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 

Gold Quietly Breaks 1050

The dollar is what is ruling these markets right now. For the time being, the gold price seems inextricably linked to the dollar. Higher dollar, lower gold; and vice versa. 

There have been some buyers coming in in gold this week, but the dollar spoiled their plans starting around 5 this morning. Bad European economic data caused the dollar to rally. The dollar rally extended at 8:15 when the ADP preliminary employment number came in better than expected. The dollar continued making new highs as Janet Yellen spoke in the afternoon. By the end of her speech (which my angry colleagues tell me I am lucky to have not listened to) the dollar had given up all of its gains, even dipping back below the psychologically important 100 level on the dollar index.

The one thing that has actually been clear in these markets is what data is bullish and bearish for the dollar index. Bad Euro economic data is perceived as bullish dollar. Bad Euro data increases the perceived likelihood of European QE, which would put pressure on the Euro. Positive news in the US (good jobs report) increases the perceived likelihood that the Fed will raise rates later this month. Since there is at least a literal connection between interest rates and the economy, positive US data makes it appear that the Fed is more likely to raise. This, in turn should be bullish dollar.

But what happened this afternoon? As my friend put it, "She made it seem like they were going to raise rates, and the dollar rallied. Then she started talking about what might happen after that, and I just got confused". Apparently, whatever confusing words she used were enough to bring some selling into the dollar, and gold managed to hold a low of 1049.4.

I find it interesting to note that the stock market took a turn to the downside after her confusing speech. I apologize for having not listened to the speech I am referencing, but I have been confused enough by her in the past, and will take people at their word when they tell me she made things unclear. The stock market does not like this uncertainty. We have seen this before. "Raising rates" is not necessarily enough to derail the stock market. We know this because stocks have rallied as the perceived likelihood of a rate raise has increased in the past few weeks. But market uncertainty about the message being delivered by the Fed is a different thing all together.

At this point, most market participants are banking on a December rate hike as an inevitability. A rate hike is thus largely priced into markets. The question will be, how do they describe their future intentions. If for some reason they don't raise rates, gold could see an epic short covering rally. But my contention at this point is that a rate hike does not imply lower gold prices. It will, ONCE AGAIN, be in the language that is used.

I am not much for giving out gratuitous advice, but I'll make an exception this time. Try to go into the announcement flat if you can. That is my game plan. Over the past two years, I have seen what seemed so obvious NOT work on these announcements and major events. I have personally put on what I thought were well thought out positions into these kinds of events, only to lose a month of hard work in minutes. I know, I am not alone on that one.

One of the reasons the risk is so great right now is the general lack of liquidity that is so pervasive across markets. I will write more on this "fake liquidity" next time, but I have been watching the liquidity dry up in the gold futures and options markets for some time now. It has been getting progressively less and less liquid. Take today in gold for instance. ~4500 lots traded on what was clearly a stop getting run. The seller left 2000 lots (offered on the screen). After a few minutes of futures silence, buyers took the seller out. Then, with the exception of one small blip, there were no orders to be seen. One would think that a 6 year low might interest some participants. It didn't. This is not the first low gold has made of late, nor is it the first time the participation following such a low has been a complete dud. To my mind, a multi year low would be reason for interest to pick up, but the volume is telling us otherwise. Rather than watching futures change hands throughout the day, you are seeing intermittent volume spikes, followed by silence. This is the ultimate sign of illiquidity, or at least, lack of participation. If a size player is caught of guard at an illiquid time, it increases the likelihood of a gap move. If you want to hold positions into the Fed announcement (or any time leading up to it) just keep in mind that getting out may be tough if it doesn't go your way. 

This Friday is the jobs report. As a colleague reminds me, trend changes in gold tend to begin on NFP days, and on Fed announcements. We will see how it plays out, and I will write more following Friday’s action.

Good luck,

Ben

Gold Returns to Critical lows below 1100

Gold managed to get a lot of people excited over the course of the last few months. Following the late July dip to 1080, it was unable to make any further progress to the downside. 1080 became major support, and the metal managed to rally over 100 dollars off of the lows to 1191. Then, in the course of about a week, all that hard work was undone, and gold is back near the lows of 1080, and mere tics off of making a multi year low at 1073.

There are a few interesting things to note about what has gone on for gold, and how investors are approaching it. Interest rates, or more specifically, the expectation of a rise in interest rates has been the main driver of price. If you take a look back at gold’s price action in the last two months you will find that one basic rule holds: Expectations of a rate rise leads to gold selling, when the expectation is that a rate raise will be pushed further into the future, it gets bought.

The NFP on Nov 6, which came in better than expected, provided the impetus for sellers to knock the metal below 1100. The idea is, better jobs report means the economy is better, and therefore interest rates are more likely to go higher. The logic is not really logic at all. Sustainable jobs are not created from twenty five point raises or decreases in interest rates…. but the soundness of the logic behind interest rate moves, and gold’s reaction to them, is not our concern. We just need to know how gold is perceived at a given time, and what drives investor sentiment towards it. Lately, it has been all about interest rate expectations.

I found it very interesting to learn that the managed money crowd has been behind a lot of the selling. Take a look at the Nov 3 Commitment of Traders.

Notice The -30,958. That would indicate the amount of futures that the longs in the managed money category got out of during the week. I read this as showing that managed money longs bailing marked gold's last gasps in the 1180-1190 area. Had gold been able to recapture the 1180 area and consolidate the chart would look far different than it does right now. My view is that "managed money" is using gold as a proxy for Fed hike expectations, and the market is moving largely off of that view.

Wednesday, November 4th the Fed released their minutes from the previous meeting, and the general consensus was that the tone in the meeting was hawkish (expressing a greater likelihood that a rise in rates was imminent). The Friday jobs number helped to support that hawkish outlook…. Good jobs, less reason for the Fed to change their hawkish tone.

Where from here? Gold made a very interesting efforts at the lows at 1073. Unable to even make an effort above 1090, gold found itself retesting multi year lows.

 Note: Gold made highs near 1191 in the week previous to this chart, and likely marked the levels where managed money started selling. The selling was reinforced with the first big red candle you see at the top of this chart.You will notice that selling came in after 2pm on Wednesday afternoon, just after the Fed had released their minutes. 

Look at the volume on the bottom of the chart. You will notice that the the big down candles tend to correspond to high volume the whole way down, showing real selling. On Thursday however, there is major volume on a green candle at the low of 1073. Consider the longer term chart to see why this level is so significant.

Look at gold from 2007 to now above. As I read it, someone looking to get short futures on these lows would likely be targeting ~1000 dollar gold, near where the old tops from 2007 should serve as support. But those shorts did not get their way on their first try last Thursday. As mentioned in the short term chart above, real volume came into buy at 1073, and defended the previous low. The shorts cleared out quickly as gold managed to rally back nearly 15 dollars, likely representing shorts giving up on their immediate plans to capture such a drop.

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.

Short term directional trades don't make sense in this kind of range. If you want to play long or short, I think you need to be working with 25 dollar wide stops and looking for a big move in either direction. If the long/short battle in this range appears to be clearly going to one side, it may be worth it. For now, we will wait to see what this Wednesday's Fed minutes reveal. We should be looking for any big volume that might come in and use it as important information in getting a sense for the bigger picture in the gold market.

In looking back at what I wrote I had to adjust the 100 handle on a lot of what I wrote. It is so easy to get confused as so many of the numbers 100 higher have such similar to the significance 100 lower (1180/1080 especially). Good luck trading and as always, please feel free to share any questions, comments or critiques.

All the best,

Ben

The Liquidity Illusion

“Tighter markets will lead to more liquidity and more efficient markets”.

Maybe, but so what?

At any given moment you can look at the options boards for most of these options and get a tight quote, probably much tighter than you would 5 years ago. While that is nice, it is not clear that it does a great service for the “efficiency” of markets. While the market is tight, it is prone to change more drastically, more quickly as a result of lower volume.

Take for instance what has gone on in gold options in the last week. Call skew (the difference in volatility that a call option is priced at vs the at the money vol) is the highest I have ever seen. That includes the call skew when gold made all time highs at 1900.  The degree of movement in call skew, on a mere move to 1150 on October options expiration took all of us by surprise. While it might signal some short term bullish sentiment, it is being priced as if gold is going to 1300 some time soon. That seems a bit optimistic as 1220 should serve as strong resistance on the longer term.

As an options trader, it is important to keep a close eye on size options orders as they may be indicative of a shift in sentiment. My view so far is that while rallies to the 1220-1230 level are not out of the cards, moves above that will require a complete shift in sentiment toward gold. At that point, we might see the beginning of a major bull market. But we are not there yet. 

In the ~ 3 year daily chart above, you can see that gold is still in the middle of the longer term slow moving downtrend. The significance of this 1220-30 area (and perhaps up to 1250 depending how you draw the downtrend line) is that a breach of it would indicate a break of this long term down trend. 

If we use the chart as our guide, we can certainly see that bulls might have a decent reason to get bullish. But it is not the most bullish setup anyone has ever seen.  You can see the challenge in predicting the change in skew in calls in gold. We are in the middle of the range, so we cannot get aggressive with our calls either way. If that is our attitude (rather neutral on market direction) then we certainly wouldn't expect call skew to blow out like this. We always need to pay attention to orders, because they could be an indicator of things to come.... but there could be other reasons for this massive move in call skew on a historical basis.

Liquidity.

The locals, options traders who historically traded their own books, are dying like flies, but have not adjusted their mentality to the new realities of the market. I am one of these unfortunate souls. In an effort to be optimistic we remind ourselves of how much money we can make when things go awry. But this time IS different. While we have always been the less capitalized on an individual basis, we are more commonly becoming less capitalized as a group. The advice and thoughts I have given this site and my close friends has been net profitable over time. But that doesn’t mean that those who listen to what I have to say, or even that listening to my own good advice will remain profitable.

Options prices are dictated by 2 things. The performance of options, and the price people are willing to pay, or sell options at. This site has made the point that volatility is underpriced in the gold market, and has been over a 2-3 month time frame for the last few years. How then could a trader who is long options lose in this market?

LOCALS, aka THOSE WHO VIEW THEIR JOB AS GETTING PAID TO TAKE THE OTHER SIDE OF A TRADE, ARE AT THE MERCY OF THOSE WHO HAVE THE REAL MONEY.

While I feel very fortunate to have a backer who will risk his personal capital on my investment decisions within the COMEX gold market, I cannot pretend to be more impressive than I am. Because we are small, my future is highly dependent on the big players’ willingness to put on trades that reflect the nature of the market, not its liquidity.

I do not expect the readers of this blog to do research on options pricing and how it resembles future pricing. It takes a lot of time to understand this market, and once you think you do, you will often find yourself disappointed.

As such, I’m forced to repeat the same thing I’ve been saying for some time. YOU CAN WAIT FOR BETTER OPPORTUNITIES.

It has been a while since I have written about the gold market. Here is what has happened since I last wrote.

My partner Georgi and I have been completely on top of price action. We have been so right that my close friend, who had been asking about our outlook, thanked us for putting him into so many good trades.

This is not a self-congratulatory comment. I have had my worst performance on an options trading basis since I got my own book two years ago. I have been more on point with respect to price movement than I have been in my career, and I’ve lost more money in that period than I ever had over a similar time period.

How to reconcile such a situation? On some level I feel like a genious; but my P/L makes me feel like an idiot.

While I wish I had made what I would expect given my options positions over the last month, I have felt this strange sense of optimism. I have realized that my current business model is less effective than it was two years ago. I realize the market has changed. I only write about it because I hope my readership (however small) might gain some perspective from my experience.

Money moves markets. Retail, small companies, and individual traders have a relatively small amount of money. While we might be right in calling ourselves “sophisticated” we are still relatively poor. Locals like myself historically profited from their understanding that curves would come back into line over time. If a fund came in and paid for an April 1250 call, selling it and buying a front month 1200 call would be profitable in the course of a day or 2. In the current market environment, the person who put this trade on might find themselves surprised by the profits that are NOT flowing into their account in the short term.

In the current environment, it might take a month to recognize the same profit. If a local is poorly capitalized relative to the initiator of the trade, they might be forced to puke out of their trade before recognizing the profit they would historically come to expect.

Welcome to the new market.

There are fewer participants available to take the other side of real orders. When a trade goes against the locals, they have to take their trades off too soon. Bottom line? Being poorly capitalized relative to the major players in a market makes for big challenges ahead. This was probably always true, but now, the money that could be made trading throughout the duration of such a trade is less than it has been historically. As such, less capitalized players, with backers who need to justify their own investment in their traders, are in a challenging place. Being right is not a precursor to making money. Options prices are more often controlled by the supply demand of the market, and as the “local” becomes more obsolete due to their capital constraints, accurate assessment of price movements have a smaller impact on the profits one can expect.

The conversation as it started was focused on the idea that it is dangerous to invest in options when the volatility of those options can be so drastically impacted by the supply/ demand concerns of the market. This is the take-away that I hope all readers remember. I have been right at an all time high rate, and profitable at an all time low. It is not because I have put on a bad position. As mentioned, such a position historically was the desire of all traders. As I watched myself be correct, I watched the losses pile up. It was a sobering lesson that the people with capital, and their choices about which part of the curve to invest in, are more important than my own opinions about the market, even if my expectation are fulfilled at an impressive rate.

Readers. Please, do what any self loving person would do. Look out for yourself. Don’t get too heavily involved in markets when being right doesn’t mean being profitable. We constantly make bets on things that have happened historically, but have no fundamental reason for happening again. Don’t bet on the latter. Patience is best for this (and probably all other markets) market. While liquidity, or the lack thereof, despite “tight markets”, is a great reason to fool us into believing we can be profitable on a basic understanding of the market….we have to be smarter. I am a firm believer that the investor who makes fewer bets, and only when they have strong reasons for making such bets, will be successful going forward.

If there is one take-away from this, please let it be that being right is not the same thing as being profitable. I have a million things I could write about with respect to gold, but it is not worth writing. It is simply not an asset class that any investor has a great reason to go either long or short. Let us wait until that changes, and we can discuss why. Until then, remember; you are never in a rush to take a stance, and if you feel rushed, it is best to step away until such urges go away.

All the best,

Ben Ryan