2021 Preview Stocks, metals, and Crypto

 

Dec 30 2020                        Market Commentary, Stocks, BTC/ETH, Metals

 

People are excited about markets. Sunday morning, I looked at my phone around 830 am and saw that I’d received texts from two different people. I text about markets every day… but before 830 on a Sunday only happens when there is genuine excitement.

 

Going back 3 years, to late December 2017, the S&P was trading ~2900. As I write at 3740, up ~29% in the last 3 years. The incredible fall and rise in 2020 aside, markets seem to be moving up high single digits on an annual basis. Have you seen the sell-side list of price targets for the S&P in 2021? They’re all higher! Average target price? 4042. That imputes a consensus expectation of 8.5%, right in line with recent history. These expectations all seem quite muted given more recent history, but we’ll see.

 

I was taught to pay attention to the breadth of rallies. One of the concerns about the post March rally was the amount of money that flowed into FAANG, TSLA, a select few names. As summer turned to fall, the recovery trade was in full bull mode. Now the rally is broad. That’s a welcomed sign for those sitting in index funds. Since the big names represent such a large portion of the S&P weightings, you find yourself in a situation where a few volatile stocks can dictate the short term fate of the whole index. As the rally broadens, that risk lessens.

 

 

Crypto

There are lots of narratives out there about BTC. If you are considering investing/trading in BTC, I’d recommend that you only follow two of those narratives.

1)  Reputable people/organizations are buying

2) Regulation and the impedements for interested parties who have yet to dip their toe progresses

 

I would avoid listening to any of the talk about “hedge for inflation”, “hedge against central banks losing control” or whatever other reasons many of the die-hards may state in their buying. It is not to say they are necessarily wrong in their thinking. They may be right in time. But BTC hasn’t been widely traded for very long, and the evidence certainly does not support that it’s a safe haven. It does not necessarily “diversify” your portfolio either.

I remember vividly last March when BTC made its lows around 4-5k. I had written a post on linkedin not long before called “why I’m not selling at 13500”. Standing in my kitchen, receiving texts from an old trading friend reminding me that “BTC is going to 0, where is your stop?”, I remember feeling physically sick. I still believed in the story, so I never sold, and bought some at higher levels after things seemed to stabilize. But that experience has led me to operate with the belief that “Bitcoin is a hedge for nothing”. If I’m considering future buys/sales, it will not be to “hedge a portfolio”. If you are thinking in this way, unless you are talking small single digits, I suggest you reconsider. Please recall that at those lows, BTC was the worst performing asset on the board. Lot’s of volatility, not a safe haven if stocks are to sell off.

 

But there are a few things BTC (and eth) has going for it.

1) Big names buying- A few years ago, the debate was “will this thing last”. When Paypal, Square, and insurance companies are buying and making it accessible through their platforms, it’s not going anywhere.

2) Legendary managers/traders touting it’s virtues. PTJ and Minerd to name a couple. If you step in, at least you are amidst the company of some of the best. The “this is a scam” logic that was prevalent a few years back is dwindling

3) Regulation- This may frustrate some of the early adopters. The more regulation imposed, the less “decentralized” it may seem. But if the concern is price, then regulation has the potential to be a good thing, because it creates a path to allow new buyers to enter a market. Looking at the news, my take is that everything except for BTC and ETH is at risk. They are the darlings, and have/will have their own CME futures contracts. You see what’s going with XRP…. Once liquidity providers start pulling because of regulatory crackdown, the damage is done regardless of whether they are indeed compliant. As for Stablecoins, the treasury dept recently stated they should be used in a way that “effectively manages risk and maintains the stability of the U.S. domestic and international financial and monetary systems”. No one said anything like that about BTC or Eth. Takeaway? Regulation will likely make alternatives to ETH/BTC less attractive, while simultaneously making it easier for a wider class of investors to invest in BTC/ETH.

 

BTC Options: You can check out the price of options on Deribit. Unfortunately, at this point it’s a lot harder than you might think to get into the options game. Very few of the retail brokers are allowing for trading of BTC at all, let alone the options. The margins are currently prohibitive, and I have heard that a number of FCMs currently lack interest in supporting traders looking to get into the market. That I think above all is why you see fairly light CME volumes. I assume that will change in time, but we’re not there yet.

 

Nonetheless, we can see where the options trade on Deribit. No surprise given the recent volatility, the options are juiced. As I write with BTC trading 26,500, the 36,000 calls expiring in 60 days are 1500+ bid. When option trading becomes more universally available, it’s going to be a big deal. There will almost certainly be interest as the amount of premium is to great to pass up for those longer term holders. Sure, they’re priced where they are for a reason, but consider that you can collect (1500/26500). That’s 30+% on an annual basis. That feels like a lot given that those writing covered calls wouldn’t be called away unless it moves ~10k in 60 days. With active options markets, the potential for interest and participation in the crypto markets will grow. I find it frustrating that I can’t trade these options, as selling calls against part of the position would allow me to better justify the size of the holding from a risk management stand point. We’ll get there, but it’s early days.

 

Gold/Silver- One of the big narratives around particularly gold has been tied to BTC, and the idea that BTC replaces the need for gold. They both have limited supply and can act as stores of value, but BTC can be used for payments and is much cooler. There was likely a real impact from this narrative, as there have been outflows from GLD, the best proxy for retail interest in Gold. While I’m tempted to say who cares, it can’t be overlooked as Western retail demand tends to be the primary driver of the gold price. That all being said, I have found that gold is typically better to buy when no one is interested. When people start getting excited about gold, I get cautious. One only has to look at the history of how the hedge fund community fairs vs the dealer community to know that speculatively finding good entry and exit points has not been the forte of retail or the “sophisticated” buy side.

 

 

Above is a weekly chart of gold back to early August when it made its all time high just shy of 2100. There was a clear downtrend that ensued thereafter. Right now it appears the downtrend has stopped, at least temporarily. I like to pay attention to setups where an up or downtrend appears to stop and consolidate. Out of a consolidation pattern, moves (when they do happen) tend to be greater in either direction. Think of consolidation as a sign that both buyers and sellers are generally in agreement about price. When one side gains an advantage, the other side is wise to back off and wait for better prices. If gold manages to trade above 1900 for a day or two, that should give us some confidence that the medium term downtrend is over and that our near term downside risk is limited.

 

Like gold, silver peaked in early August. It dropped faster and has been in a consolidation pattern, as opposed to gold’s more clearly defined downtrend. If it can clear the 28.5 level, there is serious room to run to the upside. The following chart shows Silver (green and red bars) overlayed with gold (purple) since they both made all time highs in 2011. It is not news that silver has massively underperformed in the last few years, but if it is to play catch-up, there might be a big trade here.

 

 

Notice the red line going across the chart above. This was the ~1525 level in gold that had served as support for close to 2 years after it broke down from its 2011 high. Once that level broke, gold began a multi year downtrend. Look at what happened in 2019 when gold (purple line) got back above this level. 6 years of resistance had given way and gold took off like a slingshot to make new all-time highs.

Silver still hasn’t broken through the support that gave way in 2013. Above 30, SI will have clearly broken that long term resistance. Gold managed to make a new all time high ~6 months after the break.  An all time high for silver would imply a ~66% move.

None of this is investment advice. If you are looking for trades with asymmetric risk reward setups however, SI seems like it is worth the attention.

 

Happy New Year to Everyone, and best of luck in 2021.

 

-Ben

Big picture Context following swiftest sell-off since the financial Crisis (2/29/2020)

Context in Markets 2/29/2020

Following the swiftest sell-off in equities in over a decade, I thought I would share some general thoughts about the state of the markets to provide context following last week's roller coaster.

Above is a chart of the S&P 500 going back to 2010. At 3,000, the S&P now trades at three times the price of it's 2010 low, and nearly 5x the 2009 lows.

Notice the simple line on the chart to give a sense of the uptrend the market has been in since. Don't call this technical analysis! I am not drawing arbitrary lines to make wild price predictions or calculations. I'm just showing the history of prices. This line  shows the general speed at which the S&P has moved higher over a 10 year period. Notice how each time price went above the line sell orders came in and brought prices back in line with the longer term trend. Why am I pointing this out? Just over a week ago the S&P was trading further above its 10 year trend-line than ever before. Prices are not obligated to stay within a trend, but it is worth noting that stock prices were trading the highest in 10 years relative to the trend before the swift sell-off.

Then, while the market was making highs around 2/19, there was an increasing awareness that the numbers of Covid-19 cases in China were being understated, and that it was spreading. I for one remember being more shocked that stocks had not sold off sooner, than I am now that they did. Stocks were overbought on the short term, and there is increasing evidence that the risk (Covid-19) the markets more or less shrugged off, is a real. That is a bad scenario for stock prices in the short term.

One of the things about the Covid-19 that poses a challenge for pricing of assets in general is that it is unfamiliar and unpredictable. Aside from it's novelty, the implications are essentially impossible to calculate. Even if we knew for certain when the virus would be fully contained, predicting the response of individuals is a fool's errand. I for one watched myself change my mind on what activities I might and might not do rapidly in a 3 day period. If I can't figure out what I want, how can I venture to create a model for how 6 billion others' behavior might change?

A few times in the last week I thought about the Asian Contagion of 1997;
 https://en.wikipedia.org/wiki/1997_Asian_financial_crisis

While I know nearly nothing of the specifics of the Asian Contagion, I remember the lesson that chain reactions can be set off from seemingly contained incidents. In the context of the Covid-19 scare, it is hardly unreasonable to worry that short term stagnation in commerce could lead to insolvency for some (governments/corporations). Companies with significant short term debt obligations could default setting off a chain reaction that could reverberate far beyond the companies themselves. We will see some companies whose most painful days may be ahead of them if supply chain disruptions lead to delinquencies debt payments. Personally I am wary of the energy sector, where producers with high debt obligations are facing declining prices amid global supply concerns.

Friday's price action was positive.

Some companies will certainly feel the pain more than others, but the broader indexes gave reason for hope. (3 year S&P 500 chart below)

The bounce off of the low yesterday occurred at 2850. 2800-2900 really served as the battle zone for S&P price since the beginning of 2018. It is generally encouraging when you see a level that served as resistance act as support when it tests that level from the upside. The size of the bounce (150 handles by end of day) is also encouraging for the bulls.

It is worth re-iterating that (notwithstanding dividends) at Friday's lows, S&P holders were EVEN over a 25 month period. While the August 2019-Feb 2020 rally may have gotten a bit ahead of itself, the last two years have not been a one way train. I think the 2019 returns on the S&P created a misconception of what has been going on in markets in the wider context. The S&P was up ~30% in 2019, but that is misleading performance. September 2018-end of Dec 2018 the S&P gave back 500+ handles (a similar sell-off to last week's, just spread out over months). The recovery from early Jan 2019 back to the levels of the Sep 2018 highs made up the bulk of the 2019 performance.


The absurd post financial crisis attitudes towards market volatility that have become the norm

I have recently read a number of posts about how this move is a sign that our markets aren't healthy. That is preposterous. The Post financial crisis investing public has been spoiled by a Fed/government that has been incredibly accomodative. Despite the fact that indexes are up multiples from where we were just a decade ago, a 5% pullback in markets is enough to get the pundits/politicians acting like its 2008 again. And I suppose why not. If people vote with their wallet in elections, why not sound the alarm bells every time it looks like your equity portfolio might take a hit? While I can understand "the why", the reasoning and excuses for this level of fear is unwarranted. Just because the fed has all but destroyed volatility in markets, does not mean that volatility is bad. Volatility in markets is healthy. This isn't the early 1900's where crashes were frequent and the extreme swings created challenges for the stability of business. This is a 10-15% correction that happened quickly in a market that had gotten ahead of itself and faced a major unknown that could disrupt global supply chains. Sell-offs are a part of any bull market, and nothing about last week's price action tells me markets are "unhealthy".

These markets are in fact much healthier than the 2011-2014 markets. While both markets have been the beneficiary of accomodative policy,  the former saw far less volatility on a single stock level than the markets of today. Back then, QE/broader policy was a tide that allowed all boats (stocks). Today's market often brutally punishes stocks that miss earnings/ rewards those that beat expectations with double digit % returns. While (notwithstanding last week) volatility has been low at the index level, the volatility on the underlying stocks has been tremendous. I remember when people used to say commodities were not suitable for trading for most investors because of their volatility. Now, the FAANG names, TSLA etc are far more volatile than most metals/commodities. Traders need to know that at the single stock level there is plenty of risk, but from a market perspective, this is healthy.

Big picture for US equity investors

There is still money on the sidelines, and the rally from August to recent February highs took place amidst a backdrop of generally bearish market sentiment. Some have argued that the recent wipe-out was due in part to levered longs who were out of the market looking to catch up with performance (forced to liquidate accelerating the sell-off). It is worth keeping an eye on equity flows. If there are massive inflows to equities, it is wise to be aware of the increased risk that there will not be buyers to provide support on a down-move. When there is money on the sideline/bearish sentiment, longs can feel more comfortable knowing that if converted, those bears/sideline money can bring the demand needed to push prices higher. This may be what took place towards the recent peak... but as is commonplace... those converts get to the party just as it is about to end.

The one clear defining characteristic of the markets from 2009- now is an accomodative backdrop. I think it is safe to say that a friendly rate environment will persist at least until next year's elections. At the simplest level, this is good for equities because there is so little yield in bonds. If you want returns, there just aren't that many places to go. On the flip side, with rates this low, the fed's toolbox has shrunk. That puts investors at greater risk as even with the will of the people/fed to act, their tools may be too blunt to stop extended sell-offs and stimulate the economy. In that world, you can still be bullish equities, but reasonably expect  more frequent sharp draw-downs along the way.

There are always unknown unknowns, like Covid-19 that change the entire investing picture. Unfortunately, aside from some insurance against extreme events, there isn't much we can do to predict. Even then, that insurance doesn't always work out (I thought I'd be selling gold at 1800, not 1580 this week). But if a business friendly/ accomodative Fed is the characteristic of this bull market, I would see anything that serves to disrupt that as the biggest knowable risk. Populism is on the rise globally, and thus predictability of election outcomes decreases (Brexit, Trump election were not accurately handicapped). While I would rather spend my time doing anything but watch political news, I will be keeping an eye on how the odds shift for Democratic nominee and ultimately the general election. As discussed previously, it doesn't take a lot for post 2009 stock owners to kick and scream with fear at the smallest sell-off. If there are any major shifts in expectations along the way about who will be president, I would expect to see markets to become more volatile.

Feel free to ping me if you'd like to discuss any of the above. Enjoy the weekend.

-Ben

2018 Gold Preview: New Year's Edition

Let's start by looking at a chart of gold in 2017 and working our way out into a bigger picture view.

2017

For reference sake, this chart shows the spike high (spike of green on the far left in the chart) around 1330 in November of 2016. This marked the high made on election night when the polls began to indicate that Trump would be the winner. Initially this was seen as bullish for gold, but as readers may remember, that had all flipped by settlement the next day. Gold gave up all the gains of election day, dropping some ~$200 from that high to the lows made at end of 2016/early 2017 around 1125. This was the low for 2017, and it was never retested.

2017 was a challenging year for prop shops and market-makers alike. Prop shops, who aim to outperform major indices (and charge fees) NEED volatility in markets to differentiate performance. After four years of trading gold as a market maker, I decided to close all of my positions in October 2017, just before the following chart's price action. I am quite confident I would've lost money trying to trade such a stagnant market.

Above is a chart of just under 2 months of price action in gold (October-December 2017). Notice that the bulk of trading over this period took place between 1270 and 1295, a $25 range. $25 represents ~2% of the price of gold at these levels. When a commodity is trading in a 2% range for two month, you are living the definition of low volatility. I do not have the official numbers, but can confidently say that in 2017 the implied volatility (price of options) in gold reached their low for at least the last decade. The lower the volatility goes, the more exposed traders with limited capital are to blow out risk (forced liquidation) when playing from the short option side. Large institutional players can martingale (double down on selling options) their way out of these situations should movement pick up, but small market makers and prop groups are essentially forced to be long options and hope for the best. As I believe has been the case for a few years running, there are fewer market participants (on the options side) now than at the beginning of the year.

But while gold may have had numerous sloth-like trading periods in 2017, the chart continues to be constructive for further price appreciation.

Take a look at the weekly chart going back to April of 2013. Keep 2 things in mind.

1) notice how well defined the downtrend is

2)The importance of the 1305 area

You can see how starting in April 2013 (left of the chart) gold fell into a very well defined down trend lasting until the beginning of 2016. I have written about this downtrend in detail in past posts. The most important takeaway for now is that gold was in a downtrend for years, and that trend broke in Feb 2016. 

Here is a closer look at that downtrend

Notice the White Circle. This is the Final rejection of buyers solidifying the downtrend before gold dropped 250 dollars to new lows. This white circled area took place around 1300. You will notice that there is a lot of consolidation around this 1300 area from 2013 until demarcated high in early 2015. Since 1300 established itself as a sell zone, any break and established trading above it would re-enforce the flip to the 1300 level as strong SUPPORT. At the very right of the chart above you will see that gold broke this downtrend in Feb 2016. Let's look at the price action from the end of the multi-year down trend in Feb 2016 until now.

Here is a look at the weekly chart in gold going back to late 2015

Notice The white arrow. This is an incredibly significant point on the chart. The line that runs from left to right through it is the Multi-year down trend line. 

Were gold to have fallen lower here, The whole long term picture changes. The breakout in Feb 2016 would look like a failure. When resistance is broken, it should act as support if retested in a rising market. This also happens to be the low for 2017. 

To recap 2017. It was a year that gold had a convincing hold at an important point of support on the long term chart. It spent the year consolidating but managing to grind higher and finish the year at a significant point of long term resistance (1305).

Notice that gold is making higher highs, and higher lows. It appears that we have a reasonably well defined up trend forming. The rally here at the end of 2017 showed convincing buying that helps re-establish the lower line up this uptrend as strong support. 

These trend lines are approximate, but the demand we saw at #3 reinforces the notion that this lower line is attracting buyers. We have an intermediate term uptrend (1 year) coming into long term resistance. I would argue the 1280-1300 level has served as an important level for nearly a decade (see below)

If gold is able to hold above this 1300 level and turn it into support, I believe the likelihood of range expansion is greater. 

The Trade:

I have put forth my views and perception of gold's price action throughout this post, but I could be right or wrong. Let's just say there is a 50% chance I'm right and 50% chance I'm wrong. Is gold worth buying?

To answer this we have to consider our targets and stops relative to each other. This is where we can use our trend-lines to help us.

If we are betting on this uptrend maintaining itself into next year, knowing the speed of that trend is important for setting targets. If we believe this trend-line holds, our lowest target would be $1380.

The support line of the uptrend comes in around 1270, so it will be $1380 ($1270+$110)in one year. 

Doing similar math for the uptrend, I think the high target would be somewhere near 1525-1550 depending on how you measure the line.

For time's sake let's just assume we are looking for 1380. It is a reasonable target as it been clear resistance since gold broke above 1200 in early 2016. So, if we bought around Friday's close

$1380-1305=$75 low target profit.

Where do we stop out? 

If we use the current level of the support line in our uptrend (1270, which will increase ~ $10 a month) to stop out we would lose 

1305-1270=$35   $75/$35 risk reward is decent, especially if you are looking for potentially higher targets. For those who want to widen stops, the low around $1240 is $65 below current levels. With this stop we aren't getting very favorable odds (though still better than 50/50), but we would not stop out until we were confident our thesis was wrong. Violation of the 1240 level would certainly mean that the uptrend concept has failed.

It is amazing to look back at this chart of gold (above) going back to 2010 and notice just how little time was spent between these two prices. $1380 has been formidable resistance, spoiling every upside breakout above 1300 since 2013. Above it however there has been very little price action. For the last few years, gold has remained congested within ranges that bring buyers and sellers to the table in tighter intervals. If gold were to break above 1380, there is not a lot in the way of chart resistance between it and that 1540 area.

Notice the white X where the downtrend began in 2013. This comes in around 1470. Retesting the level where the great downtrend (2013-2016) began would seem like a reasonable possibility, posing potential resistance.

Also worth keeping in mind as far as targets go is the 50% retracement from high to low since 2009. The 2011 high was ~1920 and the low at the end of 2015 was ~1050. 

1920-1050=870

50% 870=435

1050+435=1485.

Predicting these prices with accuracy is hardly ever possible, but it is worth noting there are a fair number of things out there that support a positive picture for gold, should it break the 1380 tops. I like to look for trades where my bias aside, the price of my low target is more favorable than my stop out point. If you subscribe to the background evidence and logic I've put forth, then the potential kicker with this trade is that if it goes in your favor, there are reasons to believe it might continue to trend.

Admission of bias

 I admit my personal upward bias towards gold being due in part to the thesis I had a few months back that gold would bottom out just after the December rate hike. For those paying attention, gold has done that the previous two years (2015 and 2016) making lows immediately following the rate hike and starting the year in buyers markets. The success that getting in front of those trades yielded early longs is not lost on me, and may influence my views a bit. Still, the higher high/lower low trend analysis speaks for itself outside of any historical bias I might be allowing to alter my view.

Final thought

The name Fiat Gold was intended to be a bit paradoxical, highlighting the fact that gold has fixed quantities and fiat currencies do not. Because of its finite supply, gold is viewed as a store of value. Much of the wealth generation we have seen in the US has been due to the appreciation of the stock market. If gold is a store of value, and the stock market is the main driver of value creation, we should be able to get a sense of how the two might be priced relative to each other. What "fair value" is cannot be answered with any great confidence but I do think it is worth noting the relationship between the two over time.

The purple line represents gold (and the prices on the left). The main chart is of the S&P 500 with Prices on the right. Notice how the all time high in gold represented the greatest divergence between gold and the S&P. Now we see the greatest divergence in relative value since that gold high in 2011 the other way (Stocks more expensive now). If gold is a store of value, and so much of individual wealth generation has come from stock appreciation, it would stand to reason that gold would have positive headwinds. Gold could continue to stagnate and stocks could sell off as well. We can't predict those things, but it is worth noting that the two are diverging in price about as much as they have for the past 10 years.

For fun, here is a look at the two graphed over each other for the last 20 years on a monthly chart.

If anyone would like to discuss anything here further feel free to message me on Linkedin.

Best wishes to everyone for a happy and healthy 2018,

Ben Ryan

Traders Expo Speech, OptionsHedger, Potential Opportunity For Gold Bulls

Dear readers and friends,

This coming Monday, Feb 22, at 3:15 PM I will be speaking at the Traders Expo New York.

Below are links for the Traders Expo.

Register For Traders Expo

Why Directional Traders Need to Understand Options Details

OptionsHedger.com

I’d like to thank Options City for coordinating the opportunity to give this talk.

I would also like to announce the launch of our new website, OptionsHedger.com. Scheduled to be up next week, OptionsHedger will feature consultancy and commentary across multiple options markets. All commentary on the site will come from people who professionally trade the markets they comment on.

The vision for the site is to become the place individual traders and small-mid sized businesses come to get their options questions answered. Understanding options is becoming more important with the recent onset of global volatility. We are creating the site to become the resource that sophisticated traders and businesses come to when they are considering putting on options trades. In world markets that feature progressively less real liquidity, slippage in options trades, or undisciplined execution of a concept can become costly. OptionsHedger will be the one stop shop for those who want to avoid those costs.

Please visit us next week at OptionsHedger.com

Topic for the discussion Monday Feb 22, New York Marriott Marquis Times Square

The goal of this talk is to discuss how directional traders can use options to create trades with better risk profiles than simply buying or selling futures, ETFs or Stocks.

Why this topic?

Recently a number of traders I consider to be market savvy have asked me whether options make sense for them to trade when they are bullish or bearish in a given market. That is an impossible question to answer without knowing more details about how the options in that market are priced. That being said, there are ways that directional players can learn to find opportunities within these markets using options. A friend of mine who has market experience but limited options experience recently asked me about whether he should be using options to carry out his directional bias on the S&P. After about 45 minutes of asking questions about where things were priced, I still had no simple answer for him. I spent about an hour talking about all the risks that he probably hadn’t considered. Don't worry, I promise this talk won't be that long.

“Why Directional Traders Need to Understand Options” continues my conversation with Brian to explore the ways that options can be used to generate better returns. I will spend a portion of the talk going through historical examples in gold, where opportunity was clear for those who were paying attention. This will not be a long complex rant on options pricing. The goal of the talk is to help traders and hedgers consider ways to more intelligently approach the options markets they are trading in.

Gold Update:

Gold has been extremely exciting since I last wrote. A near 70 dollar rally on Feb 11 was the crescendo of a near 200+ dollar rally low to high.

In my last post,(Feb 6) I showed the below 3 year gold chart and said the following::

I think the chart above tells gold’s story. The upper line of the down-channel, which has held as solid resistance for nearly 3 years comes in near the October high around 1190-1210 depending on how you draw the line. This however, is not the 1200 of old. Consolidation around this area would be to my eyes bullish and would expect a retest of the 1325-1350 area should it break above. The length and strength of the down-channel we have seen for the last 3 years in gold must be respected. The extremes have brought buying in on the lows and selling at the nearby tops. I am not one to question history, so I will be watching these levels and the ensuing price action very closely. If gold is able to regain this area for a period of time, buyers may be emboldened if the resistance appears to weaken around 1190-1210.

This same chart 12 days later looks like this.

You can see that gold pierced through that upward resistance. It has quickly sold off and sits hovering right above the line. In keeping with last weeks theme, I think the concept that consolidation around this area could be quite bullish. The push through 1200 led to an onslaught of buying. Once that resistance gave way, new highs were established over 60 dollars higher. It is back here again, but those who hate 1200 in gold because of the monotony of last time should not lose sight of opportunity if we sit here for a bit. The longer gold is capable of hanging around up here even if it is doing nothing, the more bullish it becomes. Spending time above this clearly defined trend line would signal that the conviction of sellers had weakened. The longer term and bigger a price a channel is, the more likely you are to see a strong move when it breaks away from it. We shall see if this was a blip and a fail, but this type of situation might create opportunity for options traders with a directional opinion on gold.

Gold Options are historically expensive right now. Volatility, while off the highs, is at the far upper end of its multi-year range. While that does not mean they are overvalued, they are not at the point that a directional trader considering using options should look to be getting involved. But the opportunity might arise.

This is a perfect example of how a trader with a directional opinion can monitor options prices and find real opportunity with some basic homework. Let's say looking at this chart that you are bullish gold. You believe that gold will chop around this area for a while and then rally to new heights. Whether or not gold is to rally, someone who is bullish could reasonably look for an extend move higher because it would appear that it has broken out of its downchannel. This might be a reason to own options.

But the problem is if gold sits, and you buy options, especially at prices well above the 3 year historical average, you will painfully lose your premium. Time becomes your enemy. However, if you are of the mind that consolidation here is bullish, then you should be monitoring the options market carefully and waiting to look for entry points where the risk reward gets good.

Understanding the risks of owning options can be complex but in a scenario like this it can be simple. If gold consolidates into a tighter range, options almost inevitably get sold. As the movement becomes and less more and more options selling ensues as the cost of owning in a dead market is too high based on the movement. This creates the opportunity to put on an options trade based on the concept of a breakout out of consolidation.

The key is not to be in a rush. You do not have to do any trade. But if gold consolidates, and you view that as bullish, you will be able to buy options at lower and lower prices, giving you a lower cost basis on your investment/trade. In its simplest form, I am advocating that anyone who is bullish gold, unless they see it spiking back up, start monitoring the implied volatility in the options. If you view consolidation as bullish, and watch closely, you can find opportune times to get options at prices that give you a better risk adjusted return than you can get by trading futures alone.

I hope to see you all on Monday Feb 22nd.

Ben

Gold takes out 200 Day Moving Average. Front month Gold Options continue to provide good risk return for directional traders. 2/6/16

On January 20^th I wrote the following:

“The last week or so has shown that a down stock market does not necessarily mean higher gold. Today the February gold futures contract made a high of $1109.9. That is lower than the 1113.1 high that gold made on January 7th. Stocks made a new low today with the S&P making a low of 1804; on January 7th the low in the S&P was around 1930. So 125 handles lower in the S&P later, gold did not make a higher high.”

In the ~ 3 weeks since then gold has rallied 65 dollars to Friday’s high of 1175. During that three week period, The S&P rallied a similar ~60+ handles and is currently trading near 1870.

Gold and the Stock market rallied together. I track price post to post because it can help show how perceptions on the day to day can be misleading. The idea of stocks and gold working inversely makes intuitive sense, but it works inconsistently over unpredictable time frames. We should remain careful not to let biases that a rising or falling stock market is what is driving gold’s price.

Admittedly, my comment from last week warned to be careful about getting long gold. I was taking a very neutral stance because it wasn’t clear what the Yen would be up to next. The yen, unlike stocks, seemed to show a much more real correlation to gold. You can read my last post here which goes into more detail on the yen and gold. Safe Haven Status Wearing Off? 1/20/16

Had you told me what the Bank of Japan would do since I wrote that post, I would probably expect gold to be trading somewhere around 1000. The BOJ announced NEGATIVE INTEREST RATES. Being forced to pay to hold bonds is a TAX on the currency. Logically, this should lead to a sell-off in the yen… The BOJ must have thought that. Take a look at the 20 day, 15 minute chart of the Yen.

Notice that big move down. That was what happened after the Bank of Japan announced negative interest rates. The yen is now trading HIGHER than where it was trading before the country effectively put a tax on holding the currency. So logically, if you had known the BOJ would ease, you would sell the Yen and gold because the two have tended to correlate. You would’ve lost. Both are higher.

It is times like this that I work to adjust my trading strategies to be as nimble as possible, because, simple logic simply doesn’t prevail in these markets. Moves like this on news like that tells me that there are forces involved in markets that will move things in ways that are not intuitively logical to most of us. The global stage has materially changed over the course of the last few years. The lowering interest rates method of easing gets tough when interest rates are 0%. Our intuitive logic is accustomed to thinking about lowering rates from 4 to 3.5% as an incentive for businesses to borrow. But when we are going from 0 to negative, the implications are a lot different. I don’t profess to understand all of those implications, and I don’t want to make my opinion on them the basis of my trading.

It is important to differentiate between being a trader and an economist sometimes. Understanding the economic environment at large is critical to protecting ourselves in these markets. But can that work against us? The question is, how reliable are our perceptions of how the global economy is functioning, and how might that impact our trading. I used the example of the Yen’s price action after introducing negative interest rates to show how logical ideas don’t always lead to profits. It is times like this that I believe it is easy for traders to make big mistakes, and overvalue perceptions about things that are completely random. I think it makes sense to keep a view of the bigger picture, but look for small, stick and move type opportunities. Such opportunities exist in volatile markets, and you don’t have to spend futile hours trying to figure out the world all at once to trade that way. I’ve tried trading with a “smarter than the market” attitude before.  It’s a waste of time and money.

The action in the Yen is also a reminder that there are people who have real money at stake here. When a central bank puts in an easing measure that leads to currency appreciation, there are a lot of people who get exposed to big time changes in risk profile (banks etc). When those kind of institutions have that kind of money on the line, big orders can come in at unexpected times moving markets. That is not in any of our control, and it is essentially unpredictable. When the market becomes unpredictable, volatility of all positions tend to increase. There can be opportunity in these spots, but you have to be careful not to casually leave on big positions that seem benign. When money is whipping around in an unpredictable manner, good positions don’t always work.

In the past week, there were some opportunities in gold trading. Front month vol briefly got below 13% (a daily breakeven of only 10 dollars) in a market that saw some aggressive late week moves. Gold also managed to eclipse the 200 Day moving average. Take a look at the below chart which includes the 200 DMA overlaid on the 3 year gold chart.

The 200 DMA is approximate in this picture, and denoted by the purple line. Gold has been in a steady downtrend, and spent the bulk of its time in the past few years below the 200 DMA. In gold’s last attempt higher, in Late September, the 200 day served as strong resistance. Now, Gold has blown through the 200 DMA by 40+ handles. The early October rally was less impressive with respect to the 200 day.

In this week’s trading, there were opportunities to buy the breakout. I tried a few times swinging and missing, but was there when it did move. The options, particularly front month options get priced too cheaply sometimes, and represent a real opportunity to people with a directional bias, or in this case, a possible breakout concept. If you notice, over the course of the past 3 years the times that gold did break through the 200 DMA it was often in a spike like fashion. I mentioned that the last break was more muted than the previous few, but even there you got a 20 dollar move on the break. In all cases, owning options has been very profitable. While you can’t always catch the breakout, the risk reward of owning options priced in the 12-15% range with 2-3 weeks expiration tends to be very favorable to the buyers.

I think the chart above tells gold’s story. The upper line of the down-channel, which has held as solid resistance for nearly 3 years comes in near the October high around 1190-1210 depending on how you draw the line. This however, is not the 1200 of old. Consolidation around this area would be to my eyes bullish and would expect a retest of the 1325-1350 area should it break above. The length and strength of the down-channel we have seen for the last 3 years in gold must be respected. The extremes have brought buying in on the lows and selling at the nearby tops. I am not one to question history, so I will be watching these levels and the ensuing price action very closely. If gold is able to regain this area for a period of time, buyers may be emboldened if the resistance appears to weaken around 1190-1210.

It is hard to call a breakout. Options won’t always be cheap. But it is worth looking at the options as a way to play these breakouts. Sometimes people sell options right as a breakout is underway. That represents real opportunity for prospective buyers. If you are bullish, view consolidation as positive for your view. Options will likely get hit under such circumstances, and give you a cheaper entry point for a look at a sustained breakout. Just like the 200 DMA break brought buyers (of call options as well as futures) so too would a break of clearly defined resistance on the longer term chart. When money flips at critical points there is significantly greater potential for a big move. The return on owning options in spots like that can make a year if it is done with a plan to hold for an extended breakout. These are the opportunities I will be looking for, and will write if I think an opportunity with a tremendous risk/reward profile arises.

If gold fails to gain traction above 1200, it will look like the downtrend remains in-tact. This could embolden sellers, much the same way a break above could embolden buyers. If gold is to sell off to the lows of this multi-year channel, the $1000-1025 area is where support would come in on the extreme. There are big implications for the coming months that should become clearer over the course of the next few weeks.  Keep a close eye on gold and these levels. If you don’t track volatility in gold, but trade it directionally, it is a worthwhile endeavor to start. It could just be another beleaguered attempt to rally by gold, but if it is not, there could be a lot of opportunity. It is worth the extra effort to keep it on your radar for now.

Wishing everyone good trading in the coming week,

Ben

Safe Haven status wearing off? 1/20/16

The term "safe haven" is back in the investor lexicon. With stocks off to a brutal start to 2016, gold got some favorable attention for the first time in a while. Up over 50 dollars low to high since the year began, gold has certainly been a beneficiary of some of the chaos in the world. But does that make it a safe haven?

Perhaps, but don't fall in love with the idea that gold is the thing you buy when stocks are down. The last week or so has shown that a down stock market does not necessarily mean higher gold. Today the February gold futures contract made a high of $1109.9. That is lower than the 1113.1 high that gold made on January 7th. Stocks made a new low today with the S and P making a low of 1804;  on January 7th the low in the S&P was around 1930. So 125 handles lower in the S&P later, gold did not make a higher high.

I am aware anyone with a chart can look at that and notice it, but I think it is important to point it out to make sure that we are all looking at the facts with respect to gold's price action. It is true that gold has generally been up on days stocks have sold off, but at least for the greater part the last two weeks, one would be hard pressed to argue that gold performed well for investors during this period of struggle for stocks. Cash would've done just as well.

As some of you who have read my writing before know, I often like to focus on the identity that gold is being given at different points in time. This lack of continued inverse correlation between gold and stocks makes the safe haven label hard for the metal to maintain. Perhaps a lack of general demand means that it should get sold, but that isn't obvious either. If stocks recover, it doesn't necessarily have to go down, but a strong rally in stocks would likely put some short term pressure on gold.

If you really want to know what makes gold move take a look at the yen.

90 Day hourly Gold and Yen

The purple line is the Yen, the green and red is gold. You can see that the general patterns of these two have been very close. The yen ran into some strong selling this morning when stocks were selling off, and perhaps that is what helped keep gold in check today. Whatever the case may be, the burden  of proof for gold bulls looms large. If gold is simply pausing in the midst of a longer term move upward, I would expect it to retest 1075-1080. Below there it starts to look ugly, above that it looks like gold is consolidating above the lows which will reinforce 1080 as the critical level of support. Keep in mind 1080 was the low of the overnight crash last July. Funny how the same numbers seem to pop up in gold all the time.

One thing I can say from speaking with traders I know is that no one has gotten it completely right the last few weeks. The price action has been choppy across asset classes. Sometimes, following all this volatility (at least in stocks) it is easy to get caught up in the hype and look for the next opportunity to score big. I personally am taking a neutral stance for the time being. I like to put trades on when there is a clear reason that makes sense to me. Right now, I see gold in the middle of a range from 1080-1110 lets call it. It is sitting right on a major number (1100). A very similar range was carved out 100 higher (1180-1220). Those who traded that dreaded market will remember gold's love of chopping up all the speculators who bothered to participate. Even if gold is a huge buy or sale, I'd rather miss the first 20 dollars and put trades on when and where there is more reason to have some conviction.


I will write more as more clues become available to us. Gold has certainly run into some resistance here, so I wouldn't be in a rush to get long. If you want to put a short trade on here, I think you can do so while keeping a reasonably tight stop. In order to make the risk reward worth it, I think you'd have to be looking for at least 1060 on the downside. But if the last few weeks have left you a bit out of breath, follow me and take a few days to and see what develops.

-Ben

December Fed looming, Gold stands at an important inflection point.

Two posts ago, on November 14th, Gold Returns to Critical lows below 1100, I wrote the following.

So now, gold has found some buying around 1073, but has shown a lot of difficulty picking up any steam to push it towards 1100. This is an incredibly significant battle that the longs and shorts will fight out in this range. 40 dollars higher gold looks like a commodity that is finding real support and an ability to hold up dramatically well amidst all of the worlds commodity selling. 25 lower makes gold look very unattractive.

A month later, this still holds true. Despite a temporary move down to 1045, we are more or less in a range. Broadly speaking, that range has been 1060-1080. I think the levels, at least on the upside are becoming a bit clearer, and we can begin to focus on critical price points in anticipation of this week's Fed. 

You might expect I would show a short term chart to discuss these levels, but I believe they apply to much bigger levels. So, let's look at my favorite chart in gold because it tells so much; the three year daily.

The slow moving downward channel gold has been in for years is crystal clear on this chart. 

What I will mention from here on out about this chart is not technical analysis; it is just gold analysis. Even if you have never looked at a chart before, you can see that gold has demonstrated certain clear price pattern characteristics when approaching the extremities within the range.

Notice the very first low in July of 2013. That was the establishment of the lower line of this channel. How long did it spend there? Not long. It quickly rallied up to the top of the channel. Then revisiting this new down channel in December 2014 it rallied relatively quickly to the top of the channel. You can see how this pattern continues throughout the years.

Why is this so important?

Look at where gold is now. It is hovering at the bottom of this lower line. The last time it hung out on the line was this summer after the overnight 50 dollar drop to 1080. It consolidated before rallying nearly 100 dollars. Could we be seeing something similar here? My major takeaway from this chart (which is why I always come back to it for reference) is the speed at which gold rallies off of the lows. It is one of the reasons one might understandably adopt a strong bullish stance. In the last few years, betting on rallies off of the lows of this line have proven to be very profitable.

I will come up with the next argument for the bulls in a few, but there is also a way to see the above chart in a critically bearish light. 

Forget lines on a chart for a second and think about what it means when consolidation occurs at a certain price level.

Consolidation takes place at levels where buyers or sellers at a given point in time don't strongly outmatch the other. There is some buying and some selling, but not enough to push a market heavily in either direction. Over time however, when either the buyers or sellers throw up the white flag, the interest on one side of the market gets cleared out. This allows for a potentially accelerated move once the consolidation has commenced.

If you take a look back at the chart above, gold is consolidating along that lower trendline. Last time it did this it rallied 100 dollars in less than 2 months. So what is potentially bearish? The Speed at which gold sold back off  to here following that rally.

Below I am going to reinsert the same chart above.

Now focus on the lower trendlie. Notice that following December 2013, gold did not interact with this line again until a full year later. In July (only 7 months after gold revisited in November 2014) gold came back retesting the 1080 area. The latest consolidation that gold has been experiencing began in November, and has continued to consolidate for longer than at any previous time gold traded along the line.

There are two elements of this price action on the longer term chart that signal the potential for a strong down move. First, the time intervals that gold is interacting with the bottom of the downtrend are shortening. The return more quickly to this support line shows that rallies are fading more quickly across the time frame you see above. Thus while the market has clearly shown strong buying off of this level, the bull party seems to be ending more quickly.

If Wednesday's Fed decision leads to a break of this line on the downside, I think it opens the door for at least 100 dollars in downside. I would consider a break of 1055 as a true break of this line. The longer a line has held as support, the more likely a break of that support is to lead to swift down move. In the case of gold, a break of support would be confirmation that years of efforts to rally have failed.

Finally, I'd like to focus the other line you see above. Below is gold for the last 10 months or so.

This line you see slices down the middle of the down channel we have been looking at. Notice how the line served as resistance in May and June. You can see how precisely this line served to stand as resistance over the course of the last 8 months. The break above the line led to an accelarated move higher; and soon after, an accelerated down move back to the line. Now, as you can see, gold is consolidating below this line. The last time gold broke above the line in early October, it rallied 60 dollars rather quickly. While chartists might deny the validity of this line, I have more reasons for focusing on it. I have noticed that options demand begins to flip (calls get bid above it, puts get bid below) as gold's price relative to the line changes. Markets are not science. There are clearly others in this market who use this line as a guide for future price, and that is enough to command our attention.

It is rare you get a chance to see so many of the price patterns and trends converge at critical points simultaneously. Right now, as I have tried to convey in this post, gold sits in the middle of some very significant cross currents. It is probably not a coincidence that these cross currents are meeting head on in front of the big December Fed announcement. As it stands there is a greater than 70% chance according to markets that the Fed will raise. So, gold finds itself at a major decision point as markets approach the event (potential rate rise) the markets have been waiting for for years. A break higher opens the potential for a yearly close in the 1180-1200 range where gold has spent so much of its time. A break lower opens up the door for new multi year lows. Even if there is not a big move on Wednesday, there will be potential for big moves in the coming days and weeks. Big events like this tend to exhaust either buyers or sellers. Even if the move is not immediate, the potential for 50+ dollar moves over a 1-2 day period will increase at such a point of buying and selling cross currents.

Wishing everyone good luck this week; I will try to write next weekend and discuss the events of the coming week.

-Ben