As initial anxiety over Donald Trump’s victory gave way to market euphoria in the days following the election, there was a casualty. Gold prices.
Gold — often a safe haven for investors in times of uncertainty — saw strength in the weeks leading up to the election, capped off by a turbo-charged surge on election night. But as traders began to view the stock market’s immediate nosedive as a buying opportunity, the risk on vibe was back.
And as speculators started buying stocks, they began unloading their long gold positions. Gold prices have tumbled more than 10% since election night highs and some analysts see it falling a lot further (see “Panic buying-panic selling,” below).
We’re not so sure. In fact, longer-term prospects for gold are looking stronger with a Trump White House. That being said, investors can benefit from the volatility in gold today; not by picking market direction, but by simply extracting cash out of the bountiful gold market. Here is how.
the fall of gold
There have been numerous explanations as to why gold prices fell like an Elizabeth Warren regulatory proposal. For one, bond yields have surged, making gold less attractive to “safety” investors. Secondly, the prospect of a more robust economy could cause the Fed to raise rates at a faster pace, potentially stalling growth and thus, gold prices. Lastly, the U.S. Dollar has surged on Trump-related optimism. The surge in the dollar can pressure commodities in general. But gold is particularly susceptible to such swings.
Our take, at least in the short term, is simplistic. The recent selloff in gold is due to pre-election speculators unwinding their massive long positions (as of Nov. 1, the spec long position in gold stood at 215,131 contracts). A conclusive election, regardless of outcome, removes uncertainly from the market. Uncertainly spurs gold prices. Clarity can bring liquidation as investors scamper to pull money out of “safety” and pour it back into potentially more lucrative investments. Thus prices fall.
But there are some good reasons why it probably won’t fall that far, and the biggest one can is the potential for Inflation.
Despite all of the previously mentioned reasons to be a gold bear, gold prices likely hold a Trump card in 2017: It goes by the name of inflation. As the Wall Street Journal astutely pointed out on Oct. 28, the rate of inflation is currently so low that even a modest uptick could have a considerable ripple effect.
And even prior to the election, we were already starting to see that ripple. Zinc prices recently hit a five-year high. Copper prices, often seen as a bellwether indicator of economic growth, have soared 8.7% since the Trump victory (see “Doctor Copper,” below).
Copper prices were already in an uptrend before the election. A Trump win, along with Republican victories in the Senate and House, brought expectations of a massive infrastructure rebuilding plan. This poured gasoline on an already simmering copper market.
This is because the global economy is showing signs of life. With U.S. wages up, unemployment down and expectations for rising GDP next year, outlook for industrial demand is increasing. The Wall Street Journal monthly survey of economists shows U.S. GDP expected to grow by 2.2% in 2017 and 2.3% in 2018. More importantly, the slowing rate of growth in China appears to be abating.
Copper’s meteoric rise is probably overdone. But its indication of global expectations is unmistakable. Of course, the economic elixir of lower taxes and investment in infrastructure — Trump’s plan proposes $1 trillion in spending during the next 10 years — make the strongest case for inflation. The same WSJ poll shows economists expecting inflation at 2.2% in 2017 and 2.4% in 2018. Should this be achieved, inflation in 2018 would be 25% higher than 2016’s 1.8%. We see that as a little more than a modest uptick. An increasing pace of interest rate hikes could certainly put a drag on inflation. However, central banks around the globe have been trying hard — largely in vain — to spur inflation for eight years now.
A little inflation can solve a lot of problems for nations in debt. Do you really think they are going to step on the green shoots right as they begin to emerge from the dirt? We don’t.
We see the Fed taking a continued dovish stance on rates at least for the next year. The rally in zinc, copper and other industrial metals is a prelude to rising commodities prices as a whole in 2017.
And while commodities are affected by much more than just inflation, it is gold and silver prices that most directly mirror it.
is it time to buy?
With the post-election ugly selloff in gold producing an even uglier daily chart, one may wonder if this is the right time to buy gold? After all, it was Warren Buffet that said one should be greedy when others are fearful.
Does that mean you buy gold now and hold on for a ride? Buying for appreciation is not typically the most efficient way to invest. As we already stated, despite positive outlooks for inflation in 2017, that has no correlation to how gold prices may behave in the short term. Buying for appreciation is, regardless of how logical the concept, speculating on outcome.
It is better to get paid up front — regardless of what the market does.
Every high net worth investor should own a little physical gold — if for nothing else than the tangible feeling of security it provides. Here, however, we’re not interested in buying for the long term. We’re interested in extracting cash out of the gold market — not necessarily owning it.
The truth is, it is hard to say whether or not it is time to buy gold yet. Fortunately, knowing if gold has bottomed or not is not necessary to profit from the recent volatility. The good news is that the recent roll in gold prices has brought a surge in volatility, especially to puts.
That means higher option premiums at deep out-of-the-money strikes. That is manna from heaven for an option writing strategy. And it sets up high-yielding put sales for investors wishing to position for higher inflation in 2017.
why sell puts?
By employing a put selling strategy you’re giving up on trying to pick a low in the market. After all, gold prices have taken it on the chin and could keep on falling. Why risk buying it here when you can simply pick a point well below the current price and say, “It may keep falling, but it won’t fall that far.”
This is what put sellers do. And they get paid up front to do it, regardless of if the market keeps falling (moderately), stabilizes or reverses higher. They seek to harvest cash, not necessarily pick market direction.
Healthy put premiums are now available in 2017 gold contracts as a result of the recent price slide. In fact, the 975 strike in June 2017 gold has premiums greater than $500. Gold could reverse and start trekking higher today. Or it could keep falling for a while. But with inflation finally seeming to awaken from a long slumber and pro-growth policies almost certainly on the way, we don’t think it can fall that far (see “Breathing room,” below).
Gold has strong support at its December 2015 low of $1,045, which is about $170 below the current market price. This low represents a double bottom dating back to February 2010, which represents a huge speed bump to any bear market sell-off. This level is a safe distance above our put strike, as is the psychologically important $1,000 level.
Regardless, we don’t see gold prices falling to $9.75 in the near future. As an option seller, that’s all the analysis you need to do.