In my previous article, I had talked about the negative impact that rising rates and rising dollar were having on gold (NYSEARCA:GLD). These factors may prove to be resilient over the coming quarters, which will probably continue to weigh on gold. However, in the near term, the sell-off in gold appears to be overdone, especially, given there is evidence that the rapid positioning changes in gold appear to be behind us.
Let's take a look through what has transpired over the past couple of weeks:
1) Investors have been liquidating their long gold holdings
As the chart below shows, since June, the positioning in gold futures has changed markedly. The huge spike we saw on the long side, has now largely dissipated.
If this isn't hot money moving out, I don't know what is. Similarly, gold ETF holdings have dropped by almost 5M ounces since hitting their peak earlier in November.
2) The price of option protection has peaked
As gold was sold off furiously post elections, the price of options showed a very interesting trend. Whereas, investors were paying up for buying upside calls heading into the elections fearing a Trump victory, the same investors began reaching for downside protection. The cost of downside protection (puts), as a result, had become extremely expensive versus calls. The graph below is my custom model which tracks the cost of calls versus puts.
What this shows is that gold investors are extremely fearful of the downside. When the model troughs, we experience short term troughs and vice versa for peaks.
3) The US dollar is likely to consolidate
The US dollar surged to a 5 year high following the Trump victory. It appears likely that the dollar will likely pullback and consolidate here, which should provide relief to gold.
4) Gold miners are completely tapped out.
Virtually every single major gold miner is currently trading well below its 50 day moving average and the GDX (NYSEARCA:GDX) is trading almost 32% off its lows. What is interesting here is that while the price of gold has declined 13% off its highs, the US dollar has rallied 8% in the same time frame. This means that the economics of the miners haven't changed enough to deserve a 30% haircut.
When I got at my desk this morning, virtually every broker I speak to, every trader I talk to and every professional I work with are worried about golds. This, along with the reasons I laid out above give me reason to believe that gold is due for a rally. But I am cognizant that we are in a corrective phase for gold therefore I am not risking my house here on this particular trade. I am expressing my trade using relatively cheap volatility in the GDX to own some upside calls here.
Disclosure: I am/we are long GDX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.