Low Gold Price a Buying Opportunity

April 06, 2009 | By: Hard Assets Investor

Real-time Monetary Inflation (per annum): 8.1%

You could just see things ending badly for gold Friday. April COMEX gold settled at $895.60, near the low of the day, after near-term momentum turned bearish. This morning's trade looks weaker still after London dealers marked bullion at $879.50.

Another soft New York close will likely set up a test of longer-term support at the 100-day moving average, now at $869.70.

COMEX Spot Gold

London's gold spreads, too, are painting a rather dreary tableau for bullion. The 12-month contango is shrinking against that of three-month forwards after gold's previous run-up yielded only modest gains for bull spreaders.

Throw in the narrowing of credit spreads and the current resurgence of the equities market and the indifference to the metal is palpable. The three-month TED spread – that is, the difference between U.S. Treasuries and the London Interbank Offered Rate [LIBOR] – dipped below 100 basis points (1%) last week for the first time since February 26. The spread's downward momentum through the week reflected an easing of the worries that had driven so much capital to seek the shelter of gold.

London Gold Forward Spread (3-Month Vs. 12-Month)

That's not to say that gold's run is over or that we've finally turned the corner on the financial crisis. There's an ebb and flow to any market, even those that are strongly trending.

A market like this, in fact, seems to be providing opportunities for gold buyers with modestly bullish sentiments. Some were seen this morning trading gold puts on June COMEX contracts.

With June gold at $880, the $850 puts changed hands at $26 an ounce. Put sellers gave buyers the right to put, or to sell, June gold futures at $850 through May 26. For taking that right, put buyers paid a per-contract premium of $2,600.

Here's the reason the put sellers took on the risk. It's unlikely that the puts would be exercised until, and unless, June gold dipped below the puts' $850 strike price, so the put sellers either hold a conviction that prices will remain above that level, or, if they in fact sink through it, that the excursion will be short-lived.

If the puts remain out-of-the-money for the next month, the sellers get to keep the premium and the put expires unexercised. If futures are instead put to the option grantors, they'd end up with a long position at an effective purchase price of $824. Subsequent price advances in June futures above $824, if they occur, would engender gains for the option writers. Of course, losses would be open-ended if prices collapse.

More glass-half-full optimism brought to you by your friendly neighborhood options marketplace.

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