive Director of Gold and Silver Investments and writing at MoneyWeek.com prefers his statistics on the fundamental side, and even so, agrees with this analysis and says so in an essay titled “Why Gold and Silver are Table-Thumping Buys.”

He says that “Gold production is stagnating, and output in the leading gold producing countries continues to fall year on year, despite higher gold prices leading geologists to wonder whether we may have or may soon have reached the point of ‘peak gold’ production. The world’s biggest producer – South Africa – produced nearly 1000 tonnes of gold in 1980. This was down to 264 tonnes last year, the lowest since 1932.”

Even China is getting into the gold mining thing, as Chinainfoworld.com reports that “China Tops the World in Gold Output”, which is something that I did not expect. In fact, “The China Gold Association announced that China’s gold output was expected to reach 300 tons in 2008, surpassing that of South Africa and making China the world’s largest gold producer.”

In case you were wondering, China actually kicked our American butt a long time ago, as China “surpassed the United States as the world’s second largest gold producer in 2007 with 270.491 tons of output.”

As a result, Mr. O’Byrne concludes, “Gold and silver are cheap vs. many commodities and oil”, especially considering that “the long-term average gold-to-oil ratio is 15 to 1, or 15 barrels of oil to one ounce of gold”.

Today, he notes, the gold-to-oil ratio is down in the low 7’s, which is Very, Very Low (VVL). “At the higher end of the scale,” he reminds us, “gold has traded at over 30 times a barrel of oil.”

It is eerily similar, only more striking, with the oil-to-silver ratio! Silver is a screaming bargain!

With a sly smile, I realize he knows that I cannot calculate these kinds of things, so he helpfully adds “Should there be a classic reversion to the mean average of 4.4 in the ratio of ounces of silver per barrel of oil, then silver prices would rise to $30 per ounce! And silver is selling at less than half that price right now!”

With a burst of Mogambo Interpretive Thinking (MIT), I conclude that if there is one thing that you can count on in this crazy world, it is like Bill Bonner here at The Daily Reckoning once so famously said: “Things that are out of whack tend to get back into whack”, which I extrapolate to mean that things that sell for half their value end up costing full price.

So if now is not the time to buy gold and silver, when things are so seriously out of whack, then when is? Hahaha! Exactly!

P.S. To get The Daily Reckoning sent directly to your inbox, sign up for our free email newsletter, or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Source: Gold and the Out of Whack Economy

Gold shares have traded in a large channel since last September. It’s taking both the good and the bad at this stage. On one hand, there are the rising prices of bullion. Gold has moved up to US$930 just this morning. On the other hand, it has suffered from generally choppy share conditions.

The price action of the index illustrates those contrarian forces. The chart is a succession of fast moves in both directions. It’s a rangy market where no clear long-term direction appears.

We’ll see what our indicators think of that…

Between August and November 2007, the index rose by more than 55%. Two other attempts to break above 7,000 level failed. Those historical high points constitute the resistance line of the current trading channel.

The low was posted on April 30 just above 5,100 points, which is support line of the trading channel.

The technical indicators show that mixed signals argue for a further rangy trading price action during the coming weeks. For traders, there’s a lot of potential to pick up some gains.
The 14-day MACD is bullish. This, one of our favourite indicators, fell to a historical low levels at the beginning of May. Then it turned up and then crossed above the 0 line. The underlying index was clearly oversold. It argues for upward momentum in the mid-term.

A moving average crossover agrees. The 10-day MA crossed above the 50-day MA last week. It’s a buy signal for mid-term trend-followers.

The 5-day Stochastic Oscillator, however, respectfully disagrees. But it disagrees on a shorter time-scale. The oscillator says that gold shares have gotten a little hot in the last few days.

The signals may disagree, but the conclusion is clear. There’s money to be made in the medium term according to the charts. But you could perhaps wait for a decent correction before moving in. The next price target is perhaps 5,300 points a 38.2% Fibonacci retracement. Then traders will look to switch back to long positions.

Gabriel Andre
The Daily Reckoning Australia

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Source: How to Trade Gold Shares

Why exactly has this happened? Especially when commodity prices are soaring pretty much across the board. Aren’t the explorers supposed to show leverage to the underlying resource prices to which they seek?

History demonstrates typical long term leverage with exploration stocks. If gold goes up 20% you can reasonably expect the gold shares to perform at a multiple of that figure. At the present times the “juniors” aren’t even keeping up with rising commodity prices.

The ongoing global credit crunch is a primary reason for this disparity. The appetite for speculation has waned. Global players have sold off winning positions in order to create liquidity. Some suggest that hedge funds may be shorting the explorers. Whatever the reasons are, the anomaly won’t persist indefinitely.

Either commodity prices must fall or junior miners must rise and close the gap. I don’t see commodity prices falling significantly from present levels. They stand as protection against currency debasement which happens to be a growth industry these days. The US dollar remains at the epicenter.

Opportunities abound. Let’s look at a simple example in a company called Amera Resources (AMS:Toronto).

This portrayal is for demonstration purposes only. I personally own this stock. It is not in the Resource Windfall Speculator portfolio and this is not a buy recommendation.

That’s an ugly chart. The stock is going down on exceedingly low volume (15,000 shares this day). Amera’s 52 week high is $.41. It’s near its 52 week low of $.11. Amera has 34.5 million shares outstanding. At $.14 Canadian, that gives them an overall market cap of a miniscule $4.83 million.

Surely something must be fundamentally flawed with this company. But that’s not the case. They have money, excellent management and exceedingly promising projects in mining friendly South American countries. I wrote a series some time back on “The Perfect Resource Exploration Stock”: The Perfect Resource Exploration Stock, The Perfect Resource Exploration Stock: Part II, The Perfect Resource Exploration Stock Part 3: Anatomy of a Ten-Bagger.Amera fits the majority of the qualifications for such a title.

Buying high quality speculative stocks with a market cap of $5-$10 million is pretty much a “no brainer” from the perspective of savvy resource investors. It’s called ultra cheap lottery tickets. Say they prove up an asset valued at $300 million, for example. That would be 60X the current market cap level.

There are zero assurances of such an event transpiring. That’s why it’s called speculation.

Lots of market participants would be much more comfortable buying stocks at annual highs instead of annual lows. Low prices freak them out and they end up capitulating. Capitulation is pretty much rampant these days. I believe that’s what shows clearly on the Amera chart.

When the last sellers give up their shares the market then becomes dominated by buyers. The bottom is in. The market then heads back towards the next extreme. The fear/greed cycle is inherent within all markets. All the more so in the junior explorers. Some companies are selling at prices close to their cash on hand value.

Summers are typically dreary times for the juniors as well. Buyers are more interested in their tans and exotic travel than following stocks. Will the sector go even lower during this vulnerable time? It’s entirely possible.

Still, the downside seems dwarfed by the upside potential. It’s likely to be an historic opportunity for accumulation. What’s your long term view on commodity prices?

Invest Resourcefully,

Rusty

P.S. To let me know what you thought of today’s article, send an e-mail to: feedback@investorsdailyedge.com.

Source: They’re Giving Away Resource Stocks