February gold (GCG7)

I have this idea that volatility will increase leading up to Inauguration Day. This probably isn’t a good idea, given the “January Effect“. I have not analyzed performance during Inauguration months. Maybe I should…

Also, the Fed delivered a December .25bp hike and has signaled two or three more to come in 2017 (depending on the source). Ignoring PEOTUS’s plans and the price of gold for a moment, I believe the market has not yet priced in the risk of two or three more rate hikes — and I have not read or heard of anyone speculating on when this will happen.

PEOTUS’ fiscal plans are, many say, inflationary. As an indication of risk sentiment, gold continues to confuse me, notwithstanding the anticipated shift in fiscal policy. Underrepresented, I believe, is the uncertainty of what exactly will materialize over the coming months as a new cabinet is formed and the usual politics ensue when untested initiatives are pushed through the House and the Senate. Some speculate the government will finally do what it should have done several years ago (thus taking pressure off of the Fed). Others say there is little need for stimulus today, as inflation appears to be showing signs of life already. A concern emerging within the latter narrative is that an expansionary fiscal policy (sounds funny after the last sixteen years, I know) combined with an increasingly hawkish monetary policy will combine to create more inflation than is desired and will probably kill the “recovery” that everyone is talking about. (Fear-mongering?)

So, to gold: technicals aside, the reality of inflation should encourage the usual buyers to step in, right? So why haven’t they? My guess is they are selling or standing aside until the US dollar levels off. (Or maybe investors and speculators are looking for better hedges against inflation.) So I think until the dollar stabilizes or (better still) retraces, the decline in gold will probably continue, other things remaining the same. The other part of this equation (in my mind) is what will happen in the treasuries. During the past nine months, 30 year treasury bond futures (ZB) have moved almost in lock step with gold futures (GC). I can’t say when this dynamic will end. Treasury yields will of course wax and wane with inflation expectations (and actual inflation of course) but gold has not always behaved in the same way. My guess is that at some point in the near future, ZB (and ZN) will diverge with GC again. What I’m really trying to figure out is when GC buying interest will return. The February 2017 implied move is currently $69.70, bringing the 2015 low into play since actual price ranges are typically much larger than (but rarely smaller than) implied moves.

gc-daily-2016-12-18_15-21-27

One potential play is a spread where I can capture value well below current price if the market continues lower, but also lock in a smaller but still acceptable profit if the market reverses. I like broken wing condors for this strategy. With the right pricing, they can offer a high probability, low cost way to profit off of uncertainty. My biggest concern is that implied volatility (IV) is still comparatively low, at 20%. Short term IV (55 days) is even lower, at around 10%. A 10% spike in volatility would produce large unrealized draw-downs and I have been taught to avoid holding spreads too close to expiration while I wait for volatility to unwind. I prefer to take this kind of trade when IV is above 40%, and ideally above 50%. This trade idea is on watch until I see better pricing. (See below.)

gc-scenario-2016-12-18_14-58-40

The spreads between bid and ask are currently a little uneven for February. This is normally a contract with decent volume and I am looking for $2 to $3 spreads or better. IV on the put side has tanked while the call side has actually increased a bit. Overall, there is enough volume below 1100, all the way to 1000, and this will improve as the expiry matures.

Would appreciate any thoughts. Especially more complex ideas expressed across the gold products. And if I’m making any dumb assumptions, of course.

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