In the past few weeks, gold has held up against the $1,500 level, and in the past few days it’s been on the rise.
Meanwhile, gold stocks have performed even better in the past few weeks. Perhaps the underperformance of gold stocks relative to gold over the past few months may be coming to an end. Many companies in this sector are trading at some pretty cheap valuations for gold at $1,500.
That’s why I recently bought some shares of the Market Vectors Junior Gold Miners ETF (GDXJ). With a basket of midcap producers and explorers, it’s well-poised to move upwards without the problems of a single company or the possible liquidity problems of a junior miner.
I faced two problems when making my purchase familiar to most investors: gold stocks are pretty volatile, and I’m cheap.
Fortunately, I didn’t pay retail.
When I bought shares, I simultaneously sold calls against the position. It’s a variation on covered-call writing known as a buy-write. Since selling calls lowers the cost basis, I essentially bought my shares about 9 percent below market price. That gives me a bit of protection if gold stocks start trending lower.
Yes, by selling calls I limited my upside. By my calculations, I’ll make a 16 percent maximum profit in the next six months. If I can do that again with another stock or ETF, I’ll be making a little over 30 percent per year.
But what if gold stocks take off and I get stopped out more quickly? If I get stopped out in two months, my return becomes a staggering 101 percent annualized. Of course, to get that actual return, I’ll have to keep finding such opportunities. But it’s a big market, and they’re definitely there.
Ideally, the ETF will end up slightly higher, but below where I sold calls. The calls will expire worthless, and I’ll be able to sell some more.
The overall market is at a crossroads. It could fall if debt ceiling woes get worse, or rise if the Fed decides to do more monetary easing, buy-writing the gold sector hits a tactical sweet spot. There’s some safety on the downside thanks to today’s hefty premiums, but I won’t miss out on gains if markets rise.
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