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| Low Prices Could Be Curing Low Prices in Gold, Silver |
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It is no secret that the raging bull market in commodities has been caught in the teeth of a bear in the second half of 2006. The rapid advance in prices in everything from gasoline to sugar eventually hit a point in the demand continuum where consumers cried “enough!” It is a base concept of economics. Eventually, in any bull market, prices will reach a level where higher prices will cut demand and thus, prices begin to recede.
When this happens, as it has recently in markets such as crude oil, sugar and silver, speculative funds who generally follow trends will tend to jump on the train and begin liquidating positions as the trend reverses, oftentimes accelerating the descent in prices. Eventually, however, this phenomenon begins to work in reverse as lower prices begin to spur demand, thus increasing price and the cycle begins anew. Despite the media, who now sit firmly on board the bear market bandwagon, we think this level is close to being attained in a variety of commodities, including silver, gold, natural gas, sugar, and copper.
Picking the bottom of a market can be tricky, however. Trying to buy futures contracts at the end of a trend can be a frustrating (and sometimes costly) endeavor. However, it can be a situation custom made for put selling. And of the markets mentioned above, the volatility in gold and silver appear to make them the most ideal candidates for writing put premium at the present time.
Although there is a degree of loose correlation between several commodities markets, prices of each individual commodity tend to answer to their own fundamentals. Thus, one cannot say that all of the commodities ran into a bear market at the same time, any more than one can say that all commodities have participated equally in the bull market. This also uses the term “bear market” quite loosely. There is a big difference between a bear market and a bull market correction. At this point, we are nowhere close to a real bear market in commodities. Although there have been some rapid price declines during the last few months in several markets, a look at the longer term commodities index should help one to put these declines into perspective. Although the future remains to be seen, we presently appear to have nothing more than a short term correction.
Investors, and to a greater degree the investment media, are a finicky bunch that despite all of the conventional wisdom they preach and tend to focus on the short term and disregard the longer term. The focus on the recent deflation in crude oil prices along with a handful of other commodities has everyone talking about the fallout from the “bear market.” Yet, the error of this type of thinking is that this rapid commodities price decline, especially in how it relates to crude oil, is exactly the catalyst to fire up world demand into the fourth quarter of 2006. While the rapidly expanding world economy may have taken a breather over the last several months, the world is not much different, at least economically, than it was at the height of the commodities boom.
Oil at $65 a barrel (or lower), will not only provide more disposable income to the US population, it will spur global economic growth which, combined with already lower prices in other commodities, should begin increasing demand for these commodities. Thus the very bear market in oil that is so widely discussed is exactly the catalyst to reverse the waning demand in industrial commodities.
The Chinese economy, widely touted as one of the main engines that drove the fierce bull market in copper, may be one of the first coming back to the table. Although copper prices held up rather well during the last 6 months, prices have nonetheless receded as Chinese buyers were unwilling to pay the high price producers demanded. But there are early signs that copper may be reaching value levels making it more attractive to buyers. China’s ministry of commerce announced this week that China’s copper demand is expected to grow 5.6% this year to 3.8 million metric tons. This is a substantial increase from last month’s estimate of only 3% growth in 2006. Copper bulls eagerly awaiting China’s return to the buyers table may get their wish in the 4th quarter of 2006.
But copper options don’t seem to offer the liquidity or the premiums that can be found in the option pits of it’s more glamorous cousins, silver and gold.
Our view is that if commodities are indeed in only a corrective phase, the metals markets could be the first to begin leading another advance higher. Despite mild concerns about this week’s US GDP report (for the 2nd quarter – when oil prices were testing the $80 level), we remain moderately bullish the US and World economies, especially with energy prices seeming to have come “under control.” This week’s surprise increase in new home sales readings supports our views.
While copper is used primarily as an industrial metal, gold is more of a financial market than industrial with it’s value influenced by currency fluctuations, interest rates and geopolitical events. Gold’s primary physical use is in the making of jewelry. Silver borrows attributes from both copper and gold in that it’s price can be swayed by industrial or investor demand. However, unlike gold, roughly 45% of world silver demand is for industrial use. Therefore, if global economies are indeed benefiting from lower oil prices in the 4th quarter, industry should be the first to benefit, spurring the demand for silver over gold.
We like silver as a market for selling puts, in that, one does not necessarily have to see prices move higher to profit. For sellers of puts, the market must only remain above the put option’s strike price through expiration. The market appears to have breached a solid value level and prices seem hesitant to push much lower than the $11 price range. With commercial buying coming into the market at these levels, we foresee an increase in Chinese and Indian demand close behind.
While we will not go as far as projecting a wildly bullish advance in silver in the 4th quarter, we feel it a solid bet that silver prices will remain above $9.50 an ounce for the foreseeable future and believe selling put premium below these levels is an excellent strategy for 4th quarter income. Implied volatility left over from the price moves of the last 90 days leaves attractive premiums still available in these puts.
We will be working closely with client portfolios in the coming weeks in the positioning of this trade.
For more information about selling options
in the silver market or building an option writing portfolio,
feel free to call or request a free information package
at www.optionsellers.com.
James Cordier
Michael Gross
Liberty Trading Group
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The information
in this article has been carefully compiled from sources believed
to be reliable, but it's accuracy is not guaranteed. Use it
at your own risk. There is risk of loss in all trading. Past
performance is not necessarily indicative of future results.
Traders should read The Option Disclosure Statement before
trading options and should understand the risks in option
trading, including the fact that any time an option is sold,
there is an unlimited risk of loss, and when an option is
purchased, the entire premium is at risk. In addition, any
time an option is purchased or sold, transaction costs including
brokerage and exchange fees are at risk. No representation
is made that any account is likely to achieve profits or losses
similar to those shown, or in any amount. An account may experience
different results depending on factors such as timing of trades
and account size. Before trading, one should be aware that
with the potential for profits, there is also potential for
losses, which may be very large. All opinions expressed are
current opinions and are subject to change without notice.
Liberty Trading Group
401 East Jackson Street
Suite 2340
Tampa, FL 33602
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