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Getting Long GLD Volatility As Gold Becomes Interesting Again

Although 2012 was a quiet year for gold markets, 2013, just two weeks old, already has the potential to be much more interesting. The wild ride gold has enjoyed over the past decade slowed dramatically last year. The 6% return and low volatility posted in 2012 was downright sleep inducing. Life however, is about to become much more exciting for enthusiasts of the yellow metal after a surprising press release by the German Bundesbank.

It was officially announced in Frankfurt that the Central Bank will indeed start the process of transferring a sizable portion of its gold holdings back to German soil, as has been speculated in recent months.

From the press release:

The following table shows the current and the envisaged future allocation of Germany's gold reserves across the various storage locations:

31 December 2012

31 December 2020

Frankfurt am Main

31 %

50 %

New York

45 %

37 %

London

13 %

13 %

Paris

11 %

0 %

To this end, the Bundesbank is planning a phased relocation of 300 tonnes of gold from New York to Frankfurt as well as an additional 374 tonnes from Paris to Frankfurt by 2020.

Source: Bundesbank January 16, 2013

The goal is to have 50% of the nation's holdings back on domestic soil by 2020. With Germany reportedly the second largest holder of gold in the world, this is an interesting turn of events, and one that is already eliciting a broad range of responses from bullion traders to geopolitical observers.

The widely respected Ambrose Evans-Pritchard of the Telegraph finds the Bundesbank`s decision to be a "watershed moment" and calls the move "an extraodinary breakdown in trust between leading central banks". CNBC on the other hand, indicates the German Central banks decision: ``may have a much more prosaic explanation: stock-taking". This would be in reference to domestic demands for a proper audit of official German bullion holdings.

ZeroHedge, which appears to have been the first on this side of the Atlantic to catch the story emanating from the German Handelsblatt on Monday, has an even more sensationalistic view, as one might expect:

"[I]n brief: this is a momentous development, one which may signify that the regime of mutual assured and very much telegraphed - because if the central banks don't have faith in one another, why should anyone else? - trust in central banks by other central banks is ending."

Whatever the reality, both in terms of German motivations and the implications for initiating this game of gold bar musical chairs, the true impact on markets as well as confidence in the Central Banks who warehouse gold may not be perceivable for some time.

Intrigue In Physical Gold Markets

For those that closely follow spot gold markets, there have been an increasing number of questionable deliveries of physical in recent years. Rumors of tungsten filled gold bars, and plots from organized crime syndicates have made for interesting reading, but has had limited impact on the price of the metal. There are those that question the official indications of gold held at large warehouses from New York to London, yet little concrete proof currently exists to suggest foul play.

The change in policy of the Bundesbank does, however, open the door for those whom wish to speculate on improprieties in the gold and warehousing market, German intentions of destabilizing the dollar, and even the future of fiat currencies. As Mr Pritchard indicated, this may well be a "watershed moment".

So while bankers, bloggers, and gold bugs debate whether this is merely a move to appease German voters in front of upcoming elections or a tectonic shift in the relationship between the heavy weights of Central Banking, the question remains: what does this mean for those that trade the commodity?

This author is quite confident that attempting to predict the short term movement of any metal, without a members seat on the LME, is akin to predicting the flight path of a R.A. Dickey knuckleball. What this story does clearly indicate though, is that gold will be back in the headlines over the coming months and there will be windows to execute profitable trades.

Trade Opportunities

The trade here may simply be to go long non-directional gold volatility, be that on futures, or ETFs. While bias over the coming months for gold prices might be to the positive side based on a renewed public interest, it is unlikely to be a smooth journey as more traders and investors form opinions and establish positions.

The current level of indifference towards gold can be measured by the extremely low levels of 30 day and 90 day volatility of the SPDRS Gold Trust ETF (NYSEARCA:GLD), coming in at around 9 and 12, respectively. This is roughly 50% lower than average over the past five years. Even with the VIX at extreme lows, it does appear gold volatility may well be poised for a break out given the potential for bullion bars moving around the world and increased uncertainty.

(click to enlarge)

Source: CBOE

With regards to entering this trade there are a variety of vehicles and ways to get long volatility, including futures and futures options on the CBOE Gold Volatility Index seen above. However for most traders the simplest and most liquid way of expressing this view is purchasing GLD straddles or strangles. A quick look at the volatility surface for GLD revels very little skew at this time, and the opportunity to make non-directional bets in multiple time frames.

While this story may just be the tip of the iceberg, it will also likely take some time for the implications of the massive change in policy to percolate across markets and influence the minds of traders. Patience may be required, but fortunately the cost of time when it comes to GLD options right now is more than affordable.

Source: German Gold Repatriation Will Bring Back Volatility