Buying Gold to protect yourself from the Dollar

There has been a lot of discussion about an imminent fall in the value of the dollar. Even I feel that the dollar will fall considerably in value; but not collapse completely.

The only thing that makes me a little unsure about the dollar fall is – that everyone expects it. I have not heard a single person say that the dollar will not fall.

Normally, the markets never do what everyone expects it to do. If you have a link that talks about the dollar remaining strong – please do send it my way.

The other day, I was talking to a friend who is an analyst at a Hedge Fund, and he gave me an interesting idea of betting against the dollar.

Buying – Out of Money Call Options – of Gold Stocks

There is no other currency that can replace the dollar in the current scenario. In such a situation if countries and individuals were to look for safety – they will invariably turn towards gold.

There are a lot of ways of investing in gold, and buying – call options – in gold stocks is one of them. Out of the Money – options are cheap (subject of another post) and so your initial investment will be very less.

In order to play this bet – the call should have an expiry of an year or more than that. If in that time – Gold doesn’t rise considerably – your investment will be reduced to zero. If gold does rise considerably, then you will stand to gain substantially on your investment.

You can play this strategy on the call option of something like – SPDR Gold Shares (Symbol:GLD). This is a link to see the call option prices which expire on Jan 2011 (two years from now).

The things that I like about this strategy:

1. The initial investment is low so even if the widely predicted fall in dollar doesn’t happen, the loss is limited.

2. Gold prices may still go up – even without a fall in dollar prices.

The things that I don’t like about this strategy:

1.  It is not easy to understand the fair value of a option, and, you can always end up paying much more than an option is worth.

2. Options are inherently riskier than most other assets.

3. Everyone is talking about a dollar collapse and a gold rise – so it may not happen at all.

This idea may or may not make me money, but I really like it. The reason for that is that it is an ingenious way of thinking about:

  • Who will incur a loss?
  • Who will profit from this loss?
  • How can I profit from this loss, with the minimum risk?

These three rules are quite simple and provide an excellent framework for thinking about any investment idea.

Note: I am not a financial adviser and you should consider that options investing is inherently dangerous and not meant for most ordinary investors.

6 thoughts on “Buying Gold to protect yourself from the Dollar”

  1. Manshu,

    I think gold is a good hedge too, but haven’t decided how to do it yet. In the past, I have owned gold mining company stocks, but have not been too successful investing in them.

  2. Pingback: Buying Gold to protect yourself from the Dollar | OneMint

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