The worst possible news for gold hit this week when the Wall Street Journal ran an op-ed piece touting the metal’s virtues.  Famed equity strategist, Christopher Wood, in a piece entitled “The Fed is out of Ammunition” concluded by stating the following:

“…the present crisis in the West will ultimately end up discrediting mechanical monetarism — and with it the fiat paper-money system in general — as the U.S. paper-dollar standard, in place since Richard Nixon broke the link with gold in 1971, finally disintegrates.

“The catalyst will be foreign creditors fleeing the dollar for gold. That will in turn lead to global recognition of the need for a vastly more disciplined global financial system and one where gold, the "barbarous relic" scorned by most modern central bankers, may well play a part.”

Now, I admit, Christopher Wood is a very important man with a far larger following than I – hundreds of thousands, if not more, are directly affected by what he writes.  This, of course, is the same Christopher Wood who, as managing director and global equity strategist at Hong Kong’s CLSA, predicted this year’s subprime meltdown way back in October of 2005.  He wrote at that time:

“Investors should sell all exposure to the American mortgage securities market.”

And for that he deserves a pitcher of credit.  But what he is claiming here is devilishly tricky.  And for that we say: shame on you, Mr. Christopher Wood.  Shame, shame – with fingers wagging, we say it loud, “SHAME.”  And in just a moment, we’ll parse the bloke’s words and explain why.  But first, let’s examine the unbelievable reaction to Wood’s piece.

First, on gold hub, Kitco.com, head scribbler, Jon Nadler, served up a meal heavy on the meat by quoting Wood’s entire piece, and adding:

“If you ever needed more motivation to either acquire or to ensure that you maintain your 10-15% gold allocation, this might be the call to arms that does the trick.”

Huh?

And there was more.  The article was either linked or reprinted in full on nearly every major market commentary outlet on the net within just a few hours of its initial splash on the WSJ.  That includes with the GATA goofballs, stockhouse, ronpaulnews, technorati, tickerforum, buzzflash, whatreallyhappened, and a few more intriguing sites that go by names like: “The Mortgage Lender Implode-o-Meter” and “The Guns Network.”  In short, every gold bug riding a donkey through a stream had it in his hand by day’s end.

Mr. Wood did not comment on the necessity of buying gold, however.  Nor did he speculate on the near-term direction of the gold trend.  And he certainly didn’t speak of the possibility of gold trading deep into the $600’s at some point in the not too distant future.  What he plainly did say is that when the “the paper-dollar standard… disintegrates… a vastly more disciplined global financial system” will emerge in which gold “may well play a part.”

So what?  Maybe it will or maybe it won’t.  Basically, the guy didn’t say anything.  He didn’t say anything material regarding gold in his whole blinking, Charlie-arsed article!

But by the chatter on a few forums I visited and a quick glance through emails I received, one would think that the ALMIGHTY had given His go ahead to purchase gold and gold stocks now!

Do Not Buy Gold or Gold Stocks, Rather…

Ladies and gentlemen!  Please!  The valium is in the medicine cabinet, second shelf up, right hand side.  Take one – at least one – and get over yourselves.  The only safe bet on gold these days is against the metal/stock index ratio.

Many goldphiles follow the Gold/XAU ratio, others the Gold/HUI ratio – it matters little.  All of these ratios are at or near historical extremes, and the only safe means of playing gold is by betting on a contraction in the ratio with options – long dated.  And for that you’ll need the GLD and GDX varieties – since they go out the furthest of all the indices.

Buy equivalent numbers of at-the-money puts on GLD and at-the-money calls on GDX and await further orders.  Because gold (the metal) may go up or down, and the shares may go up or down – not even Christopher Wood can tell you.  But what’s almost certain is that the current gap between the two will diminish.

Here’s the way it looks graphically:

The spread between these two gold based ETFs is as wide as it has been in the last two years.  This trade nets you the closing of that gap, and the long dates on the options allow you to roll out safely to the next expiration – and with plenty of time to react to moves in the underlying shares.

Now is the time.  Even veteran Swiss millionaire and loudmouth, Marc Faber, believes that,

“the gold mining exploration sector is at extremely depressed levels and even if gold falls, gold mining exploration companies will go up.”

Believe me: gold exploration companies are not going to rise if producers don’t.  And GDX is full of the best of them.

Here’s another spread worth playing

While we’re at it: it’s no secret that treasury prices are being held up by inflows from abroad – a situation that may continue for some time.  But most everyone agrees that the longer term pressures on treasuries are down.  Yields are going to rise from here – and potentially dramatically.  But what’s more dramatic is what’s going to take place in the high yield and corporate markets, where the pressure on yields will very shortly be sharply down.

There’s no doubt that forced sales from hedgies, mutual funds and other floundering banks and brokerages accounted for the backup in yields we’re currently experiencing.  Look what’s happened in just the last three months!

And look how it appears over the past two years!

There’s no apocalypse coming, friends.  There will be bankruptcies and defaults, but nothing like what current yield spreads are indicating.  Simply put: margin calls and pissed clients who wanted their money caused a selling avalanche.

Here’s the trade: short the treasuries and go long the corps.  Use long dated call options on JNK:NYSE for the high yielders and TNX calls (this trades as a measure of yield) for the treasuries.

Matt McAbby
Analyst, Oxbury Research