What the BLEEP is Going on With the Euro?

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Stocks started off strong Thursday morning, with the futures edging out new highs prior to the cash market open.  And then it happened.  Wham!  The futures got whacked and the Dow was down over -100 points in the blink of an eye, and kept heading lower all day long.

What happened?  A terrorist attack?  A bomb?  Justin Bieber’s concert tour canceled?

No.

What happened is that the ECB (European Central Bank) made a quick announcement.  They said, and I quote:

“We have no immediate plans for a large-scale purchase of government bonds.”

And that’s all it took.

Why?

This is a move investors had been hoping for to help ease the region's debt crisis.  Simple as that.

Why is this a big deal?

"Markets regard the summit as a final chance to save the euro," strategists at Credit Agricole CIB said in a research note.

The bottom line is that there are serious problems going on in Europe and this mess continues to unfold.

The interesting dilemma though is that this action pushes the US Dollar higher – and it could propel it much higher.  The problem here is that this is bad for gold and silver.  As the US Dollar goes up, the value of gold and silver goes down in US Dollar terms.

So is it time to dump all of the gold and silver coins we’ve been buying?  The good news is this: Absolutely not.  In the long term all fiat currencies are in trouble and it’s important to have some liquid, tangible assets such as gold on hand.  That said, it’s no fun holding onto an asset, tangible or not, that is going down.  Don’t worry; there is an easy fix to this.

The fix is to buy put options on the following exchange traded funds: GLD (gold) and SLV (silver).  These ETFs track the metals prices tick-for-tick.  As they move lower, so will the ETFs.  This way, as the price of your physical gold and silver is falling, your put options are making money.

Depending on how many you buy, you can offset this loss nearly to the dollar, or just make it a bigger trade and make more money on the put position than you are losing in your falling bullion hoard.

But what about gold and silver stocks?  Couldn’t you just buy put options on those in order to hedge your bullion?

In a word, no.

I know that sounds crazy, but the price of the actual metal can sometimes have little to do with the price of a gold or silver stock.  The reason for this is simple: Hedge Funds.

Hedge funds like to “hedge” their bets.  If they are long gold and silver metals, they will short gold and silver mining stocks.  This way, if the price of the metals plummets, they are at least hedged by their short positions on the mining stocks.  The problem with this is that as they are creating the hedges it creates a disparity in price.  That is, you could see the price of metals rise, while the prices of mining shares fall, and vice versa.  This can be financial painful at worst, and frustrating at best.

That’s one reason.  The other reason is this:  Stock markets love, love, love, quantitative easing.  Essentially what the ECB said today is that they aren’t going to be doing any quantitative easing.  This is going to hurt stock prices overall.  And if stocks in general start falling too far, too fast, then it takes down all stocks, including the mining stocks.

Why is this?

Even if the price of gold is going higher, and even if we are in a period where hedge funds aren’t messing up the markets creating hedged positions, there is one remaining factor.  In a down market, people who loaded their portfolio to the gills on margin get in trouble.  When they get in trouble they are issued a margin call.  And when they get a margin call, they have to sell everything in their portfolio – including the mining stocks they would like to keep.

The bottom line?

It’s time to buy those put options on GLD and SLV for the short term.  This works both as a straight trade as well as a way to hedge your physical gold.

And in the meantime, it might be a good idea to pick up some Euros as souvenirs before it vanishes . . .

Successful investing,

John Frederick Carter

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