I'll Sell My Gold Stocks to You

Last week the bonds were peaking and getting ready to revert to the mean. This week it’s the gold stocks.

Coming into today, Gold/Silver (XAU) was exactly two standard deviations above its 90-day mean price. And those standard deviations are quite large. With an implied volatility of 38, the options market sets the three-month expected trading range for the index at nearly 66 points. That’s 11 points per standard deviation, placing XAU among the most volatile sector indexes.

We like to buy into sectors when they’re two standard deviations below their means, then sell those sectors once they’ve risen to two standard deviations above their means. Here’s why: A full 96% of all price points are expected to fall within two standard deviations of the mean, up or down.

The key is obtaining a worthwhile standard deviation. We believe the standard deviation estimates delivered by the options market – in the form of implied volatility – are the best you can find.

Back to the XAU. The index bottomed during the day back on August 16, reaching a low of around 120. We even called a couple of our preferred customers to let them know XAU had fallen to two standard deviations below its 90-day mean. (These guys already knew, just like they already know now that it’s time to sell. But they appreciated the calls.)

Here’s part of our post on this blog on August 19:

“XAU touched Zone 1 during intraday trading Thursday and then rallied. We suspect you’ll get another chance to buy in the lower 120s before this is over. The index is still in Zone 2, so it’s already a good buy. Buy some now, save some cash for buying some more later.”

A month later, and the index is up 50 points. Yesterday, XAU sold off at the end of the day after a real nice rally. That’s an indication the speculators are getting ready to bail. We wouldn’t be surprised to see the same thing happen today. But we love the liquidity because it allows us to sell on the offer.

So we’ll reduce our risk by taking all our profits now, with the index up more than 40% since we jumped in. Nice trade.

In fact, we’ll buy some puts here. Just as we did it on the way up, we’ll buy some puts here while saving about half the money we want to invest in the position for buying more puts if the index continues to rise.