Since posting about my “weird feeling” towards Gold’s price action on Tuesday, we’ve seen some major mixed moves in Gold futures and I’ve been able to perform some additional analysis worthy of an update. In full disclosure, I added June 1200 puts on Wednesday, but I did not end up putting on the long Gold derivative hedge I contemplated earlier in the week. After running the options analysis – which, I still intend to post, I determined the hedge was simply too expensive. While both $GDX and $NUGT had considerably elevated IV percentiles (IVP) versus $GLD, $GLD, itself still made for too costly a hedge. Interestingly, $GLD actually had a lower IVP than the front month /GC contract – calling all /GC arbitrageurs! That being said, post-Draghi, all three alternatives would have look pretty damn cheap, in hindsight! Back to the update…
Without the ability to model Gold intrinsically, we’re forced to look at pricing relative to other assets and their correlations.
The major takeaways from my prior analysis were:
- /GC’s Tuesday price action was indeed, anomalous
- Yen appears to be a leading indicator of /GC correlation divergence
- /GC is most strongly driven by US Rates
- Longer-term currency correlations could be reaching extremes
MY REFLEXIVITY TRADE
The quick and dirty thesis for my “Reflexivity Trade” is that inflation is warming up faster than expected, such that, the market will need to re-price fear of the Fed being too, too far behind the ball. The ensuing catch-up trade will force a re-pricing of steeper FFR hike risks and resumed dollar strength. Higher rates and a higher dollar bode very poorly for Gold.
Just this morning, Canadian March CPI came in hotter than expected – across the board, with core printing 2.1a vs. 1.7e, 1.9p. Immediately following the release, US treasuries dumped, yields rose – with the 10yr yield hitting a new weekly high at 1.895%, and Gold dropped 50bps.
That said, Gold and rates – which remember, have the strongest correlation, actually began their accelerated moves much earlier during the US overnight session, following a trial balloon from the BOJ that it might consider lending to banks at negative rates.
Gold’s weakness today shouldn’t come as any surprise! As I pointed out in my prior analysis, Yen has been acting as a leading indicator of Gold correlation divergences – even across multiple time-frames. The USD/JPY ramp higher (weaker) – just after midnight, was as clear a signal as I can imagine to short the yellow metal.
Here’s the Yen signaling Tuesday’s divergence in Gold, a week before:
Here’s we see two instances – since February, where Yen bottoming has led Gold topping.
Sure, Gold has had an incredible leap off the 11/15 lows – around 1040, but the rally – ignoring macro forces, is rather long in the tooth. Gold bulls love to quote the YTD performance, which currently clocks in at 16%. What they don’t like to mention is what the YTD performance used to be! Since, the March FOMC meeting, 25% of the YTD rally has been lost! I fear more is to come. With the Dollar Index’s correlation to Gold topping out and the Yen and US Rates’ correlations strengthening, watch USD/JPY and the 10yr yield as guides for the directionality of the next leg.
From a technicals standpoint, /GC is trapped in a symmetrical triangle pattern, which is characteristic of a consolidation period. Today, Gold broke down below short-term rising support (orange line A), which makes it likely to test the lower support of the ascending triangle (orange line B) around 1220 before having another go at falling resistance (red line) around 1250.
Oh yeah – before going, I wanted to bring up market positioning in Gold futures. Last week’s CFTC data showed money managers getting even longer – both in absolute and net term, than they already were! Right now, the “smart money” is longer than they’ve been in Gold futures since 2011! Historically, front month /GC prices track well with net positioning data. However, during cyclical price peaks, an apparent small reduction in net longs precedes a rapid and dramatic collapse in both prices and net positioning, typical of a “stampede for the exit!”
During these cyclical peaks, net positioning is really only a function of the number of longs in the market. Eventually, short money managers decide to cut their losses and either reverse positioning or lock in the loss and move. As such, this “stampede pattern” is also observed with long positioning data, as well.
We’ll see what the CFTC data shows in about an hour. Until then, I’ll continue to enjoy today’s vindication for being on Gold’s short side!