Gold Market Correction

Gold Market Correction: The Perils of Hyperactivity
by Eric J. Fry
The Rude Awakening
Wall Street, New York
Thursday, December 15, 2005

Eric Fry explains the perils of jumping off a Gold Market Correction during an overall bull market.

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[A quick one from Joel: The second Rude Group Research
Project is in full swing.

In Tuesday's issue of your Rude Awakening, Eric, Dan and I
solicited your vigilant eye and diligent work ethic. We
asked you to send in your favorite gold acquisition
targets. With the gold bull on the charge, we want to know
what smaller gold companies are the most attractive take-
over targets. The only qualifications are that they have a
market capitalization greater than $250 million and,
please, no inside information.

Your semi-asphyxiated editor is actually typing from under
about three cubic meters of emails printouts, here in icy
Baltimore. We have been working around the clock, like
madmen obsessing over building an army of robots to take
over the world. We have been sorting, stacking, reading,
organizing and filing. O.K., so a little hyperbole there...

We do have some great ideas from rude readers, eager to
help us fill Friday's column so I can recover from Thursday
night's Agora Financial happy hour and Eric can rise early
and do some sightseeing around Baltimore.

If you have a golden suggestion, please send it to me here
at aussiejoel@the-rude-awakening.com and don't forget to
check out a selection of the best ideas this coming Friday.

Now, more from Mr. Fry about everyone's favorite shiny
yellow metal...

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The Perils of Hyperactivity
By Eric J. Fry

Sometimes the very best trades are the ones you DON'T
make...especially in a bull market.

"Gold is overbought," CNBC incessantly reminds us, which
means that the precious metal is supposed to "correct" for
a while...And so what?  What's the smart trade to make in
this circumstance? Our guess: No trade at all.

Bull markets often correct from time to time...But that
doesn't mean an investor should abandon well-reasoned,
long-term investments. America's public libraries contain
very few biographies about individuals who made fortunes by
capitalizing on counter-trend sell-offs in a bull market.

Most successful investors position themselves for long-term
trends and ignore everything else. If they react to the
short-term sell-offs at all, they do so as buyers, NOT as
temporary sellers.

A weekend conversation reminded me of this reality...
"Hey Zack," a successful investor asked the options trader
to my left at a weekend social gathering, "where are you
seeing the cheapest options on gold stocks right now? On
the XAU Index?"

"Nah," the broker replied, "XAU options are expensive now.
In fact, they're often expensive. I'd be much more inclined
to SELL XAU options at this point than to buy them.

Whenever I'm trying to hedge gold stocks, I usually set up
some sort of spread trade. Or occasionally, I'll scout
around for inexpensive options on individual gold stocks.
But right now, with this big move up in gold, you're not
gonna find a cheap option on anything. Why don't you just
sell short GLD, the ETF for gold?"

"Sell short? I don't want to sell short!" the gold investor
exclaimed incredulously. "I'm talking about going long on
any dips. Look, I've been holding a large position in gold
stocks for the past few years. So I've got no interest in
trying to trade in and out of it. If I tried to do that I'd
be sure to get it wrong."

Gold Market Correction: Feeling Like an Idiot

"Yeah," the options trader agreed. "It's pretty tough to
trade in and out of any market. But when you trade out of a
bull market, you really feel like an idiot...Okay, now I
understand your intentions, at least. So if you're looking
to increase your exposure to the gold market through
options, I'd suggest taking a look at long-dated, out-of-
the-money options on mid-tier gold stocks. Most of those
options are expensive also. But at least you buy yourself
some time to be right. And if this bull market really kicks
into gear, you'll do quite well."

"Got any names?"

"Not that I want to buy tomorrow," the options trader
replied, "but Eric might."

"Sorry gents," I replied. "I'm just a journalist. But we're
about to poll the readers of the Rude Awakening for their
gold stock recommendations and we'll be publishing them
soon...So stay tuned."

"I'll stay tuned," the gold investor smiled. "There's
probably no big hurry to buy gold stocks over the next few
days anyway...Besides, it's the next few years that I'm
interested in."

Fresh from this weekend conversation, I stumbled upon an
email from Tom Dyson, a former contributing editor to the
Rude Awakening. Tom wrote: "I recently sold gold short at
$500, in a size that was big enough to hurt me, stop me
from sleeping, and make me look at Kitco.com for the spot
price every few minutes - even in late night Japanese
trading.

Gold Market Correction: Why Not to Sell Short

"Short gold! What was I thinking!

"I had been long. I had believed in a bull market. But I'm
a contrarian. 'Everyone thinks gold is going to $1,000,' I
told myself. 'It's all over the headlines and it's
overbought.'

"So I sold it short when it hit $500 the other day...Since
then, gold has gone up in a straight line...Up. Up. Up.
I've never seen anything like this in the five years I've
been investing in gold's bull market.

"Above all, I was gripped by the fear that, if I closed out
the trade, gold would start tanking immediately. I think
these strong emotions were a result of more than just heavy
losses. They were the result of shorting a bull market in
which you believe. Not only was I losing money, but I
should have been making money at the rate I was actually
losing it.

"Dennis Gartman says never short a bull market. You can be
long or neutral, but never short. I broke that rule...And I
also broke the sleep rule (although I don't know who coined
that one).

"Wow. I deserved my thrashing.

"So just now, with gold at $522, I closed out my position.
Not only did I close it out, I went long gold. And now I
fear gold is about to suffer a steep drop. And I'm going to
be taken to the cleaners again. But it's the right trade."
With gold down $10 – and falling – since Tom reversed his
position and went long, he might not be sleeping any better
than when he was short gold. But we suspect he will begin
sleeping much better after New Year's.

In other words, owning gold might be the "wrong" trade for
the next three weeks, but we believe it will be the right
trade for the next three years.

As we noted in Tuesday's column, today's gold market bears
a strong resemblance to the oil market of mid-2004. At that
time, very few investors expected oil to pierce $40 a
barrel...and stay there. In fact, the "smart money" was
betting big against oil. When oil busted through $40 on May
12, 2004, the Commercial futures traders (considered the
smart money) were sitting on their biggest short position
in more than a year. Then when oil jumped through $42 on
June 1, the Commercials had amassed an even larger
position. The very next day, crude oil tumble $2.37 a
barrel, triggering a steep one-month selloff.

By the end of June, as oil was flirting with $35, the smart
money felt quite smart indeed. But two months later, oil
was back up to $44, and climbing. Three months after that,
oil was through $55. And the oil bull market continues
still.

Coincidentally, today's Commercial gold traders hold one of
their largest short positions of the last 12 months. This
fact may bode ill for the near-term, but holds no
significance whatsoever for the long-term, as the oil
market's recent history demonstrates.

In theory, a (very) nimble trader who sold short crude oil
on the high tick of June 1, 2004 and bought to cover their
short position on the low tick of June 29 would have made
about 16%. On the other hand, an investor who bought crude
oil's high tick of June 1, 2004 and ignored the
intermittent selloffs, would today be savoring a 45% gain.
Oil stock investors would have fared even better. OIH, the
ETF of major oil-services stocks has doubled since then.
Valero Energy has tripled.

Bull markets do correct...but they also resume their
ascent.

[Joel's Note: If you enjoy bathing in the radiance of a
resource sector in bullish stampede, you NEED to check out
Kevin Kerr's Resource Trader Alert. This bloke has been
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juice, gold…you name it. Don't let his readers have all the
fun. Find out how you can step in to the profit circle
here:

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http://www.agora-inc.com/reports/RTA/ERTAFB23

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And the Markets...
 

	Wednesday	Tuesday	This week	Year-to-Date
DOW	10,884	10,824	105	0.9%
S&P	1,273	1,267	13	5.0%
NASDAQ	2,263	2,265	6	4.0%
10-year Treasury	4.45	4.52	-8.00	4.41
30-year Treasury	4.65	4.72	-8.00	4.60
Russell 2000	691	689	2	6.0%
Gold	$505.35	$518.95	-$21.05	15.5%
Silver	$8.39	$8.47	-$0.62	23.1%
CRB	331.39	335.62	3.58	16.7%
WTI NYMEX CRUDE	$60.70	$61.26	$1.31	39.7%
Yen (YEN/USD)	JPY 117.32	JPY 120.06	3.39	-14.4%
Dollar (USD/EUR)	$1.2000	$1.1932	-190	11.5%
Dollar (USD/GBP)	$1.7727	$1.7688	-176	7.6%

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