CPM expects gold prices to rise in the short and long term, but prices are very high by historical standards. Gold has been pushed higher since June and July 2020 by investors buying in the face of the pandemic, the global economic crisis, and worldwide political problems.

CPM’s projections for gold prices is that they plateau over the next two years, 2021 – 2022, but do not fall significantly, before rising more sharply beyond 2022.

Several alternate scenarios have gold prices dropping sharply in the next two years, as the global economy and society recover from the triple whammy of the pandemic, the recession, and the decline of global political cooperation in a rising nationalistic political environment. CPM’s main scenario does not have that happening.

This article speaks to investors who want to buy gold as a long term asset, to preserve wealth and diversify their portfolio. Our advice has been and is that this is wise. Such investors can buy insurance against a gold price drop.

The insurance can be shorter or longer term in duration. As with any insurance, the premium is higher the longer the coverage one buys. And, as with other insurance, the buyer, in this case an investor, can choose how much insurance she or he wishes to buy, and for how long she or he wishes to be insured.

At present CPM is advising some of its investor clients to hedge for about eight months, using June 2021 options. April puts are less expensive than June, but the seasonal price pattern suggests that April options, which expire in late March, probably would expire just before a sharp price decline would be expected. June options, expiring at the end of May, would be more likely to catch such a drop. August options, expiring in late July, would be more likely to catch any decline in the second quarter, but are more expensive than June.

Besides: CPM’s view is that one might buy such puts now, in the middle of November, and look to sell them back if gold prices fall sharply in the middle of December. There are several economic, political, fundamental, technical, and mechanical reasons to think that gold prices could fall sharply, briefly, in the middle of December.

On 16 November, when this was written, the nearby active December Comex price was $1,887.30. The June 2021 put with a $1,700 strike price was priced around $26. If prices fell sharply, to around $1,650, in the middle of December, depending on the volatility in prices at the time such puts might be worth between $90 to $115. An investor with such puts could take the profits from this insurance policy and reduce its net effective acquisition price of gold. 

For comparison, an April 2021 put with a $1,700 strike price was around $16 on Monday 16 November.

Should prices fall toward $1,650 in a month or so, the put might be worth maybe between $70 to $100, depending on the volatility of the market at the time.

A word of caution. In the early days of options on futures in the United States, 1987, CPM was advising an institutional investor client about buying puts on its U.S. equity portfolio. We suggested compound options to reduce the cost of the options premium, but this was too sophisticated too early in the client’s options learning curve so it decided to simply buy puts. The puts were expensive, so as a test the client bought puts covering about 10% of its exposure to U.S. stocks. In October 1987 the stock market crashed. The client complained that the insurance program did not ‘work,’ since it only covered about 10% of the loss it had incurred on its long equity portfolio. Of course, it had only covered 10% and the puts worked as expected. The lesson, hard learned for many investors seeking to hedge:  If you only cover a portion of your exposure, only a portion of your exposure is covered.

CPM Group provides a range of services related to asset management and price risk management. We advise investor clients on the normative roles of gold and commodities in investment portfolios, and help them efficiently and effectively invest in these assets. We also provide advise and management services related to effective price risk management, including structuring hedging programs for investors and commercial enterprises.

More information is available by contacting CPM Group at [email protected], and visiting our website at www.cpmgroup.com.