HardAssetsInvestor

Written by Brad Zigler  |

October 29, 2009

Gold On Sale?

Details

When was the last time you caught sight of an item displayed in a retail store or a catalog and thought: "Gee, I'd buy that if it ever went on sale"?

Perhaps you've noticed the discounts now being taken on gold. On Wednesday, the lead December COMEX contract settled near $1,030 an ounce, more than $40 off its recent peak.

COMEX/NYMEX Spot Gold Settlements

Is a 4% reduction enough to entice you to buy gold?

A lot of would-be buyers are waiting for bigger discounts. Those with a sense of history look at the December gold contract's track record and figure a pullback to the $1,009 level is needed to attract new buying interest. Those who feel the market's been more overwrought are eying a dip to $989 before sellers are washed out.

In either case, they're putting in limit orders just under these price levels to snag their anticipated bargains.

Now, the good thing about open limit orders is this: You get filled only if the contract is offered at or below your limit price. The order forces you to wait for your discounted sale price (don't you wish you could do this at Macy's?). No discount, no purchase.

That's also the bad thing about limit orders. If the market doesn't drop to your limit price, you're shut out. Well, shut out of an automatic purchase, that is. If you set $989 as your limit, only to see December gold dip to $1,009 before rebounding, your limit order remains unexecuted. If you wanted to be a gold futures buyer, you'd then have to consider canceling your limit order and purchasing futures at the market price.

There's no compensation offered for waiting around, hoping for further price concessions. Not directly through futures, anyway. There is a way to get paid, however, through the options market.

Suppose you'd sold short a December gold futures option with a $990 striking price. As you may know, the buyer of a put option obtains a right, but not an obligation, to sell (to "put") the contract's underlying asset to the put grantor at the exercise price. It's profitable for the put buyer to exercise the option when December futures fall below the $990 strike price. Until, and unless, futures decline below that threshold, the put seller has the advantage.

Why? Because she received the buyer's premium when the option was granted. Wednesday, the $990 December put settled at $5.70 an ounce, in essence offering sellers a $570 payment for a $990 limit order.

If the December contract never dips below the $990 strike by its expiration date, it will likely be abandoned by its owner, allowing the grantor to pocket the $570 premium as profit.

And the risk on the other side? Getting assigned a long futures contract if the market drops below $990. That was, however, pretty much the same risk anticipated by placing a regular limit order on December gold futures at the $989 retracement level.

Knowing this, the question for would-be gold buyers now becomes this: Do you want to get paid for bargain-shopping or not?