The recent pullback in gold to below $1,200 an ounce looks like a good opportunity for bullish investors who may have missed the move up to consider buying at cheaper levels. A bull call butterfly spread can be an appealing strategy for bullish investors looking for defined risk.
Gold can be considered an insurance play, and I think investors will continue to flock to gold when there is distressing news or fear in the market. Last week, we saw six new bank failures make headlines, bringing the 2010 total to 96. We saw 140 bank failures in 2009, 25 in 2008 and only three in 2007. We are only half-way through the year, so we could surpass last year’s levels. It just shows that banking and housing problems are far from over.
There are other factors that could drive gold. A breakdown in the stock market after we get through earnings season and into the fall is a definite possibility—particularly if we don’t see the employment picture improve. In Europe, the sovereign debt crisis has not yet been resolved, even though some countries are taking steps to reign in spending. Portugal and Spain have been able to roll their debt that’s coming due, but they are just buying time. They will have to face these obligations eventually.
Gold has also historically been a hedge against Inflation, which tends to follow the types of fiscal and monetary stimulus measures that have been put in place in the U.S. While it hasn’t shown up yet in the U.S. Consumer Price Index or Producer Price Index, that doesn’t mean prices will stay down forever. In Congressional testimony this week, Federal Reserve Chairman Ben Bernanke said he is prepared to take further action to support the economy if necessary, but expressed reluctance to do so. The economy is still under stress, so I don’t think we can rule out additional stimulus that could result in inflation.
"The best approach, in my view, is to maintain some fiscal support for the economy in the near term, but to combine that with serious attention to addressing what are very significant fiscal issues for the United States in the medium term," Bernanke said.
A run on the physical market is also a possibility for gold. We saw this in the cocoa market recently. London cocoa hit a 33-year high last week as an investor accumulated a massive amount of cocoa futures positions on the NYSE Liffe exchange. There were 24,866 contracts for July delivery open on the exchange, equivalent to 248,600 metric tons. That’s more than amount available in storage and approved for delivery.
