Making Friends With Precious Metals

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The stock market continues wobbling today, as gold and silver continue soaring – gold has jumped almost $30 an ounce over the last two days to a new all-time high of $1,485.00, while silver has popped almost two dollars to a new three-decade high of $42.75 an ounce.

And the show is probably not over yet…

Your editors here at The Daily Reckoning have been long-standing – and sometimes long-suffering – fans of gold and silver. And yet, even they are amazed by the robust price action in the precious metals pits. Like watching a hotdog-eating contest, you know ahead of time what you’re going to see. But when you actually see it up close and personal, the images before your eyes are still hard to believe.

Most financial market observers say the precious metals are “way overbought.” This hotdog-eating contest is over, they insist, and the folks who have gorged themselves on gold and silver are likely to suffer severe indigestion.

Your editor’s disagree. The precious metals markets will certainly digest their gains. But indigestion is the fate that awaits Treasury- bond buyers and dollar-holders, not gold-holders.

“The trend is your friend,” as seasoned investors like to say…and few trends are friendlier at the moment than the upwardly sloping trend of precious metals prices.

Ironically, this friendly trend results directly from one of the unfriendliest trends of all: the dollars in your pocket are losing value as quickly as a freshman Congressman loses credibility.

The dollar’s bearish trend is well established…and actively nourished by the Federal Reserve itself. Ben Bernanke has promised to erode the dollar’s value…and we believe him. So does billionaire hedge fund manager, John Paulson.

Gold will continue to rise, Paulson predicts, “in proportion to the creation of paper dollars… In these times of uncertainty for paper based currency, I feel more secure in holding gold; [it] offers good protection against the paper currencies devaluation and even the possibility of generating a return.”

Putting his money – and his clients’ money – where his mouth is, Paulson has amassed sizeable positions in various precious metals investments.

The Paulson Fund’s number one holding, representing 15% of its assets, is the SPDR Gold Trust (NYSE:GLD). The fund holds more than 31 million shares of GLD, along with 41 million shares of Anglogold Ashanti (NYSE:AU) and large positions in Gold Fields Ltd., Kinross Gold Corporation (NYSE:KGC), Novagold Resources Inc. (AMEX:NG), $40 Million of Randgold Resources (NASDAQ:GOLD), and Barrick Gold Corp. (NYSE:ABX).

Importantly, Paulson is not trading his gold positions, he is simply amassing them. Perhaps there is a lesson there.

The high day-to-day volatility of the precious metals tempts some of us non-billionaire investors to trade in and out of them. Probably, that is a temptation worth resisting.

Recently, an acquaintance made one of the best investment calls of his life…and one of the worst trades of his life. He did both things at the same time in the same market.

Sometime around last Halloween, this acquaintance concluded that silver was poised for a major move to the upside. The move he anticipated was so major, in fact, that he decided to purchase call options on silver, rather than just buying and holding some silver.

He loaded the boat on call options – buying various strikes with various expiration dates between November 2010 and April 2011. He established his largest position in far-out-of-the-money April calls. Hold that thought.

The friend booked small profits on his November and December options. But then his fortunes turned south. After hitting about $31 an ounce in early January, the silver price tumbled toward $26.

This sharp, swift correction wiped out his January and rendered his February calls almost worthless. He lost a lot of money. He panicked. As silver rebounded from its February lows, he salvaged what he could from his disastrous trade by unloading his February options for a large loss and his April options for a small loss.

Silver continued rallying…and rallying…and rallying. The friend watched. (Perhaps he cried privately). Today, the April options he sold for no gain are worth about eight times his original purchase price.

Too bad he traded silver, instead of simply buying it.

Your editor’s friend is a big boy. He won’t rue his unfortunate trade for long. But most of us probably would.

Bottom line: Silver, like gold, is money. Silver and gold are hedges. They are “anti-dollars.” So if it’s anti-dollars you want to own, just own them.

Eric Fry
For Daily Reckoning Australia

Eric J. Fry
Eric J. Fry has been a specialist in international equities since the early 1980s. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short- selling. Mr. Fry launched the sometimes-abrasive, mostly entertaining and always insightful Rude Awakening.
Eric J. Fry

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Comments

  1. I’m so glad to see silver on the rise and doing so well

    Francis Bart Bertholic
    April 19, 2011
    Reply

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