Wednesday, December 16, 2009

A Safe Way To Trade The Tricky Gold Market

I realize that I've admonished readers from attempting to time what I expect to be a wild and woolly ride: Marko's Take: Gold Revisited: What To Do Now.  However, the strategy that I'm about to explain has nothing to do with trying to pick short term tops and bottoms. I discussed this approach very briefly in the blog cited above and I'd like to amplify on it today. 

Let's take two scenarios:  First, that I could be wrong as to my opinion that we are at a critical juncture and that one should buy with both hands.  Or, Secondly, that I've been indeed correct and Gold is concluding its bottoming process prior to vaulting much, much higher.

The way I'll know I'm wrong will be simple - Gold breaks $1,100 on the downside.  If this should occur, my advice is simple.  ABORT!  I would use that figure as a point of "stop loss", meaning that one should keep that figure in mind as a failsafe in order to prevent a potentially significant loss.  As of last night, Gold closed at about $1,125, so any losses could be kept to a minimum.

Now, let's humor the absurd possibilty that I'm indeed correct!  Here's my advice:  Let's assume that you have $100,000 to deploy.  Yes, I know, who has $100K?  However, I'm using that number for simplicity.

I've continued to recommend the Junior Gold and Silver Miner basket, which trades under the symbol GDXJ.  Step one:  Place the entire amount in GDXJ, which closed yesterday at $25.89 per share.  That would afford you nearly 4,000 shares.

Assuming that GDXJ rises in concert with Gold itself, begin the following process:  Let's say that your account rises to $110,000.  At that point, you might SELL $10,000 worth of GDXJ, thereby reducing your  basis to $90,000 while retaining the original $100,000 to ride.

Next, allow the $100,000 in play to reach $120,000 and then SELL $10,000 of GDXJ again.  As a result, you will have a basis of $80,000 (the original $100K minus the $20K you've sold).  In addition, you'll have $110,000 riding.

Keep repeating this process.  Once the $110,000 reaches $130,000, take another $10,000 "off the table".
Now your total maximum loss will be reduced to $70,000, while you'll be benefitting from a $120,000 on-going position.

This process should ultimately allow you to remove your ENTIRE original investment and have a substantial amount of dough "in play".  The reason that this method will prove invaluable is that once Gold does top, it is likely to turn on a dime and may very well come crashing down, wiping out one's entire gains.  Don't believe me?  Just ask one of the temporary "dotcom" millionaires who saw the Nasdaq fall by a mind-numbing 80%, which in some cases, wiped them out completely!

Had they followed a strategy similar to the one described above, they would have prevented losses and kept the bulk of their gains!

One important issue with this strategy regards the type of account in which it is employed.  For example, an IRA is ideal as it avoids short and long term capital gains accounting.  However, I'm not an accountant, and everyone's situation is unique, so it might be a good idea to consult with a tax professional.

I realize that this process may be cumbersome and is in complete contrast with famous investors like Warren Buffett, who advocate a long term buy and hold strategy.  However, the Gold market, in my opinion, is in the second and possibly FINAL stage of a bona-fide mania.  Mr. Buffett, to my knowledge, avoids participating in manias altogether.  However, things are tough and following this strategy in Gold at this time, may literally prove life changing!

During the second phase of the last mania in Gold, a bottom was reached in January, 1977, at $120 per ounce.  The ensuing high was reached exactly 3 years later at $850 per ounce - a 7 fold gain!  As to the current mania, the latest major low was reached in November, 2008, at roughly $700 per ounce.  Applying the historical precedent, a similar gain would project to $4,900 per ounce by 2011!!!

I hope you found this piece useful and informative.  It ought to be interesting. Who couldn't use some dough these days?  If you have comments or questions, please leave them in the section below.

Marko's Take


Take me on!