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Obama's Stimulus Will Send Gold and Gold Stocks Into the Dustbin

Commodities / Gold & Silver Stocks Feb 25, 2009 - 09:57 AM GMT

By: Oxbury_Research

Commodities Best Financial Markets Analysis ArticleWe've been stressing the point ad nauseum for roughly a month now that what's necessary to get markets in gear and put the money back to work is theater, financial theater, and it appears we're about to get it. Today. Finally.


For those who are tuning in late, here's the skinny: the market has done exactly nothing since September/October. It's drifted sideways, as we said it would, and will continue to do so until confidence is restored within our financial system and the economy of the United States in general. Mr. Obama tried to avoid giving it to us for as long as he could, and that we understand. A simple matter of politics. Better to let the outgoing administration bear the brunt for as long as possible, then send in the underlings to buy some time (Geithner, et al.). And if the money that's been spent and the plans that have been revealed still don't get things turned around, fine. Then the boss can step in.

Bottom of the Ninth

Plan A failed, and now it's crunch time. Barack Obama must now step up to the plate and let one crack. We're in the bottom of the ninth of a game that has no end. Can we hit foul balls forever? Eventually the fans will all leave; the broadcasters and stats keepers will tire and go home. Even the two teams will go into the clubhouses and sleep while pitcher and batter face off ad nauseum . And this is the way we circle the market merry-go-round.

It can't be. The cameras are about to go on and record the speech that will ring in (in Edgar Allan Poe's memorable words) either a “world of merriment” or a “melancholy menace.” We are at the turning point that will signal a market rally or utter financial ruin. And it all depends on Mr. Obama's delivery.

In past installments on this matter we voiced our confidence that the rhetorician would be up to the task. We still believe him to be so. And let's make no mistake that that's what's required here: feel good theater of the grandest political variety. Nothing more. Buyers will emerge when confidence is instilled. The Bernanke/Paulson botchings – however ridiculous they looked – stanched the bleeding. Just look at the market charts; the bloody thing has moved exactly sideways since the September/October plunge. But here we repeat ourselves. In short, there's been no move down because the selling is over. Whether the buying begins is in the hands of a showman who happens also to be the President. Let him have some game tonight, or we're all through.

“And now the gold is shattered by the force of Obama's blow.”

That said, if you plan on holding gold positions through tomorrow, you'd better think again.

A successful ignition of equities will send gold and gold shares to the dustbin. Not because gold and gold shares are worthless investments – on the contrary: because they are the safest harbor to pull into when seas are raging. If investors perceive the storm has passed, they'll pull up anchor and set sail for the most exotic shores they can find. This is a risk-ready crew a'waiting, and they're fixing for equity island.

So what to do for those of us who are genuine gold-philes and believe in the long term prospects of the shiny yellow stuff? For starters, keep buying bullion coins regardless the price. But if you can't – if your only options are ETFs and mining shares – it's time to do a little hedging.

Take a look at the chart:

This is the London daily gold fix for the last two years. It's a little different from the NYMEX gold futures chart, and since we've discussed the benefits and pitfalls of charting both in past installments, we won't bother getting into it here. Suffice to say it's a fair reading of gold on a daily basis.

The chart shows three runs at $1000 gold, two of which proved unsustainable and a third which appears to be faltering as we write.

Not only this, but despite the rise in bullion, gold shares, too, have been weak. Look here:

We can argue whether the HUI is truly representative of gold shares, whether the XAU is a better proxy, or GDX, or the Toronto Stock Exchange's XGD – but why bother. The shares have failed to keep pace with bullion as the chart above plainly indicates. That means gold is losing steam. It means that gold shares, which are supposed to be leveraged to the gold price, don't believe the current rally in bullion. Let the numbers prove me wrong.

That being the case, gold holders need protection, and it can be gotten in a number of ways.

  • First, by selling calls against your current mining shares. If you're not going to sell at this point, it makes sense to collect some income off the buggers as they fall – reduce your purchase cost as well. And if we're wrong and the shares rise, you'll still profit when your shares are called. Go out to April and sell roughly 10% out of the money calls.

Or:

  • Sell the bullion and buy the miners – a sort of arbitrage that sees a profit as the gap between the two closes. Buy puts on GLD and calls on GDX. Get the longest dates you can find.

Or:

  • Just buy some calls on the Proshares UltraShort Gold ETF (GLL) . That should offer you some rather inexpensive ultraleveraged insurance on gold shares dropping.

All in all, we're for gold. It's the only real money out there. But in the meantime we're against dead money. And that's where your gold stock investments may be for several months if Mighty Casey bats one out of the park.

Now go mix your metaphors.

Disclosure: no positions

Matt McAbby
Analyst, Oxbury Research

After graduating from Harvard University in 1989, Matt worked as a Financial Advisor at Wood Gundy Private Client Investments (now CIBC World Markets).  After several successful years, he moved over to the analysis side of the business and has written extensively for some of corporate Canada's largest financial institutions.

Oxbury Research originally formed as an underground investment club, Oxbury Publishing is comprised of a wide variety of Wall Street professionals - from equity analysts to futures floor traders – all independent thinkers and all capital market veterans.

Copyright © 2009 Oxbury Research - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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