The global slump has caused sharp sell-offs in nearly all commodities as demand has slowed and investors have been forced to liquidate positions to raise cash. Gold has been hit by this trend, but I think gold prices will rebound in 2009 as we start to pull out of recession, and recommend setting up positions in 2009 gold futures and options. If you’d like to possess the physical product, Lind-Waldock can even help you take delivery of gold through the COMEX division of the New York Mercantile Exchange.

With all the bad news about the economy over the past few months, I’ve been asked why gold and silver prices aren’t exploding. That’s certainly a good question. Gold in particular is seen as a “safe haven” investment that individuals have flocked to in past times of turmoil. Let’s look at the environment we are in to help answer this question.

As the stock market was rising at the start of 2008, five-year Treasury note futures were selling off, as you can see in a continuous chart. At that time, everything was more or less ok with the economy and the Federal Reserve was worried about inflation. Then credit started to tighten. The pattern on the chart shows double-bottom pattern. The second bottom tends to flush out weak longs and stops.

The interesting thing about this chart is that it shows serious credit tightening, and when credit tightens, you see less spending. Housing starts dropped 4.5 percent in October, retail sales fell a record 2.8 percent, and housing prices are falling farther and faster than mortgages outstanding. People are becoming scared and hoarding cash. This is an important concept in understanding why gold has been in a deep sell-off. When people start to hoard cash, it creates a bull market in the U.S. dollar. And when you have this type of credit tightening, it slows the countries economic growth. You can see it reflected in the retail sector, in manufacturing, and in news of layoffs from companies like Citigroup recently. We’ll also likely see companies start announcing bankruptcies, consumer confidence will drop, and gross domestic product will contract.

The reason the gold and silver have sold off so much is because when you have a recessionary environment, consumers and businesses spend less, and we start seeing widespread price deflation in goods and services. You can spot deflation when you look at markets that are typically non-correlated to each other and are moving down in tandem, or when you see markets that should be bullish; that is, they have supply issues that should generate bull markets, but aren’t reacting the way they have in the past. Crude oil is a perfect example of the later. While a slowdown in global demand has been blamed for pulling crude oil lower, it is still a limited resource that is still in need globally. Traders are selling, no matter what news or fundamentals are reported. The market is in freefall mode, without much of a bounce at all. There have been a lot of developments in the crude oil market that would’ve caused a spike higher in previous times. Bullish news has been ignored, and that’s a sign of deflation. An example of an uncorrelated market to crude oil or gold would be cattle, which is bearish as well and shows similar chart patterns. The market has been selling off with little upward movement. Margin calls, panic selling and hedge fund redemptions all are taking place, and causing liquidation of commodities as well as stocks.

See how trends in various commodities are similar in the chart below. The green line represents coffee, the black line represents corn, and cattle is in red.

Another question I’ve had is why the U.S. dollar is rallying if the economy is in such bad shape. Other countries have been faced with similar troubles we’ve seen in the U.S., only they are in an earlier stage of the cycle and their interest rates haven’t come down as much as ours have. Credit is tight and they’ve been unable to export or import goods or services, so their currencies are selling off in greater degree than the U.S. Many commodities are priced in U.S. dollars, so we typically see opposite trends in the dollar and many commodities, such as gold and crude oil. See the chart of the ICE Dollar Index contract below.

Looking at a daily chart of gold, you can see how the market is essentially ignoring any outside bullish fundamental developments (similar to crude oil) and is selling off almost artificially, in my opinion. We have seen reductions in interest rates and a stimulus package pass in an effort to boost the economy, loosen up credit, and get the stock market back on track. But these measures haven’t had much of an impact yet.

Policymakers are injecting billions of dollars into the system, and we are seeing the potential for corporate bailouts such as in the auto industry too. Everyone wants a life raft. The government is going to have to start creating money, and that’s likely to create mass inflation in the long run. Interest rates have been moving lower on a global scale, and that should pump money into the system eventually and loosen up credit. I think that has the potential to cause massive inflation down the road, and we’ll shift from an environment of deflation to inflation. What the government is trying to do it create capital until the credit markets unfreeze, and consumers and business can finance debt.

As a trading strategy, I would take a look at gold and silver as a way to hedge against inflation down the road. Gold has been in a bull run since about 2000, and although we’ve had a sell-off recently, I think the market will head back to its 2008 highs above 1,000 an ounce, and possibly up to 1,250. It might take a while, so I recommend looking at a long-term bullish strategy incorporating gold and silver call spreads. I like options for a long-term trade like this, as they offer you defined risk and plenty of wiggle room in case the market doesn’t immediately move in your direction. When you buy an option spread, the margin requirement is the amount you pay for the spread.

Consider the December COMEX gold 900/1000 call spread, which expires on November 28, 2009. I’m looking for gold to remain bearish for a while longer, then make a move to the upside next year. You would have the right to hold a long gold futures position at $900, and your risk is what you paid for the option. To help finance the $900 call, you can sell a $1,000 call and collect the premium. Your upside profit is capped with this trade, but it offers an attractive risk-reward ratio and a nice $100 price spread. You can also consider buying a December 2009 silver $12.50 call; you can sell a $16.50 call for a similar bullish silver strategy.

We’ve seen a serious lack of confidence in the system, and that’s forced investors to abort some of their positions to meet margin calls and raise cash. I think the stock market’s fall somewhat artificially sunk gold. Investors tend to sell their winning trades and hold onto to losing trades to try and pick a bottom, which isn’t the wisest of strategies. A lot of people are right about the direction, but wrong about the timing, so that’s why I want to overshoot on the amount of time for these trends I expect to take shape. If the stock market rebounds, confidence will return and people will remember how gold had worked well in the past as a diversifier and a hedge against inflation.

In terms of other metals that are more industrial in nature, like platinum and palladium, I don’t think we’ll see prices turn bullish until industrial production increases, in tandem with consumer demand. These metals are heavily tied to the auto industry, which is in a perilous position right now as we know. Copper, an important material used in housing and construction, has also been depressed, and won’t likely start rallying until we see the credit market expand, the housing industry bottom, and expansion occur in countries which are heavy commodity users, such as China. It could be until the second quarter 2009, or the summer, until some of these fundamental factors start improving. That’s why the recommendations I’m making are going out until 2009.

In addition to trading metals futures and options, you can also consider taking delivery of the physical products if you’d like to own them. In order to take delivery of gold or silver as contract expiration nears, you would be required to have the full contract value deposited in your account with Lind-Waldock at the price it was purchased. The COMEX gold contract is a 100-troy ounce contract, so if the price on the front-month gold futures contract is between $695 - $735 per ounce, the full value of the contract you bought would be $69,500 - $73,500.

Once the contract is delivered to you, it is in the form of a certificate. Most of our clients will have Lind-Waldock hold the certificate for them so they can sell the contract(s) back into the market at a later date if they wish. Lind-Waldock can send you the certificate as well. In either situation, the costs for taking delivery would include your commission charge, a delivery fee, and if you’d like the metal held in a designated storage facility, an additional storage charge.

Taking delivery is not a common occurrence in the futures markets, and there are a number of considerations and details you would need to know about the process that are beyond the scope of this article. Please contact me for more information if you are interested in learning more about the ways you can participate in the gold and silver markets.

Phillip Streible is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 800-803-8037 or via email at pstreible@lind-waldock.com. Ask about our special half-off commissions offer for new clients.

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.

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