There are many different investment vehicles one can use to invest in gold.  The key aspects that we as investors and traders look for are the vehicles relationship and correlation with gold prices, and how much that correlation is or isn’t leveraged to the gold price.  More leverage is not always the objective of an investor, one may be looking for less sensitivity to the gold price, or simply to match gold’s performance.

If one is looking simply to match gold’s price performance then this is easily achieved by purchasing the physical metal or a gold ETF like GLD.  If one is looking for less sensitivity to gold prices, this again is relatively easy to achieve, by simply buying less gold and holding more in cash, for example instead of investing $1000 in GLD, investing $500 and leaving $500 as cash in your account will give the investor half the overall performance of gold.  However it is when we are aiming to increase our leverage to gold prices that things get interesting.

A simple solution is by using margin.  Borrow money and buy twice as much GLD and you will get approximately twice the return than you would’ve without buying on margin.  However not all investors are comfortable with margin and with gold being a volatile market one could be caught out and face margin calls, but overall this appears to be a relatively simple and effective strategy.

One of the most popular methods for those looking to invest in gold with additional leverage is gold stocks, however we do not think this is the best way to invest in gold. Please do not take this to mean there aren’t gold stocks that are well worth investing in, there are some fantastic opportunities and a lot of money to be made in gold stocks, from the heavyweight miners to the junior resource start ups.

However gold stocks do not score highly in one of the main aspects we look for: correlation to gold prices.  Granted in general as gold prices have been rising gold stocks have been making great gains – but we feel there are simply too many other external factors influencing gold stocks to say that they are best choice for investors looking to play the gold market.  

Mining stocks can be hit by increasing costs, geo-political unrest in the region they are mining in, foreign exchange fluctuations and changes in management to name but a few factors that have little or nothing to do with the price of gold and yet affect the investment, diluting gold stock’s correlation to the gold price.  The junior resource companies are even less correlated than the miners, with their stock prices moving more on whether or not they find any gold, how much they find, where they find it, what grade the resource is and whether the project will be feasible to mine in many years to come, rather than the gold price today or in six months from now.

When looking at the leverage of gold stocks relative to gold prices, they do exert some leverage and regularly outperform the yellow metal.  However by how much they outperform gold varies considerably, and it is hard to calculate how much leverage a stock will give you due to the external factors detailed above.

So in our quest for the best gold investment vehicle, one that exerts direct undiluted correlated returns to the gold price, with added leverage that is quantifiable to a reasonable accuracy, we think that options are the best choice.  Options contracts are directly linked and correlated to gold, without the hassle of the external factors that often hamper gold stocks.  Options are also not only a leveraged product, but one can tailor the leverage to suits ones preference, so it is possible to achieve a high level of leverage or a low level, whatever the investor desires, with the right combination of contracts.

Although options can contain a high level of risk, many investors are under the false impression that all options contain this same high level of risk, when in fact they vary greatly in their level of risk, with some having relatively low risk, and some having higher risk.  This means the investor can choose how much risk they wish to take on, and in some cases owning options results in less risk than risk than owning gold stocks.  At SK Options Trading our goal is to maximise our reward/risk ratio and optimize our returns, aiming to maximize our potential gains whilst minimizing the associated risks.

Sam Kirtley

SKkoptionstrading 

Mr. Kirtley manages www.skoptiontrading.com and offers real time trading signals to subscribers. You can click here for more information.