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Will Fresh QE From ECB Boost Gold?

The threat of deflation in the Eurozone is an issue that continues to plague the ECB. The current easing measures have failed to drive inflation above 0.3%, which is far short of the 2% inflation target that the ECB is mandated to reach. This has led ECB President Mario Draghi to begin the discussion of further QE to stimulate prices in the region. Just last week Draghi commented that:

“We consider the APP [asset-purchase programme] to be a powerful and flexible instrument, as it can be adjusted in terms of size, composition or duration to achieve a more expansionary policy stance… We will do what we must to raise inflation as quickly as possible. That is what our price stability mandate requires of us.”

Dovish remarks such as these signal the markets that more QE is coming from the ECB. Following the GFC, massive quantitative easing from the Fed drove gold prices to new all-time highs, yet similar sized programs, including those of the ECB, have failed to fuel a bull market in gold. Here we will discuss why an increase in the ECB’s easing measures now will not just fail to be bullish for the metal, but will in fact be likely to drive gold prices lower.

The Currency Argument

New QE from the ECB will see the Euro weaken relative to the USD. The chart below clearly shows that since the ECB first began discussion of new easing measures in mid-2014, the Euro has fallen significantly. We believe that this decline is likely to continue as we approach the launch of fresh easing from the ECB.

In the US the Fed is moving ever closer to the beginning of a new tightening cycle. Increasingly hawkish statements from the Fed and speculation that the first hike will come this December has led to the USD reaching 10 year highs. This strength has also been a product of the monetary policy of other central banks moving in the opposite direction. Case in point, the ECB introducing more quantitative easing.

Now consider the effect of a stronger US dollar on gold. Historically as the US dollar has rallied gold has fallen in US dollar terms, and vice versa. Therefore, if the US dollar strengthens then one would expect gold to decline. Given that the US dollar and Euro often have an inverse relationship, it is clear that if the Euro weakens, then gold could follow suit. Accordingly, we reach the conclusion that from a currency standpoint alone, gold will fall if the ECB increases their monetary easing programs.

Why ECB QE Will Not Be Bullish For Gold

Many gold bulls in 2014 called that the introduction of new QE would re-ignite the bull market and drive the yellow metal to new all-time highs. The reasoning was simple, QE from the Fed had fuelled the gold bull market for years, so why should QE from the ECB be any different?

The answer to this is simple, ECB QE has had a different effect on gold, because it is a different type of program. The measures used by the Fed during QE1 and QE2 were broad based programs. Their goal was to stimulate the economy by keeping interest rates low. To do this the Fed targeted buying long term Treasuries to push the price of that debt higher and the yields lower.

However, this has not been the goal of the ECB. Long term interest rates are already at all-time lows, so instead the ECB’s QE programs target Asset Backed Securities (ABS) to incentivize bank lending. An ABS is a financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. This means that the ECB’s QE program was similar in nature to QE3 from the Fed, which targeted Mortgage Backed Securities (MBS).

Given that the ECB is already using targeted QE and that targeted QE has been successfully used in the US, it’s logical that the ECB will again use targeted QE. This means that they will not use the broad based measures similar to QE1 and QE2 that drove gold higher. Therefore we do not expect that new easing from the ECB will drive gold higher.

ECB QE Will Be Directly Bearish

Targeted programs will be used when the ECB increases their easing measures. We have established that these will not have a bullish effect on gold as they differ subtly but significantly from the easing programs that fuelled the gold bull market. However, we are yet to cover why new measures in Europe will drive gold lower, rather than simply not push the metal higher.

In the US QE3 was successfully used to stimulate growth and improve the health of the employment sector. While the employment sector has not recovered to full strength, shown by a lack of significant wage inflation, jobs growth has been considerable. Therefore, although employment has not reached its full potential, QE3 has resulted in an economy that is ready for higher rates and tighter monetary policy. This means that targeted measures can be effectively used to improve long term economic health.

If this conclusion extends beyond the US, which we and most economists agree it does, then targeted QE can be used to increase inflationary pressures in Europe and avoid the threat of deflation. From this we can see that if the ECB’s new QE programs are successful, then over the long term inflation and economic health in the Eurozone will rise.

This means that further measures are unlikely to be necessary, and that in fact over the longer term monetary policy will begin to tighten, which will be highly bearish for gold. This view will likely be priced in to markets as the ECB’s QE is shown to succeed, which means that gold is likely to be sold off as the new measures take effect.

As the economic health of the Eurozone increases we are also likely to see gold sold off as a safe haven asset. Improvements in the economy generally lead to investors becoming less risk averse, as the probability of a significant downturn is decreased. This means the "risky" assets, such as stocks, become more favourable than safe haven assets, such as gold. Therefore gold is likely to be sold as the economy improves simply because it is a safe haven asset.

Accordingly, we believe that fresh QE from the ECB will be directly bearish for gold, rather than just non-bullish.

What If the New Measures Don’t Work?

The argument can be made that the current measures from the ECB have failed, as these now need to be increased to combat the still weak inflation outlook, and that because they have failed all future programs will also fail. We believe that this argument is flawed for a two key reasons.

Firstly, the view that just because the most recently announced easing programs from the ECB have been unsuccessful, all future attempts will also be futile is naive. In the US, QE3 was the third round of easing from the Fed under the quantitative easing banner, and even QE3 was initially considered unsuccessful. After being announced in September 2012 the Fed increased QE3 at their December meeting that year. This shows that the initial program may not achieve all of the desired targets, but can still be successful when increased or adjusted.

Secondly, although the inflation situation in Europe is poor, it has not severely weakened. In fact, core inflation has improved in the region with a print of 1.1% in October. While this appears soft on the surface, it is worth noting that in the US core inflation is only 1.9% and the Fed is approaching a rate hike. This means that although the current ECB measures are not enough, they are on the right track. Therefore it is likely that an increase in ECB QE would be effective in the same way that the increase in QE3 was.

When we consider the effect on gold prices, the key factor is the markets perception of the programs. It matters little whether one personally believes that the current measures have worked, as the markets hold the view that they will work over the long term. This means that the long term effect of gold being lower due to higher interest rates will likely be priced in while the programs are in place. This is true regardless of whether they are effective at that time, as markets believe that the ECB’s action will eventually drive growth in the region, which will necessitate higher rates.

How to Trade Gold from Here

We hold the view that more QE from the ECB will be bearish for gold prices. Additionally, we believe that the Fed will hike this December and that this action will drive gold lower. Together these actions are likely drive the US dollar higher and gold consequently lower. Therefore, we clearly believe the right trade is to be short gold, but when is now the right time to open new shorts?

Gold has fallen around $100 since mid-October when the Fed signalled that they would hike in December if data remained steady. This selloff has led to the yellow metal becoming oversold, as shown by the RSI, which is currently at 32.92. The MACD is also poised for a sub-zero bullish crossover. These crosses have often signalled a rise in bullish momentum and at least a small rally higher. Therefore gold has the technical potential to move higher from here.

The $1080 level is likely to impede this, but gold has failed to break significantly beneath the level. This indicates that the resistance is yet to be fully broken, and therefore is unlikely to fully stop a rally higher if gold breaks to the upside.

Although we hold the view that the fundamentals are highly bearish for gold, we admit that the current technicals show that the metal has the potential to move higher in the near term. Therefore we would not look to add new gold shorts at this stage. Whilst we are maintaining a core short, we intend to wait until gold approaches resistance at $1150 before adding new short trades. This would ensure that these positions are opened at optimal levels to take advantage of the bearish effects of new ECB QE.

We will signal our subscribers when we open these positions, providing them with the exact trades that we open in our own portfolio. We will also be publishing our regular market updates with further analysis of the effects of new ECB QE, the Fed meeting this December, and how we are trading gold to our subscribers only. If you wish to become a subscriber, you may do so via either of the buttons below.

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Swinging For The Fences - A 20 to 1 Option Play On Oil

Over the last year oil, and commodities in general, have been much unloved. China and emerging market woes have created demand concerns while a mountain of supply side pressure has also been in play. This has seen oil prices fall from over $100 in early 2014 to hovering just above $40 now at the end of 2015. We believe that the rapid decline and extreme pessimism in the oil market could create a trading opportunity, and that this would be best harnessed by using options.

Firstly, we do not claim to be experts on the oil market. This article will not be an in depth discussion of supply and demand dynamics. Although we rarely trade oil directly, we do follow developments closely for their implications in the global macro picture and the other markets that we do directly trade, such as equities, volatility and, gold. However, the risk-reward dynamics at play in long dated call options for oil have brought us close to pulling the trigger on an oil trade for the first time since 2009.

Our bullish view is based on just a few simple observations. Firstly, oil bears are everywhere and bulls are tough to find with nearly all having thrown in the towel over recent months, secondly the ECB is about to embark on more QE that we believe will be supportive of all commodity prices, and finally, there is a real risk of a significant conflict in the middle east which could disrupt supply.

RIP The Oil Bulls

In 2008 as oil was soaring through $100 and even past $140, there were calls left, right, and centre for $200 oil. Now, with oil on the floor there are calls for $20 oil. As mentioned above, we are not oil experts, but we recognize that the oil market has a trait of swinging violently from overly bullish to overly bearish.

Bank analysts are growing still more bearish on oil, predicting that crude prices will remain capped next year as the market struggles to recover from a supply glut. A survey of 13 investment banks by The Wall Street Journal showed that the average forecast is for West Texas Intermediate is $54.40 by the end of next year. Whilst higher than current spot, it is only 12% higher than where the December 2016 futures contract closed on Friday ($48.85).

It is very tough to find anyone calling for a return to $70+ prices, let alone the $100+ highs. We take this as an encouraging sign since we are looking for a contrarian trade with a high payoff and low probability of success, but positive risk-reward dynamics.

Inflation Targeting QE

While the Fed is looking at increasing rates next month, across the Atlantic it is becoming more apparent that the ECB will increase its QE program in an attempt to stimulate inflation.

Draghi said at his speech in Frankfurt last week; "We will do what we must to raise inflation as quickly as possible. That is what our price stability mandate requires of us." The ECB has an inflation target of 2%, but prices in the Eurozone have continuously stayed low, with the annual CPI at 0.1% in October.

Commodity prices are a major component of inflation, with energy prices having knock-on effects throughout all products and services. Earlier this year the disinflationary impact from lower oil prices arguably was a major contributor to the Federal Reserve’s decision to delay any rate hikes until year end. The ECB is growing increasingly frustrated with the lack of inflation, and therefore will likely upscale and upgrade their QE program next month.

If oil and other commodity prices fall further, this will eliminate the chances of any uptick in inflation. Therefore such a decline is likely to lead to yet more QE from Draghi until some pick-up in inflation is achieved. There is a chance that the market catches on to this theme, and that oil and other commodity prices begin to head higher next year as the ECB’s inflation targeted QE sees demand increase across the board.

In short, QE is targeting inflation, and inflation needs higher oil prices.

Geopolitical Risks

The risk of a severe supply disruption in the Middle East is very real and in our view quite asymmetric. Although there is increased supply coming from Iran, this is largely priced into the market and now all but fully expected by market participants. Elsewhere there is a risk that a conflict, as a result of the recent tragic events in Paris, could severely impact some OPEC suppliers.

The region is unstable and crucially it is from this very region that the mass increase in supply has come from. Even if the supply is not disrupted, the threat of disruption adds to the risk of a spike higher in oil prices.

Risk Reward

Taking it to a practical level is where we believe the rational for a trade becomes most apparent. The Oil ETF USO is what we will use to demonstrate the type of trade we are considering. The following chart roughly equates USO to crude oil prices, will a few approximate translations. Note these are not exact due to a number of factors including ETF fees, the shape of the oil futures curve and other factors.

We are looking at long dated, far out of the money calls, and speculating that $70 oil isn’t as unlikely as most people think.

At the most basic level, the Jan-2017 $18 strike call options are priced at $0.67, and the $20 strikes are priced at $0.47. If USO could return to $25 (roughly equivalent to crude at over $70) at or before expiration, then those calls would be worth $7 and $5 respectively, or a respective return of 945% or 964%.

Taking it a touch further, using vertical call spreads makes the risk-reward dynamics easier to define. This strategy involves buying a call option and simultaneously selling another call option with the same expiration date at a higher strike. This limits the potential return of the trade but reduces the entry cost. Both strategies are limited risk.

For example we look at buying the Jan-17 $20 call and selling the Jan-17 $25 call. On a net basis this costs us $0.25 and the maximum the trade could be worth is $5, the difference between the strike prices. If USO was at or above $25 upon expiration the trade would return 2000%. This is our favoured 20-1, swing for the fence, trade.

We note that one could extend expiration and execute the same trade with Jan-18 expiry for $0.43. Although this costs 65% more in premium terms, it does buy nearly double the time available. However, we caution that at present liquidity in the Jan-18 USO options is not great and some investors may struggle to execute their desired size.

How hard to swing?

When one swings for the fence, the most likely scenario is that one misses completely. Thus we acknowledge that the most likely scenario for this trade is that we lose our entire premium. The chances of this trade being profitable are slim and the probability of a loss is high. However on a risk reward basis we think the trade has merit, if only for a small amount of one’s capital.

Initially our inclination is risking something like 5% of our portfolio over two years. We favour the USO Jan-17 +$20/-$25 Vertical Call Spread around $0.25, and would look at rolling this position to Jan-18 when liquidity improves in that expiry. A loss of 2.5% per year is tolerable in our view when the payoff is that one's portfolio value could double.

In conclusion we are not experts on oil, or regular traders of this market. However, our speciality is identifying trades with positive risk-reward dynamics and this is one that ticks the boxes. The chances of success are very low and the chance of a loss very high, hence our extreme caution with the quantity of capital allocated to this trade.  Nevertheless the payoff, if this contrarian trade proves right, is enough to justify a capital allocation in our view. To see if we pull the trigger on this trade, and what other trades our capital is allocated to, please subscribe via either of the buttons below.

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The Global Central Bank Put Option

Highly accommodative monetary policy and the increased responsiveness of central banks globally to economic shocks and other crises has led to a situation where, if such a shock occurs, then central banks ease monetary policy  quickly in response. This action calms markets, resulting in minimized selloffs and contained volatility while driving equities higher.

This phenomenon can be described as the Central Bank Put Option, as the situation effectively means that investors have a put option given to them by the central banks. We will discuss its origin and how it is currently in play, and then cover different strategies that can be used to take advantage of the put. Following this we will also look to analyse whether the Central Bank Put will be in play next year and how it may be traded going forward.

The Bernanke Put

The term “Greenspan Put” was first coined in 1987 to describe the situation of then Fed Chair Alan Greenspan adding monetary liquidity to avert a further deterioration of the markets after the 1987 crash, and throughout his term as Fed Chair. With Ben Bernanke taking over as Fed Chair in 2006, the term “Bernanke Put” became widely used as the Fed continued the practice of lowering rates to counter falling markets.

Following the GFC and during the Great Recession the Fed took on a highly dovish stance, cutting interest rates repeatedly and engaging in monetary easing on a massive scale. This has resulted in a massive bull market in equities, with the periods of greatest strength coming during periods of increased dovish activity by the Fed.

Less than three months into QE1 the stock market ceased its decline, following which the S&P rallied more than 70%. The next round of easing lasted only six months, but QE2 nonetheless saw the S&P push a solid 15% higher. During Operation Twist markets rallied again, this time by more than a quarter. Throughout its span QE3 saw the S&P rally another 40%.

It is important also to consider the movement in stocks in between these gains. The most telling of these is the weeks between QE2 and Operation Twist. This gap saw markets decline considerably, erasing the gains made during QE2 and threatening to move lower. Thus we have a situation of markets falling without new action from the Fed and the Fed responding with further easing that drove markets higher again.

Therefore, investors could speculate on the stock market without the fear of a crisis negatively affecting their portfolio’s, as the Fed would quickly intervene with new easing measures to ensure that any selloff was quickly reversed. This means that if an investor held a long position on equities, then they had protection from the Fed Chair Bernanke on any downside. Thus, we have the Bernanke Put.

The Global Central Bank Put

Major central banks, such ECB, BoJ, and BoE to name a few, took highly accommodative stances on policy following the GFC. The effects on their stock markets has been much the same as the Fed’s has been on US equities. European markets can rally knowing that if things go south, the ECB will step in.

Taking this a step further and without loss of generality, we see that European markets also know that the Fed will take action if the US economy suffers an economic shock, and vice versa. This means that every stock market is far less vulnerable to overseas shocks, as a result of foreign action, and is far less vulnerable to domestic shocks as their own central bank will take action in that situation.

The chart above shows that during QE1 and QE3 European stocks also rallied well. During QE2 stocks in Europe did not perform as well, however this was mirrored to a lesser extent in the S&P and was a result of a lack of action from the ECB in response to the Greek debt crisis. We will discuss this risk in further depth below. Now that the ECB has a QE program in place European stocks rallied well before the concerns around China’s growth panicked markets. However, these fears are now passing with the People’s Bank of China taking action. As a result both US and European equities have rallied back.

Therefore, we have a Global Central Bank Put Option in play, the effect of which is much stronger than a Bernanke Put due to the spill over of all major central banks having similar policies in place. The result is that crises with the potential to harm the global economy can be much better absorbed and without significant negative effects.

Trading the Global Central Bank Put

The Fed has been moving towards an interest rate hike this December. However, their overall stance has still been highly accommodative throughout 2015, as has the stance of central banks globally. This means that the global central bank put has been in play during 2015. We have taken advantage of this through a number of strategies, namely by selling downside protection on equities and selling volatility spikes.

We sold downside protection on equities by shorting in the money put spreads on SPY, the ETF that tracks the S&P. During February we sold SPY Dec ’15 $185/$180 vertical put spreads for $1.30. Provided that SPY remained above $185, or equivalently the S&P above 1850, we could collect the maximum gain by holding the trade until expiration.

Even with the correction made in August the S&P has not traded as low as 1850 all year. We chose to tactically exit the position after just 29 days to bank a 13.24% profit, and have used the strategy regularly since then as a part of our trading arsenal.

We have also made a number of trades selling spikes in volatility, all of which have been profitable. During the Ebola panic last year the VIX, the index that tracks S&P 500 volatility, more than doubled when it spiked to over 30. Given that the Central Bank Put was in play, we knew that this spike was highly unlikely to last. Either markets would calm of their own accord, or central banks would take action to ensure that equities rallied back and that volatility would consequently fall. Accordingly, we heavily shorted the VIX index by buying XIV, the inverse ETF for the VIX.

We allocated 25% of our portfolio in total, using 5% and 10% clips to progressively increase our volatility short as the VIX index rose. As markets calmed and the VIX fell back to normal levels below 12 we took profits on our short, gaining as much as 18.14% on just one of these positions.

While the profits banked on these types of trades are less than our average of 28.41%, they carry highly favourable risk reward dynamics. The likelihood of a loss is very low as the Central Bank Put greatly increases the probability that profits can be banked if the trade is set up correctly. Each of the trades we made have also been with limited risk, so we knew the maximum losses going into the trade.

Consider the alternatives to these type of trades that also look to take advantage of the Central Bank Put. One could have sold puts that would expire worthless if markets remain high. This is similar to our vertical put spread trades, but involves unlimited risks if markets fall, which we do not believe is prudent to take on.

The Central Bank Put does not guarantee that markets will rally, but rather protects against the downside. This means that upside directional plays, such as buying calls or stocks outright, are not ideal to take advantage of the Central Bank Put. These type of trades have their place and we regularly use them, but for simply making money on the Central Bank Put they are not ideally suited.

The Road Ahead

Monetary policy the world over remains highly accommodative. This is likely to remain the case in next year, even if the Fed hikes in December as we believe they will. However, does this mean that the Central Bank Put will still be in play in 2016?

Quantitative easing now has had diminished benefits. Broad based programs similar to QE1 and QE2 are unlikely to be effective enough to keep the Central Bank Put active. This means that more targeted measures, such as buying credit, will be necessary to ensure markets are confident that central bank action is sufficient maintain economic health, and thus keep markets from falling.

This means that the Central Bank Put is unlikely to be in play for markets where their respective central bankers are not able to effectively, and swiftly, evolve and advance easing methods when required. The value of the Central Bank Put is inextricably linked to the credibility of the policymakers that are targeting asset price stability. Therefore any announcements of new QE programs need to be analysed carefully if one intends to make a trade to take advantage of this Central Bank Put.

While the Central Bank Put offers many trading opportunities, there is no such thing as a free lunch. These opportunities must be treated with caution. If markets react negatively to a new, or even existing, measure, the downside risks to Central Bank Put based trades are substantial.

Consider the Greek debt crisis of 2010 when the ECB failed to act quickly with the necessary measures to calm markets. The result was that by the time the ECB announced a bailout plan fears had already set in. Markets did not have the confidence that the central bank intervention was enough when it came into play, and as a result the EuroStoxx 50 index decline more than 10% even after the bailout plan was released.

European equities therefore declined more than 17% from peak to bottom before beginning to sluggishly move higher again, finishing around 5% down on the year despite central bank action. This situation demonstrates the risks involved with taking advantage of the Central Bank Put. Had one tried to do so with European stocks in 2010 they would have very likely lost money. Any outright long trade would have finished lower on the year while an options based trade would have potentially lost considerably more. 

While at present the chance of this kind of downside being realised is small, the diminishing effect of various QE programs and a shift towards tightening in the US mean that these low probabilities have the potential to grow significantly.

Therefore there is no definitive yes or no answer to our question of whether the Central Bank Put will be in play in 2016. We believe it is likely that there will still be trades that can benefit directly from the Central Bank Put next year, however the nature of these positions will very likely vary. Therefore, as with all trading strategies that we employ, we will continually examine and re-examine the risk reward dynamics involved.

We believe that this will allow us to find and take advantage of those opportunities and, more importantly, avoid those trades that will be likely to lose money. If you wish to find out the results of this analysis throughout the changing market dynamics the next year will hold, please subscribe via either of the buttons below.

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Why Gold Prices Could Bounce This Week

Since the last US employment release and comments from Yellen suggesting a December hike is likely, gold has struggled to maintain its downward momentum. Whilst we believe that the Fed will increase rates in December and gold prices will move lower over the medium term, there is a strong case for a bounce in gold prices in the short term. Technically gold is oversold and holding support at $1080.  This is too low relative to market pricing for a Fed hike and should find support from weaker US data since NFP, lower stocks, lower oil as well as a safe haven bid from any escalation of issues related to ISIS and recent tragic events in Paris.   

Weak Data, Stronger Bonds

Let us begin with the data, since that will ultimately drive monetary policy as Yellen increasingly links the future path of interest rates to US economic health. US retail sales was weak on Friday, +0.1% versus expected +0.3% as was producer prices with an expectation of +0.2% only being followed by a -0.4%, even taking out food and energy a very weak -0.3%. With price indices falling there is hardly the inflationary pressure to force the Fed to hike rates. CPI data will give us more information this week, but it’s a poor start. Stocks and bonds responded as one would expect on weaker data, stocks falling and bond yields lower, but gold prices were stable.

As the chart above shows, GLD could easily rise to $106 to catch up the recent move, which is equivalent to gold bouncing to around $1100, and if bonds keep rallying it could go even further.

Market pricing of the implied probability of a Fed hike in December has dropped from roughly 75% to 65% (according to the CME FedWatch tool). And yet the gold price is barely changed from its close following the boomer NFP print? In fact it’s a just $10, a mere 0.93% from its intraday lows made this week. Even as medium term gold bears we cannot help but think that gold should bounce from here. 

Fed Speakers

One of the key developments we have been watching is the calendar of Fed speakers between now and December. With no FOMC meeting, the Fed speakers will show clues as to what they intend to do at the next meeting. As we have noted in last week’s article “Its Now Or Never For Yellen”: “Between now and the FOMC meeting next month there multiple speeches by members of the Fed. This month this includes Vice Chair Fischer on the 13th and Bullard on the 21st, as well as Yellen herself on December 2nd and 3rd. We expect the Fed’s bias to hike to be re-enforced in these speeches. This will gradually get the market more and more comfortable with a hike in December.

If instead the Fed intends to not hike, then this should be swiftly reflected in these speeches as the Fed will certainly not want to deliver a no hike when pricing indicates that one has a 70% chance of happening.”

Let us take a quick look at the speeches made this week. Firstly we had Dudley, who is a voter and generally considered a dove (biased in favour of accommodative monetary policy). Dudley said that it was possible that liftoff conditions may soon be satisfied, with the international outlook appears like less of a problem that it was a few months ago. The wobbles in China arguably stopped the Fed hiking in September but Dudley noted that although there are still legitimate concerned about the Chinese economy, China does have a lot of tools to address economic issues.

Next Lacker, who is a voter and a hawk (biased in favour of tighter monetary policy) came out strongly in favour of a hike and even said there is a chance the Fed could raise rates faster if they get behind the curve on inflation. This is no real surprise, since Lacker dissented at the last two meetings, voting in favour of a hike in September.

Bullard, another hawk but non-voter, was clear in his view that the Fed's goals have been met and there was no reason to hold interest rates low since 5% unemployment is close to full employment. Evans, a dove and voter was more neutral, saying that inflation is still too low and would rather see later rate hike as the risk of premature rate hike is greater than the risk of holding off rate hikes.

On balance these speeches keep December live, but market pricing has moved to indicating a lower probability of a hike. It is evident that the market was expecting some more explicit guidance from the Fed that they will hike in December, and whilst there is still plenty of time for the Fed to deliver such a message, the risk is that the Fed language disappoints hawks. They key speeches to watch this week are Kaplan’s just before the Fed minutes are released, then Lockhart’s and Bullard’s speeches on the economy in Atlanta and Arkansas, before finally on Friday Williams speaks on monetary policy at Berkeley.

Technically Oversold

Having turned bearish above $1150, the MACD is now beginning to converge signalling that the downward momentum is waning. The RSI is sub 30 and oversold, combined with gold being and the bottom of recent ranges and on key support at $1180 paints a supportive technical picture for gold. There is no resistance to the topside until around $1125, thus a swift $20-$50 bounce in gold prices is easily achievable given the technical backdrop.  Above $1125 gold will battle given the resistance at $1150 and the lower highs that we have seen since mid-2012 indicating that reaching the $1180 level is going to be a big ask.

Fade The Rally

In conclusion we see short term bounce in gold as highly probable given how low gold is relative to market pricing for a Fed hike and a backdrop of weaker US economic data since payrolls. Lower equities add to the risk off tone and even a safe haven bid from recent tragic events in France could support gold, as concerns grow about an increase in European involvement in the Middle East or further terrorist attacks. Position wise we have reduced our gold shorts, but will be looking to sell this rally. We are still medium term gold bears and hold the view that the Fed will hike rates in December sending gold below $1000.

However right here and now we cannot be selling at these levels. In the equities markets we sold topside protection which has worked well this week, but we are now more neutral and looking for opportunities to sell the VIX into its recent spike above 20, whilst we remain without a position on gold mining stocks. To find out details of our current portfolio and receive our full market update, please subscribe via either of the buttons below.

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SK OptionTrader Closes 160th Profitable Trade

Since the beginning of 2013 we have been bearish on gold, holding the view that the Fed would take a hawkish stance that would drive the yellow metal lower. This year we have maintained that view, although less aggressively than in the past. In 2015 we have traded gold on the view that the Fed will hike if economic data provides sufficient pressure, which has led us to construct our gold portfolio to take advantage of a rate hike either before or at the December FOMC meeting.

One of the trades that we opened on this view was to Short GLD Jan ’16 $112/$117 Vertical Call spreads. We opened this trade as gold challenged resistance at $1150 in late September, receiving a net credit of $1.50.

While gold declined immediately following this trade being opened, the metal rallied back challenge the strong resistance level of $1180 in October. This move pushed gold above a wedge formation that had held since August and showed gold to be temporarily strong from a technical perspective.

However, this was not to last. Fed Chair Janet Yellen signalled at the October FOMC that the first hike would come at the December meeting provided that the data was strong enough. The hawkish statement ensured that gold’s technical strength was quickly overpowered and pushed the metal lower.

The fundamentals then became even more bearish for gold with the US employment report for October, which showed some of the strongest data seen for the entire year. Markets immediately drew the same conclusion that we did, that this print all but guaranteed a December hike, and gold tumbled further.

By the end of trading on Friday gold was challenging support at $1080, rather than the resistance $100 higher that it had been attempting to break only a two weeks earlier.

This decline slowed on November 9th, with the yellow metal in fact climbing back a nominal amount before the close. We had anticipated this, writing in our market update to subscribers the day before that

“…there is a potential for a minor bounce due to the technical situation. Gold has fallen considerably and quickly since peaking in mid-October. The speed of this fall has led to the metal becoming oversold, indicated by the RSI falling below 30. The MACD has begun to converge towards a positive crossover, which will likely cause minor technical buying. The most likely technical factor that is likely to cause a small bounce in the metal is the support of $1080.  This level is likely to at least slow gold’s descent and has the potential to act as a base from which a small rally can be mounted.”

As a result, we were able to lock in profits on our Short $112/$117 GLD Vertical Call Spread. We signalled to our subscribers to exit the trade by buying the spread back for $0.34, banking a 33.14% profit in just over 6 weeks.

This marks the 160th profitable trade that we have closed and means that we have now closed 10 times more winning trades than losing ones.

These trades have returned a total 1208.86% since inception and an annualized return of 50.75%.

All you need to do is sign up via either of the buttons below to find out what positions we have open and which trades we will make next.

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