Throughout most of 2013, gold futures have been under major selling pressure.
Gold opened the year trading around $1,675 per ounce. As of the 12/02/13 close,
gold futures were trading around $1,220 per ounce which would mean that thus
far in 2013, gold futures have lost more than 27% of their value.
Looking back to September of 2011, gold's all time high came in around $1,923
per ounce. In a little more than 2 years, gold prices have dropped around $700
per ounce representing a total loss of more than 36% based on the 12/02/13
closing price. I would say most analysts would agree that gold has been in
a bear market over the past two years.
Before we begin looking at a few ways to use GLD option structures to take
advantage of higher future prices in the yellow metal, I thought I would focus
readers' attention on some bullish fundamental data for gold. Let us begin
with a chart of the Federal Reserve's Total Assets which is shown below.
The data shown above comes directly from the Federal Reserve's public database
itself. Essentially, this is the Fed's balance sheet and its obvious that the
money printing has gone parabolic. The Federal Reserve prints money to purchase
Treasuries and mortgage backed securities which end up on the Federal Reserve's
balance sheet.
Interestingly enough, the chart above illustrates the amount of money the
Federal Reserve has been printing since the beginning of 2011. The chart below
illustrates the price of gold futures during the same period.
Gold futures have moved lower in price while the Federal Reserve has printed
an unprecedented amount of money through the quantitative easing program. It
has been pointed out that the flow of liquidity is more important than the
total money stock, but these two charts when viewed together are rather odd
at the very least. However, we must all continue to remind ourselves that there
is no manipulation of any kind going on . . .
Another odd situation has developed regarding the gold miners and the price
of gold relative to production costs. The gold spot price has essentially moved
down below the average 2013 cash cost of $1,250 - $1,300 per ounce. Price action
in gold futures is rapidly approaching the marginal cost to produce gold which
is around $1,125. The chart of the various gold production costs is shown below.
Chart Courtesy of www.zerohedge.com
Gold prices closed on 12/02/2013 at $1,218 per ounce. Based on the closing
price, gold futures are less than $100 per ounce away from the marginal cost
to produce gold. If the yellow metal's price moves below the cash and marginal
cost of production gold mining volumes worldwide will begin to decline.
The gold miners have likely already started lowering their production levels
at current prices. The production slow down would only accelerate should prices
move down below the marginal cost of production. I believe that these production
costs will help put a floor underneath gold prices in the longer-term.
It is widely known that there is strong current demand for physical gold coming
from Russia, India, and China. If the gold miners began to slow production
levels considerably it is likely that physical gold prices could explode to
the upside.
Should production levels decline while demand remains at the same level all
of the manipulation in the world could not stop gold prices from arriving at
their natural market based price. I think most readers and analysts would agree
that the natural market based price is higher, not lower from the marginal
and cash costs of production.
As many readers know, my primary focus as a trader is in the world of options
where I focus primarily on implied volatility and probabilities to formulate
new positions. Unfortunately options on gold futures are fairly limited and
are not actively traded. However, the options on the gold
ETF GLD are very liquid.
With the longer term fundamentals intact, I thought I would post a few possible
trading ideas using GLD options to get long GLD while giving the trader some
duration to allow for the time needed for the trade to work.
A fairly cheap way to construct a longer-term bullish position in GLD would
be to look at a June 2014 Call Debit Spread or a June 2014 Broken-Wing Call
Butterfly Spread.
These trade structures use multi-legged constructions and would essentially
allow traders to get long GLD.
Due to the inherent leverage built into options, these positions would not
require near as much capital as buying an equity stake in GLD or being long
gold futures. The trade structures mentioned above would also mitigate Theta
risk, also known as time decay so the passage of time would not have a significant
impact on the trade's overall profitability.
In fact, both of these trade structures would actually benefit from the passage
of time in terms of profitability down the road. There are a variety of other
trade structures that could be used to benefit from higher prices in GLD while
simultaneously capitalizing on the passage of time as a profitability engine.
Each trade construction carries a variety of different potential risks as well
as required capital outlay or margin encumbrance.
I want to be clear in stating that these trade structures are purely for educational
purposes and should not be considered a solicitation or investment advice.
Whether we are discussing gold futures, GLD, or GLD options these are all paper
investments and they should not be viewed as a substitute for physical gold
holdings. Physical gold would likely benefit the most from any supply shock
in the future.
In closing, I believe that the fundamental picture for gold is improving by
the day. While more downside is likely in the near-term, the longer-term picture
for higher gold prices in 2014 and beyond seems quite likely.
In a world where central banks are printing fiat currency at record rates,
at some point in the future physical gold prices will no longer be able to
be held back from true price discovery.
To learn more about probability
based option trading, consider becoming a member of www.OptionsTradingSignals.com
for a totally different view of the markets and how to trade options for
consistent profitability over the longer-term.
