On January 20th 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
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