Gold futures fell last week. Retreating about 3% after a strong run-up through March. Strength in the US dollar against the euro was one contributing factor. Another, was the longer term inflationary concerns associated with the US Treasury’s new program to eradicate toxic assets from the balance sheets of US banks.

If inflation is to be a problem it will powered by a substantial surge in consumer demand.
For that to occur two things need to happen; 1) the global economies need to stabilize and
2) US consumers need to return to past spending patterns.

At best we will begin to see stability next year. As for the US consumer, we may never see a return to past spending patterns.

First of all, there is a notable change in mindset among US consumers. They have become net savers instead of net spenders.

Secondly, even if there were a desire to return to old habits, it would require alternative sources of financing. US consumers will no longer be able to re-finance their homes as a way to access credit.

The other factor that could drive gold is an outright collapse of the financial system. But that scenario seems unlikely, even to gold buffs. You can’t say on the one hand that US Treasury efforts to stimulate the banking system will be inflationary, and then on the other, suggest that they won’t work.

If gold is rallying on the back of inflationary concerns, you could argue that it is being supported by a weak foundation. Even the Fed believes that risks of disinflation or deflation outweigh the risks of inflation.

With that in mind, a couple of scenarios come to mind; one for a short term and another longer term possibility. For the short term, the easiest approach is to buy puts on gold, or precious metals stocks, betting that the price of gold will retreat in the coming weeks.

If you buy that scenario, then look at buying puts on ETFs, such as the iShares CDN Gold Sector Index Fund (TSX: XGD) or on individual gold stocks such as Goldcorp Inc.
(TSX: G, recent price $41.68) or Barrick Gold Corporation (TSX: ABX, recent price $39.70).

The longer-term strategy is to write covered calls on gold bullion, gold stocks, or gold sector ETFs. I say that, because gold is one sector where covered calls have significantly out-performed a buy and hold strategy.

Historically, gold bullion and gold stocks trade in a range. They have also been quite volatile. The enhanced volatility enriches the option premium and with a trading range environment, it means that you rarely lose your shares because of a major run up in the price of gold.