After correcting from above $1900 to below $1550,
gold prices have undergone
the necessary consolidation and now
look poised to challenge the old
Examining the chart below it is
apparent that the recent decline in gold prices was not the bursting of a bubble, but merely a correction within a larger secular bull market. Although we were not fortunate
enough to take a short
position prior to the correction, we did signal a bullish options trade on GLD to
subscribers on 26 September
2011, the day gold prices
We felt that
the longer term bullish fundamentals for gold remained
intact and on the technical side
we have long considered that a Relative Strength Index
(RSI) of 30 or below signifies that
gold prices are oversold.
This signal has worked well
for us for a number of years.
Therefore when the RSI dipped to 30 (and in fact it went below
30 on an intra-day basis) we
issued a trading recommendation to SK OptionTrader
subscribers. That options trade
is currently showing a 32% profit in 32 days.
We also consider
the 150 day moving average a key support level and although gold prices dipped below the 150dma on an intra-day
basis, they did not settle below there. In our opinion the sharp intra-day reversal on September 26th showed the strength behind gold’s longer term bullish fundamentals. Remember that the gold market is a two
tier market, one for
futures and other derivatives,
and one for the physical metal.
Although futures may have
dipped below $1600, we understand that it was
near impossible to find sellers of physical gold that day at
those prices. There are big buyers of the physical metal on dips and that buying power has put the floor
in gold at $1600.
Looking forward we think that
there is a strong chance that gold will challenge its all time highs by the end
of the year. It has only taken a week or so for gold to rally from $1600 to $1740, an 8.75% increase
in price. Another rally of that size from current prices puts gold at $1892. There is certainly enough time for this to be achieved
Another positive sign we are seeing
in the gold market comes from the trading action in gold
options over the last week, where
we have observed a significantly different tone to trading. Over the past few weeks we have seen call options being offered in rallies and puts being bid
during sell offs, which is
not a bullish sign. This week however we saw calls being bid in the rally and puts being offered, which is a bullish
sign for gold prices in our opinion.
Tuesday when gold pushed above the $1700 mark for the first time in a month, trading in the options indicated to us that this was not simply a continuation of the consolidation phase, but could well be
the start of a significant
new rally higher. Call
options and straddles were
bought heavily that day and this combined with significantly higher futures volume has suggested
to us that this move could have some weight behind it.
During Wednesday’s trading session it was more of the same. Gold prices increased and there were plenty
of bids for call options, whilst
the volatility was higher across the term structure (implied volatilities for gold options were
almost 2% higher at the front end of the curve
and 1% higher at the back
end). Basically these
indications lead us to believe that
this rally may have some real juice in the tank.
Moving on to silver, our technical analysis suggests a significant move is underway. This analysis is based on the Bollinger Bands (BBs), which are bands plotting two standard deviations away from a simple moving average.
BBs tend to tighten on silver before a large move and although this signal is non-directional, it is still
useful, especially for
option traders. If one cannot gauge what direction silver is going to move, but knows that it
is going to move significantly then profitable trades can still
be placed using options where the trader is “long volatility”,
without having a directional bias. However in this case it appears that
this move will be to the upside. Whilst we do have a small position on silver, we are reluctant to risk too much
in a market that has been
smashed twice in one year by discretionary CME margin hikes. We will watch
with interest however and be alert for future trading opportunities in this area.
Seasonality has a large part to play
in both metals. Usually after the summer doldrums we see strength building in gold during September through to as far as May. However
this year gold appears to have got ahead of itself, with the rally beginning in late July and continuing strongly through August. The chart below (from Ben Davies and the
team at Hinde
Capital, www.hindecapital.com) illustrates this point. When the 2011 price action in gold is pushed forward four weeks, it becomes
apparent that we could be in for a major rally over the next few months.
the economic situation, we
having seen an uptick in the economic picture (at least from the market’s
perspective) and this is shown by the recent steepening of the US yield curve.
those readers who may be
unfamiliar with how the yield curve works,
we will provide a brief explanation. Bonds of different
maturities have different
yields. By plotting these yields against their maturities we can build a yield
curve. The yield curve becomes steeper if longer term interest rates increase
relative to shorter term interest rates. The yield curve becomes flatter if longer
term interest rates decrease relative to shorter term interest rates. One way to measure the steepness of the yield curve is to look at the difference between the yields at two different
points on the curve. For example
one may look at the difference between the yields on 2 year Treasuries compared to the yield on 5 year Treasuries. Such a comparison will often be referred
to as “2s5s” and is measured
in basis points (bps) by subtracting the shorter term yield from the longer term yield. So if one says “2s5s are trading at +225” this means that the yield on 5 year bonds is 2.25% higher than the yield on 2 year bonds. If 2s5s go from
+225 to +275 then the yield
curve has steepened between those two maturities. If 2s5s go from +225 to +175 then the yield curve has flattened between those two maturities.
the majority of 2011, the loss
in economic momentum caused the curve to flatten massively. A weaker economy means that interest
rates will probably be held lower
for longer, therefore longer term
interest rates fall
relative to shorter term interest rates, causing a flattening of the curve.
Recently however the curve has been steepening.
question the yield curve steepening, just a month after the Fed announced Operation Twist, which involves the Fed selling shorter term treasuries and buying longer term treasuries. Although Operation Twist’s stated aim was
to flatten the yield curve, this was
only a means to an end,
not the end in itself. The ultimate
aim is to improve the economic situation.
Therefore if the Fed policy
is successful the curve should be steepening and longer term interest rates rising. This is what has happened since Operation Twist.
A similar scenario unfolded after QE2, although the Fed was buying bonds to keep interest rates low, interest rates began increasing as soon as the fed announced QE2. This is because the market perceived the economy to be improving and therefore sold treasuries in favour of more risky assets, sending yields higher.
We can see
further results of this increase in confidence on other market sectors. A combination of Operation Twist and a
“solution” to the current Eurozone problems have seen risk assets
being bought across all markets.
following chart shows this decisive shift to risk-on in the last month; confirmed across equity (SPY – S&P 500 ETF), treasury
(PST - ProShares UltraShort
7-10 Year Treasury ETF), credit (HYG - iShares iBoxx High Yield Corporate Bond Fund) and currency (Australian Dollar) markets.
what is the aggregate effect of these market shifts on gold and
our opinion we are seeing the beginning of a new
move higher in gold and silver.
Global monetary policy is not going to be tightening any time soon and there is still
room for significantly more easing
in Europe and the US. Persistently high unemployment is piling pressure on the Fed
to embark on further easing due to their dual mandate
and Europe’s problems
are well known. Whilst we may
not see some action for a
while from the Fed or
ECB, since Operation
Twist was just over a month ago and the EU has only just announced
the plans for the expanded EFSF, it is likely
that we will see easing
in 2012. Now is the time to be taking long positions in gold since
expectations of future easing will
be increasing over coming months, leading to upwards pressure on
the gold price.
conclusion our view is that there
is bullish momentum building in the gold and silver
markets. A strong floor in gold at $1600 and bullish long term fundamentals warrant a long bias
that should be increased on dips. Silver should follow gold higher, however this market is
more vulnerable to large corrections and so investors should tread with caution.
chin up and have a good
Regarding www.skoptionstrading.com. We currently have a number of open trades at the moment however, we do not update the charts until the trade is closed
and the cash is back in our
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