If you were laughing watching Trump descend down an escalator 18 months ago, you probably aren't anymore. Equity investors appear downright scared and they have been buying one thing and one thing only over the past eight sessions - downside protection. And outside of equities, they have been buying safe haven assets such as gold (NYSEARCA:GLD). The frenzy into gold has seen bullion prices ascend over $1,300 recently and the frenzy into gold options has been... well, frenzied! Now you will probably agree with me that there is such a thing as too much of a good thing and as I will show you below, the recent panic buying in gold will likely lead to a consolidation or a correction in the metal's price in the near term.
One of my favorite indicators I use to measure the amount of hot money flows either into or out of gold is to look at the price of call options in relation to put options. When call options are expensive, people are buying calls hand over fist and are willing to pay a higher volatility premium for them. The same applies for put options on the way down, when people are fearful. As the chart below shows, when calls become expensive versus the puts, gold puts in a short-term top.
We have seen this happen so far in the past year in February, July and we are witnessing it right now. Notice that the inverse is also true when people are bidding up puts because they are fearful of the bullion prices declining.
We are also seeing this show up in the trading pattern of GLD options. Notice how over the past week the volume of calls have exploded in relation to puts while open interest in calls has also climbed. The 20-day average of calls to puts has more than doubled from around 2.4:1 to 5.9:1.
This further goes to show that investors have been getting exceptionally bulled up on bullion over the past week, which in turn leads to frothy conditions.
It doesn't take a leap of faith here to see that a majority of the change in bullion prices has been driven by investors recalculating the odds of a Trump presidency. And therein lies the catch. Following the election, regardless of who emerges the victor, the hot money which has flowed into gold should move out, which in turn would lead to a consolidation and/or correction in gold over the short term. When this happens, I will be increasing my allocation into the gold because while the short-term story has gotten frothy, the long-term story continues getting better. Inflation continues to firm, supported further by recent data showing increasing wage growth in the U.S. With the Fed intent on keeping nominal rates lower for longer, real rates (rates adjusted for inflation) will likely remain below zero creating a wonderful environment for higher gold prices.
Disclosure: I am/we are long GLD, SLV. 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.