The Gold Economy

Tuesday, Bloomberg revealed the results of its gold price survey. Bloomberg surveyed 29 analysts about expected gold price highs in 2011. The median of the survey was $1,500.

In parallel, Bloomberg also compiled 17 forecasts for next year’s average gold price, the median estimate being $1,247.50.

Let’s treat the Bloomberg survey as a sample of market sentiment and consider this information a theoretical input for a speculative trade. What options do we have?

The simplest version would be to dismiss (for now) the information about the average expected price and buy now, as $1,500 would mean a plus of 20% based on today’s $1,250. The next step would be to hold until the price approaches $1,500 and decide what to do then.

More interesting options arise when we include the information about the expected average price, which is just about today’s price. What is it telling us? Combined with the expected high of $1,500, the average price expectation of $1,247 implies high volatility: regardless of when gold reaches the high (at the beginning, mid or end of 2011), an average of $1,247 would require a significant drop (as low as $1,000) to compensate for the high.

The crucial part is to identify the time of the drop. If the drop is to take place before the high, it would make sense to wait until the drop occurs, then buy and hold until gold gets near $1,500 and decide what to do then. In this scenario you could maximize your profit to up to 50%. Dangers? If the drop doesn’t materialize at all or materializes only after the highs have been reached, you have missed the rally completely.

Let’s keep the average price expectation of $1,247 in mind and suppose gold goes on to $1,500 without a significant slump. That means that the drop needs to occur afterwards. That, in turn, makes buying now and selling near the peak of $1,500 imperative. This, too, is a relatively safe trade.

Now, they say a bird in the hand is worth two in the bush. 20% as in the first and the last scenario is a handsome profit. Also, buying now gives you the option to reconsider the average price forecasts at a later point and limits the risk of you missing the rally. Besides, no positive change in the economy that would justify a sudden drop to $1,000 is in sight.

This was, of course, an isolated, theoretical exercise. But if you think that Bloomberg’s analysts’ sentiments are somewhat representative of the market and you have some cash on the side, why not give it a shot. It definitely looks like easy money and after all, you can always say you were just hedging uncertainty.

Disclosure: Long gold