Metals Thoughts: Back to school
Thursday, August 24, 2017
We've taken a couple months away from publishing Metals Thoughts as it became a bit tedious to dissect every move plus/minus $35 on either side of $1,250 due to a misspelled tweet. With gold continuing to hold just below the $1,300 resistance for the third time this year and traders coming back from summer vacations, it seems prudent to get back in the habit.
For context, we last wrote June 15, with spot at $1,270, a mere 1.5 percent below current market. Silver is less than 10 cents higher over that same period, which is less than half of the long-run daily range, so we can effectively call it unchanged. Onward:
It's fairly difficult to stake a view here that is outside of consensus. Everyone is worried about equity valuations, but economic growth seems to be grinding along, even with macro concerns that we are reaching the end of a larger econ cycle.
With equity indices at all-time highs, no one is really selling their longs in size. That has pushed investors to keeping their exposure (not much else in the macro space to buy for appreciation) but spending some money on buying hedges and funding that by selling calls.
Also, I saw a really interesting note that when you look at the equity market from an industry standpoint, we have had several corrections, and that market breadth is showing some weakness already. But the market leaders (FAANG, in particular) keep the indices elevated, leading to skewed perceptions of "all-time highs."
- Much of the bull case right now can be summarized by anxiety: central banks, debt ceiling, market valuations and geopolitical headline risk are all valid concerns, but they will have to come to fruition for the next leg higher.
- Federal Reserve Chairwoman Janet Yellen and European Central Bank President Mario Draghi both have speeches scheduled for tomorrow afternoon. The Jackson Hole conference has historically been an opportunity for central banks to float trial balloons for subtle changes in policy, and typically bullish for gold.
- The recent USD weakness has been largely driven by an orderly appreciation of the EUR/USD. It has gotten to the point that the ECB is growing concerned about the strength of the EUR versus GBP and USD, so perhaps they will skew toward extending QE. That can cut both ways (dollar strength can be bad for XAU/USD), but in general central banks extending accommodation is supportive for metals.
- What does the Fed balance sheet reduction do to markets? In the short term, you would expect higher rates as a major buyer either steps away, but that could hurt the economic expansion.
- Investors really like purchasing insurance here. Maintain the dividend yield of markets, but in theory outperform if market drops. Equity puts are very expensive and the negative carry associated with being long the VIX is punitive, so gold seems like an obvious choice, plus you get protection against weaker dollar.
- Gold has so far had a third failure at breaking the $1,300 level, and silver is struggling to hold $17. Technical traders will see a third failure as a major disappointment should we drop below $1,280 or so.
- CFTC reports show that gold traders are at their highest net long positions since November, largely driven by the level of short positions being the lowest since 2014. No short squeezes here.
- Vols: On the surface, the low levels of implied vol in the market might expose short gamma traders to spikes, but the Open Interest of short options positions is low. It's not seller's pushing down vols, it's more a complete lack of buyers.
- 14-day RSI shows gold as maintaining mildly overbought status (60 currently vs. 70 being strong overbought). With momentum waning, that can turn over quickly.
- Short and real interest rates have basically ignored any concerns shown by gold or the dollar. It's an interesting divergence, and any further moves that aren't directly driven by credit risk (debt ceiling fiasco) are going to be a problem for gold.
- Jobs: As has been the case since 2009, the job market continues to be strong, although not frighteningly so. Initial claims as a percent of the labor force continue to make new record lows and with the U-3 matching Q1 2007 lows at 4.4 percent, it's hard to argue that the employment situation isn't rose-colored. If wages ever expand, we could even worry about too much strength forcing the Fed's hand to tighten.
- There is a big pocket of air between $1,286 and the moving averages in the $1,250s and below. The 200 DMA is at $1,231. We have shown time and again that gold loves the $1,250 number.
- Physical demand remains abnormally weak. See chart below.
Equity investors continue to buy puts with reckless abandon. They are selling calls to fund it, but because of that imbalance, you are having to sell closer and closer strikes on calls just to protect your position.
The market is well insured, and if we get any good news, you could see the market scrambling to cover short calls. Risk reversals make a ton of sense here in place of vanilla long exposure.
The 12-month moving average for new silver eagle sales are at lows dating back to 2009, and August looks to disappoint versus what was a relatively improved July number, so would expect further weakness as we go into the slower back half of the year for investor physical demand.
Without a headline surprise, it's difficult to see where the next chunk of buyers comes in for gold. I'm not sure many traders are champing at the bit to short it because of that headline risk, so it seems the likelihood is for some longs to get frustrated and trim positions, leading to some profit-taking.
It's not an extremely crowded long market, but with vol low, traders will be quick to protect gains. We expect another look down toward the moving average convergence in the high $1,250s.
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