Gold and Silver Have Been Holding On Despite Stock Market Rally
The bull market in stocks still hasn't pulled gold prices that far off Monday's high levels, although it does have some observers talking about a much larger pullback.
The main reason is the excessive length in the market, which is now at 34 million ounces. On the pullback Tuesday, open interest in gold futures dropped 2 million ounces to 630,000 contracts.
In addition, the 16 tons of outflows from global exchange-traded funds Tuesday -- the largest one-day decline in three years -- has people anticipating that the money which has been flowing into the sector is not "sticky."
The drop put ETF holdings of gold at 64.4 million ounces, vs. the recent peak of 64.7 million ounces. The main reason (besides futures positioning) that I am bit nervous is that the high prices have made Indian physical imports fall into the abyss, so it is going to take a continued uptick in Chinese and Japanese speculative buying to offset this drop.
Technicians will tell us that gold has made a double top at $1,375 an ounce and now will fall back to test the 200-day moving average at $1,295, but I can not give up so quickly. I still believe that portfolio management -- whether it is performed by a retail investor or a sophisticated pension fund -- needs some safe-haven hard assets in the current environment of "free money" that global central banks have created.
So far the yen and the negative yields on Japanese government bonds, as well as the speculative demand for hard assets in China, has more than compensated for the Indian shortfall. Observers attributed strong Chinese buying of precious metals overnight to geopolitical worries after an international tribunal rejected China's claims of sovereignty over the South China Sea. The Market Vectors Gold Miners ETF (GDX) - Get Report , which tracks large-cap gold mining stocks, has rallied back to within 1% of its highest level since 2013.
Let's take a look at the options trade we recommended late last week. It involves options on the SPDR Gold Trust (GLD) - Get Report , an exchange-traded fund that tracks the price of gold bullion. To review, we recommended buying one $130 call option that expires on Sept. 16 and selling two $140 call options with the same expiration. The total cost was $1.30, and now this trade is worth $1.42. The underlying ETF is $1 lower than the inception of the trade, which I mentioned was net bullish. Remember, however, that because the trade was a net sale of volatility, the implied volatility in gold has collapsed to at-the-money at 16.3%.
The delta of the trade, which was originally 7, is now 16 as the delta on the 140 (2x) has collapsed faster. I am still holding on to this position because any large earnings miss by the U.S. money center banks in earnings over the next week may start to weigh on stocks.
Although net interest margins at these banks as well as trading profits continue to erode, they should be able to decrease the amount of bad loans set aside as energy bonds have helped lift the high-yield bond market. Other important catalysts continue to be the stock prices of Deutsche Bank, Credit Suisse, Royal Bank of Scotland and Barclays and how they deal with the Italian banking crisis.
Copper was a big mover overnight Tuesday on reports of large import increases into China both in cathodes and concentrate. The total unwrought imports for January to June rose 22%, although there was a slowdown in June. Concentrate imports rose 35% for the first six months as new smelters came online onshore, but also took a dip in June as premiums dropped. Bonded warehouse copper stocks rose to 620,000 tons.
The big story, however, was the velocity and volume in the trading on the Shanghai exchange overnight. The copper volume on Shanghai Futures Exchange was up 230% overnight for the largest day in more than four months. Open interest also increased by 10%. Short-covering at the London Metals Exchange seemed to be the main driver as the London opening drove copper through $5,000 a ton for the first time since April. The rest of the day Wednesday saw some producer hedging as well as macro players selling into the rally. It seems that Chinese speculators are leveraging bets using cheap bank loans again to give them exposure to copper, nickel, zinc, gold and silver. It may take another wobble in the Chinese economy before the much-hoped-for cut in the reserve requirement ratio comes.
The jump in steel prices in China due to a reported drop in inventories may be short-lived. Hebei province in China is supposedly shutting steel mills to clean the air for the Great Tangshan earthquake memorial. More importantly may be that both the U.S. and Europe are trying to curb Chinese steel dumping in their respective continents. Jean-Claude Juncker, the president of the European Commission, has been very vocal about curbing Chinese dumping.
The oil market has given back all of Tuesday's gains and then some on continued inventory builds in gasoline and distillates. Both gasoline and distillate inventories are at 8 week highs and prices continue to be under pressure. Also, refinery runs decreased as gasoline demand dropped by 84,000 per day. The American Petroleum Institute reported a 2.2 million build Tuesday while the Energy Information Administration reported a 2.5 million drop Wednesday, but both were lower than expectations. Overnight Tuesday, the Chinese import number was the lowest since February and the International Energy Agency warned that high inventory could threaten the market balance. Rumors are there are 95 million barrels of oil in inventory presently, which is the largest since the financial crisis.
Natural gas is not cooperating with our bullish option strategy from last week. I recommended buying the September $3 call (expiry Aug. 26) at 7 cents against selling the the August $3 call (expiry July 26) for 3 cents for a net cost of 4 cents. The present value of this trade is around 3 cents, but we still like it as hot weather is moving across the Plains and into the Northeast this week.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.