Analysts rarely get much attention for writing about “fairly priced” or “balanced” markets.
But astute futures traders can do very well if they know how to trade such markets.
A perfect example right now could be in gold.
The opportunity may not be in being outright bullish or bearish, but rather, in playing the two sides against each other. To understand this, you should first understand what the two sides are.
The Bulls Say…
Nations around the world such as Germany, the United Kingdom, even China are borrowing a page from the Fed and lowering interest rates in an attempt to spur growth in their economies. Theoretically, this course of action makes their currencies weaker. Investors in countries with lower currencies are attracted to hard assets. And there is no harder asset than gold. Thus, global QE is supporting gold prices by spurring international demand for gold.
At the same time, the US central bank is poised to take the opposite tack by raising rates. This will theoretically strengthen the US dollar, which could pressure gold prices. But with the US economy actually contracting in Q1 2015 (by 0.7%), odds are the Fed will wait until at least September and maybe longer before making any move. This has given the bulls more backbone – at least for a few more months.
The Bears Say….
First, gold is priced in US dollars. And despite Fed thumb twiddling and weaker US economic data in Q1, rates rising this year still seems likely. The US economy is still expected to grow by 2.6% this year*(*source: Kiplinger). That should be supportive to the US dollar, and thus bearish for gold.
No inflation. Gold is often used as a hedge against inflation. Thus, higher inflation or fears of higher inflation can often be supportive of gold prices. But inflation in the US is all but non existent right now. If the economy keeps growing, inflation might inch up to 1% by December. That’s up from 0.8% in December of 2014. This is not supportive to gold prices.
The New Face of Gold
This is not your father’s gold market. In the days of yesteryear, a Middle East bombing, a political crisis, or a currency war could all be counted on to bring about fireworks in gold.
These days, not so much. Consider that since the beginning of 2014, Europe has embarked on an unprecedented bout of QE done on a massive scale, the Swiss left the euro, Saudi Arabia is bombing Yemen, Russia remains entrenched in Ukraine, ISIS runs amok through the Middle East and China flexes military muscle in disputed international waters.
Where has gold moved during this time? It’s moved up a little and down a little. But on December 31, 2014, gold traded at 1190 per ounce. At the time of this writing, gold is trading at 1190 per ounce.
What does this tell us? It tells us that gold is probably not overvalued or undervalued right now. In short, it is fairly priced.
You see, there was once a time when supply and demand for physical gold was a factor in determining its price. Analyst used to talk about things like jewelry demand and mining activity. There was also a recent time where gold was more sensitive to geopolitical events.
Both of these things are out the window now. The nature of gold has actually changed. While it remains a physical commodity, it now behaves as a currency. And that currency’s fate is pegged to that of the US dollar and the direction of the US economy.
That being said, gold now finds itself in a near perfect storm of balanced factors: Aggressive international quantitative easing and questions about the US economy supporting prices from underneath and expectations of Fed tightening later this year keeping a lid on upside breakouts.
For gold to rally $100 from its current price, the US economy would likely have to take flight on its own. Yet for the metal to fall another $100 per ounce, the global economy might have to soar, leaving the US behind. Neither is a likely scenario given the unprecedented interdependence of US and international economies in 2015.
With a move of $100 per ounce unlikely (in our opinion) over the next several months, gold could likely be a trading affair for traders alert for daily market swings.
December 2015 Gold
Gold chart showing 1140 and 1250 price range
Gold, in our opinion, is likely to remain in the recent trading range between 1140 on the downside and 1250 on the upside for at least the next 90 days as these two countering forces battle it out with each other.
Therefore, sell-offs towards these levels should be treated as buying opportunities while rallies towards this level could be openings for shorts.
While we advise an option selling approach to our clients, there is no reason futures traders cannot also benefit from this range bound market.