Seeking Shelter in Gold on Rising Geopolitical Risks
Shining bright and sizzling hot, gold has surged 8% over the past two weeks. Ample supply of geopolitical shocks from violence in the Middle East to ongoing Russia-Ukraine conflict has been driving gold high.
This paper examines the drivers supporting the gold rally and prevailing bullish & bearish factors. It posits two hypothetical trades to astutely position portfolios amid a raft of geopolitical and economic shocks.
GOLD IS A HAVEN WHEN GEOPOLITICS DELIVER SHOCKS
In a previous paper, Mint Finance highlighted that gold is a resilient store of wealth as it outperforms in times of extreme volatility. Geopolitical tensions remain intense amid ongoing armed conflicts in Russia-Ukraine and Palestine-Israel which underpins gold as an investor haven.
Gold responds to elevated geopolitical risks as reported by the World Gold Council. A 100 unit increase in the Geopolitical Risk Index (GPR) has a 2.5% positive impact on gold returns as measured by the Gold Return Attribution Model (GRAM).
GOLD IS TRADING AT KEY PSYCHOLOGICAL PRICE LEVEL
Gold prices have catapulted more than 8% since the rapid escalation in violence in the middle east over the last two weeks. Gold now trades just below USD 2,000/oz.
The USD 2,000/oz mark is clearly an important psychological level. A more crucial level is USD 2,100/oz. Gold prices have failed to breach 2,100 three times over the last three years.
Gold prices are exhibiting a solid bullish momentum. It has surpassed two resistance levels (1,902.9 and 1,943.4). Price action is close to forming a golden cross between 9-day and 100-day simple moving average.
Gold is likely to surpass the USD 2,000/oz over the next few days. However, passing the sticky USD 2,100/oz levels might be more challenging.
The continuous rally over the past two weeks may be due for a correction if the momentum fails to hold. RSI has already raced past its upper bound. Large upward moves are known to be followed by sharp price pullbacks.
SEASONAL DEMAND FROM GOLD MAJORS POSITIVELY AFFECTS GOLD PRICES
The top two largest gold consumers are China and India. Combined, they represent ~50% of total global demand. Both paint a positive picture for gold demand.
1. Shrinking Premiums in China to bolster demand
China represents 25% of global gold demand. China’s domestic gold availability has been strained over the past few months while demand has remained high leading to an all-time-high premium on domestic gold prices over international gold prices.
These premiums have eased sharply over the past few days as supply conditions improve after China’s golden week holidays. Lower premium on domestic gold makes it an attractive buy.
Furthermore, wholesale gold demand in China is showing signs of improvement. Gold ETFs are attracting notable inflows. The PBoC is building its gold reserves at a brisk pace.
2. Strong Monsoon cements solid demand for Gold in India
India represents 24% of global gold demand. Monsoon and festivals have a major impact on Indian gold demand.
Indian consumers buy gold as wedding gifts or as investments during festivals. Demand is expected to spike during the upcoming festival and wedding season.
This year, India witnessed a wet monsoon which bodes well for farmers. Consequently, that is good for gold demand too. Rural India represents 60% of the country’s gold demand.
As highlighted by Debbie Carlson in CME OpenMarkets, a wet monsoon leads to better harvests and higher earnings for farmers driving a positive effect on gold demand.
GOLD PRICES ARE SIZZLING HOT
Despite the bullish drivers, a major headwind to the gold demand is its high prices. Gold prices remain elevated. Higher prices lead to guarded consumers.
With prices 9% higher YTD and 20% higher over the past one-year, the rally in prices until now has been rapid, making consumers wary of overinvesting in the yellow metal.
Gold does not generate yields. It pays no dividends or interest. When risk free rates remain high, investing in gold is not lucrative. As the 10Y US Treasury yield stubbornly stays around 5%, investors opt for treasuries over gold.
Gold prices are at record high in several non-USD currencies. That makes gold even more expensive. Weaker Indian Rupee and the Chinese Renminbi crushes domestic demand down.
INSIGHTS FROM COMMITMENT OF TRADERS AND OPTIONS MARKET
Asset managers had been building up net short positioning in CME Gold Futures until recently. Bearish sentiment in gold began in July, when investors started to anticipate further Fed rate hikes.
Against the backdrop of rising geopolitical tensions, these asset managers are shifting away from net short to net long positioning over the last one week.
Implied volatility on gold options has shot up to levels last seen during the banking crisis in March, but historical volatility remains far lower in comparison. This suggests potential for rising volatility ahead.
Skew on gold options have surged with call premiums having risen faster than put premiums.
Options traders are far more bullish than those trading Gold futures. Put/Call ratio for gold options is 0.52 implying two calls (bullish bets) for every put (bearish bet).
HYPOTHETICAL TRADE SETUP
A hypothetical long position in CME Micro Gold Futures can be used to harness gains from the overwhelmingly bullish sentiment in gold.
CME Micro Gold Futures expiring in December (MCGZ23) provides exposure to 10 oz of gold. It requires an initial maintenance margin of USD 780 (as of 23rd Oct 2023). These micro contracts can be used to secure granular exposure in a capital efficient manner.
Still, given the uncertainty and the risk for sharp reversal, a tight stop loss is appropriate to protect from a sharp price correction.
Alternatively, investors can deploy bull call spread on CME Gold Options expiring in December (OGF4) to express the view that gold may retest USD 2,100/oz but not rise beyond.
A Bull Call Spread consists of a long call position at a lower strike (USD 2,020) and a short call position at a higher strike (USD 2,100). The position requires net premium of USD 2,400 (USD 4,970 - USD 2,570).
The payoff for the hypothetical position is provided below. Both upside and downside for the position are fixed. Hypothetically, the position breaks even when prices reach USD 2,044/oz and has a maximum payoff of USD 5,600.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
This paper examines the drivers supporting the gold rally and prevailing bullish & bearish factors. It posits two hypothetical trades to astutely position portfolios amid a raft of geopolitical and economic shocks.
GOLD IS A HAVEN WHEN GEOPOLITICS DELIVER SHOCKS
In a previous paper, Mint Finance highlighted that gold is a resilient store of wealth as it outperforms in times of extreme volatility. Geopolitical tensions remain intense amid ongoing armed conflicts in Russia-Ukraine and Palestine-Israel which underpins gold as an investor haven.
Gold responds to elevated geopolitical risks as reported by the World Gold Council. A 100 unit increase in the Geopolitical Risk Index (GPR) has a 2.5% positive impact on gold returns as measured by the Gold Return Attribution Model (GRAM).
GOLD IS TRADING AT KEY PSYCHOLOGICAL PRICE LEVEL
Gold prices have catapulted more than 8% since the rapid escalation in violence in the middle east over the last two weeks. Gold now trades just below USD 2,000/oz.
The USD 2,000/oz mark is clearly an important psychological level. A more crucial level is USD 2,100/oz. Gold prices have failed to breach 2,100 three times over the last three years.
Gold prices are exhibiting a solid bullish momentum. It has surpassed two resistance levels (1,902.9 and 1,943.4). Price action is close to forming a golden cross between 9-day and 100-day simple moving average.
Gold is likely to surpass the USD 2,000/oz over the next few days. However, passing the sticky USD 2,100/oz levels might be more challenging.
The continuous rally over the past two weeks may be due for a correction if the momentum fails to hold. RSI has already raced past its upper bound. Large upward moves are known to be followed by sharp price pullbacks.
SEASONAL DEMAND FROM GOLD MAJORS POSITIVELY AFFECTS GOLD PRICES
The top two largest gold consumers are China and India. Combined, they represent ~50% of total global demand. Both paint a positive picture for gold demand.
1. Shrinking Premiums in China to bolster demand
China represents 25% of global gold demand. China’s domestic gold availability has been strained over the past few months while demand has remained high leading to an all-time-high premium on domestic gold prices over international gold prices.
These premiums have eased sharply over the past few days as supply conditions improve after China’s golden week holidays. Lower premium on domestic gold makes it an attractive buy.
Furthermore, wholesale gold demand in China is showing signs of improvement. Gold ETFs are attracting notable inflows. The PBoC is building its gold reserves at a brisk pace.
2. Strong Monsoon cements solid demand for Gold in India
India represents 24% of global gold demand. Monsoon and festivals have a major impact on Indian gold demand.
Indian consumers buy gold as wedding gifts or as investments during festivals. Demand is expected to spike during the upcoming festival and wedding season.
This year, India witnessed a wet monsoon which bodes well for farmers. Consequently, that is good for gold demand too. Rural India represents 60% of the country’s gold demand.
As highlighted by Debbie Carlson in CME OpenMarkets, a wet monsoon leads to better harvests and higher earnings for farmers driving a positive effect on gold demand.
GOLD PRICES ARE SIZZLING HOT
Despite the bullish drivers, a major headwind to the gold demand is its high prices. Gold prices remain elevated. Higher prices lead to guarded consumers.
With prices 9% higher YTD and 20% higher over the past one-year, the rally in prices until now has been rapid, making consumers wary of overinvesting in the yellow metal.
Gold does not generate yields. It pays no dividends or interest. When risk free rates remain high, investing in gold is not lucrative. As the 10Y US Treasury yield stubbornly stays around 5%, investors opt for treasuries over gold.
Gold prices are at record high in several non-USD currencies. That makes gold even more expensive. Weaker Indian Rupee and the Chinese Renminbi crushes domestic demand down.
INSIGHTS FROM COMMITMENT OF TRADERS AND OPTIONS MARKET
Asset managers had been building up net short positioning in CME Gold Futures until recently. Bearish sentiment in gold began in July, when investors started to anticipate further Fed rate hikes.
Against the backdrop of rising geopolitical tensions, these asset managers are shifting away from net short to net long positioning over the last one week.
Implied volatility on gold options has shot up to levels last seen during the banking crisis in March, but historical volatility remains far lower in comparison. This suggests potential for rising volatility ahead.
Source: CVOL
Skew on gold options have surged with call premiums having risen faster than put premiums.
Source: CME Quikstrike
Options traders are far more bullish than those trading Gold futures. Put/Call ratio for gold options is 0.52 implying two calls (bullish bets) for every put (bearish bet).
Source: CME Quikstrike
HYPOTHETICAL TRADE SETUP
A hypothetical long position in CME Micro Gold Futures can be used to harness gains from the overwhelmingly bullish sentiment in gold.
CME Micro Gold Futures expiring in December (MCGZ23) provides exposure to 10 oz of gold. It requires an initial maintenance margin of USD 780 (as of 23rd Oct 2023). These micro contracts can be used to secure granular exposure in a capital efficient manner.
Still, given the uncertainty and the risk for sharp reversal, a tight stop loss is appropriate to protect from a sharp price correction.
- Entry: USD 1,994
- Target: USD 2,090
- Stop Loss: USD 1,945
- Profit at Target: USD 960 ((2090-1994) x 10)
- Loss at Stop: USD 490 ((1994-1945) x 10)
- Reward to Risk: 2.1x
Alternatively, investors can deploy bull call spread on CME Gold Options expiring in December (OGF4) to express the view that gold may retest USD 2,100/oz but not rise beyond.
A Bull Call Spread consists of a long call position at a lower strike (USD 2,020) and a short call position at a higher strike (USD 2,100). The position requires net premium of USD 2,400 (USD 4,970 - USD 2,570).
The payoff for the hypothetical position is provided below. Both upside and downside for the position are fixed. Hypothetically, the position breaks even when prices reach USD 2,044/oz and has a maximum payoff of USD 5,600.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
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