Sometimes — no, if you are trading, the word should be always — you need to trade perception and not reality. It is time to hook onto the current trade on inflation — it picked up this week after Federal Reserve Chairman Ben Bernanke said he is not raising interest rates anytime soon.
The Reality – the thought there could be real inflation in the U.S. is laughable.
Perception – traders are increasingly fearful of Fed created inflation. Therefore, you should think precious metals, and options trading on ETFs on gold and silver, such as the SPDR Gold Trust (NYSE: GLD) and the iShares Silver Trust (NYSE: SLV).
That’s my recommendation. First, let’s consider some background on reality versus perception.
First, the reality. Inflation is the upward movement in prices created by too much money available to buy too few goods.
Historically, when the Fed lowers interest rates, capital is cheap so people buy too many homes and stuff, and businesses build too many factories. This time, consumers are broke and not spending, and business is awash with capacity and is not building.
Wait a second, you say, what about the $4 a gallon and rising I’m paying at the pump? Energy is a very small portion of GDP so it has little impact on the core rate of inflation.
Now, let’s get into the perception. Many believe low interest rates MUST mean extra liquidity created by the Fed MUST mean inflation is coming. These folks are very loud, indeed they are screaming – and that is creating fear among traders and many foreign investors.
Forget reality and trade the perception.
What trades are best for this next leg of the inflation trade? Precious Metals.
Everyone says that precious metals are too hot and are in a bubble. Nope. They are a key long-side play on the inflation trade. They may have run too far too fast but that does not mean the run will end. It may pause, but it should continue. And in addition to inflation fears, silver is actually used in electronics and medical treatments.
First, do not play the commodities themselves, play the exchange-traded funds, such as the SPDR Gold Trust and the iShares Silver Trust.
Look at two different trades depending on your appetite for risk.
Straight Calls: The metals may be taking a pause — SLV sure will as it nears $50 — so either look at late summer out-of-the-money calls or buy Weeklies to minimize your exposure to a correction.
A Buy-Write: Think about buying the GLD ETF and immediately writing covered calls, either to average down the price you paid or to generate some cash. You can do this every week if you want to, these ETFs have Weekly options. Always sell out-of-the-money calls.
There are many other plays against inflation but why stray from great charts and the current attitude towards precious metals. And think about the price of gold and silver is something nasty happens in Saudi Arabia? Or if Egypt’s new leaders make too much noise about Israel? Traders will switch from inflation to geopolitical fears, and you win that way as well.