Gold Moving Opposite of Oil Ahead of Fed
The past two weeks have shown little absolute movement in gold prices as net length and open interest in Comex futures has been reduced.
We are now showing a reduction of total open interest since the peak ten days ago of 10 million ounces with bearing bets on the rise. Volumes in the futures arena (online) have been huge but mostly because of spread trading from August-October and August-December (GCZ6), which is now the actively quoted contract. The narrow range the past week in GCZ6 of $1326-$1340 has implied volatilities flattened for at-time money options between 15.2% and 15.5% from one month to one year. Options volume remains very light as it seems the summer doldrums have begun to set in. As I stated on Monday, the biggest move has been in 25 delta risk reversals which have come down from 3% at the start of the month to 1% presently.
For Bulls, this is starting to be a good way to wade back into the market. For example, in the one month expiration (August 25 expiry) you could buy a $1375 call/sell, a $1290 put and pay less than 40 cents per ounce. This is based off the October future price (GCV6) of $1330. As I feel today's mini rally higher is based on possible Fed tightening rhetoric being overhyped, I prefer to a pullback to spot of $1312 (GCZ6) $1320 before looking at this strategy. I may even go further out as I think gold will be stronger for longer going into the uncertainty of the U.S. election.
The GLD ETF (GLD) - Get Report has had 10 tons of outflows the past week, losing assets 27 sessions this year vs. gaining 69 sessions. Other Gold ETFs are still offsetting some of these outflows. The GLD is presently trading at 126.6 but I will stay with our one by 2 September 16th expiry long $130 calls/short 140 call as it is basically unchanged despite the decline in underlying, as the short volatility is offsetting the price component.
The more muted net length is only one reason I am staying with my bullishness in gold. It is difficult to like gold when energy and food prices at the terminal markets are sinking -- but the fundamentals of each market vary. Granted the physical demand for gold presently in China or India is great but it is also price sensitive.
That said, the central bank policies of Japan and Europe (and possibly China) will keep investors clamoring for hard assets. The $265 billion preemptive fiscal stimulus unveiled by Japenese Prime Minister Shinzo Abe (was supposed to be released Friday) is very confusing as the Bank of Japan will now have to come in proverbial bazooka or possibly disappoint global markets, especially within Japanese domestic investor class. The meltdown for the Japanese equity market, which has risen 9% since Abe won reelection but is down over 50% since 1989, could be devastating. The BOJ may issue a 50-year bond and may push bonds into further negative yielding territory, both of which it has been trying to avoid. Any of the outcomes could be bullish for gold as the yen as a safe haven may become diluted and uncertainty on the outcome of any of these policies in combination with the European Central Bank extending asset purchases, and the Bank of England likely to lower rates next month will send more portfolio protection into gold and silver.
Let us not forget about the Fed, which will not raise rates as long as the dollar seems vulnerable to gaining more strength with these easing policies around the globe. Both the Japanese who have an active silver, platinum and palladium market, and the Chinese speculators, have been buying these alternatives to gold. As commodity hedge funds (not CTA's) have disappeared from the investing landscape the past few years due to poor performance, they are being replaced by the Asian class of speculators. It is difficult to decipher how long these traders will buy and hold or just day trade but on the fundamentals, palladium continues to be the precious metal that will be in deficit moving forward.
I mentioned on Monday the copper price, which has appreciated from $2.00 to $2.25 in the past six week as net shorts moved to net longs, which should help Freeport McMoRan's (FCX) - Get Report cash flow. But it did not help its earnings due to its crushing $19 billion debt, which is forcing the company to do its third equity raise this year. The flip side is that in its earnings conference it did everything but solicit bids for parts or all of the company. The gambit reversed a 9% decline to a 5% advance in the price.
The crude market is tumbling to new three-month lows, moving closer to the $40 level. I believe that $40 will bring some dip buyers from hedge funds, especially on a forward basis, as looking 12 months out the supply story may be more prove friendly. The biggest catalyst in today's move is the EIA report that inventories rose 1.67 million barrels as opposed to predictions of a 2 million barrel draw. There have been some large option purchases in various 2017 months. As all moving averages in the front month have broken down technically, I would wait for a few days before taking advantage of the put skew. Dealers may have exposure to hedges, and lenders may have to buy more 2017 puts to protect Armageddon on their loans like they had in the first quarter. The high-yield market may get a bit unnerved if we start to see a $39 handle on WTI again. I will be looking to buy December 17 calls financed by selling puts with the same expiration for zero premium as it currently has a 3.75% put skew for 25 delta risk reversal -- puts over calls.
Natural gas has been unable to gain any upward momentum despite the warm weather. There have been no drastic forecast changes and I need a major upward push on the underlying price to see my $3 calls gain any value. The U.S. electricity output rose 5.4% last week on a year-over-year basis and up 4.8% from the previous week, so there is still hope. Mid-Atlantic power usage was the biggest mover.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.