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The Big Put Option On The Bond Market Is An Even Bigger Put Option On Gold

Summary

  • The Fed is back in dovish mode, and it is more accommodative than ever.
  • Central banks around the world are spraying liquidity with a massive firehose.
  • Look past the exchange rates- Currencies are falling.
  • The put on bond markets is a put on the price of gold.
  • Nothing is free, but this put option is as close as it gets in the markets.
  • Looking for more stock ideas like this one? Get them exclusively at Hecht Commodity Report. Get started today »

Options are valuable but wasting assets. A put option appreciates when the price of an asset falls, and a call option’s value moves higher when the underlying market rises. The beauty of options is that they give market participants choices. Options can serve as price insurance or speculative tools. The options markets have flourished because of the leverage they allow. Buyers can control a significant position for a small payment, the premium. Sellers can act as the insurance company, collecting the premium.

The primary determinate of the price of a put or a call option is implied volatility, or the level of price variance the market forecasts into the future. Since the beginning of the global financial crisis caused by Coronavirus, option premiums have increased dramatically. As with all insurance products, premiums are a function of risk levels.

Savvy traders search for optionality in markets at all times. Experience attorneys attempt to create options for their clients in contracts. A free option is a valuable asset. The US Fed and global central banks have responded to the worldwide pandemic with policies that amount to free options for market participants in the interest rate markets and gold.

The ProShares Ultra Gold product (NYSEARCA:UGL) is a double leveraged instrument that moves higher and lower with the price of the yellow metal.

The Fed is back in dovish mode, and it is more accommodative than ever

After realizing that the Fed went too far when it hiked the Fed Funds rate four times in 2018 at a time when quantitative tightening was pushing rates higher, the central bank reversed course in 2019. Three 25 basis point rate cuts and the end of the balance sheet normalization program last year caused the price of gold to break out to the upside above its critical level of

The Hecht Commodity Report is one of the most comprehensive commodities reports available today from the #2 ranked author in both commodities and precious metals. My weekly report covers the market movements of 20 different commodities and provides bullish, bearish and neutral calls; directional trading recommendations, and actionable ideas for traders. I just reworked the report to make it very actionable!

This article was written by

Andrew Hecht profile picture
28.81K Followers

Andrew Hecht is a 35-year Wall Street veteran covering commodities and precious metals.

He runs the investing group The Hecht Commodity Report, one of the most comprehensive commodities services available. It covers the market movements of 20 different commodities and provides bullish, bearish and neutral calls; directional trading recommendations, and actionable ideas for traders. Learn more.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis. The author is long gold

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (21)

K
Hi. I don’t understand. Are you bullish on silver and gold?
A
It's a strange way to describe things ... he's saying there is no downside risk currently, which is the same thing as buying a put option on a stock you own.
d
Excellent summary. I would, however, have high quality gold stocks with a small basket of juniors in geographically safe areas over the intermediate term and not hold only gold bullion beyond the short term.
b
Good article Andrew. Wake up call to the elephant in the room: currency devaluation
Peter Cooper profile picture
Will gold get dragged down with the Dow as it was in March? In 2008-9 gold did not get dragged down again after the initial sell-off. Perhaps this time will be the same. Then again if it is a really powerful collapse? I don't know. Maybe gold and gold stocks will head in opposite directions for a short time in another crash. For investors wanting an immediate investment the 'Sell in May' crowd could pose a clear and present danger...
b
Hate that all asset correlation of 1.0
A
Depends more if crash is based on fundamentals or liquidity event. Kind of hard to imagine true liquidity event with the amount of stimulus supplied. More likely will step lower I'd think, as gold steps higher.
S
Those leveraged ETFs might have some problems.

They tend to underperform the underlying.

I'm not talking about just this particular ETF. I'm talking about all the leverage ETFs. they have some slippage built into them.

There are various articles on seeking alpha about just this problem.

I think you would be better off with a call spread on GLD, or sell the put spread, or do something with the futures.
s
Great analysis as usual, thank you.
A
@Andrew Hecht

What do you think of Scotiabank closing its precious metals division you used to work in a similar precious metals department didn't you? Is this big news?

seekingalpha.com/...
Andrew Hecht profile picture
I think they probably lost a boatload in ETF positions, which are arbitrage positions between gold for delivery in London and on the COMEX exchange. Short COMEX and long London cost lots of dealers lots of money and is the likely reason for the closure, imo
j
Scotiabank got out some time ago. Big news, no/ old news.
sumark4221 profile picture
Andrew
Nova Scotia has been trying to sell the business since 2018 and could not find a buyer. Their closure has more to do with their desire simply to exit the business. Highly doubt they were running a big book at the time of the Comex April basis blowout.

However, that event has contributed greatly to overall lower trading volumes in both LBMA bullion and Comex. As the dealers no longer have a reliable hedging instrument, they are forced to cut back on inventory positions. If dealers no longer can offer "size" or are now
prohibited (by their risk managers) from making bold and swashbuckling short raid, the price of gold shall rise as demand keeps growing but the supply shrinks.

This market dynamic will add to the fuel of the coming bull market move in gold. Personally, I think there is a solid chance that the Comex gold futures market will experience a "failed delivery" moment akin to what happened to the May WTI contract in which prices went NEG as the "longs" suddenly (and tragically) realized too late that there was no PHYSICAL STORAGE and, therefore, nobody to sell to as the contract expired.

Gold may see the reverse if some buyers decide to take delivery and the "shorts" discover that nobody wants to sell to them because it is self evident that there is a "shortage" of gold for sale at current prices. The "only" sellers had been the LBMA dealers, NOT actual holders of gold, such as the CBs and large institutional holders.

We shall see
V
Thanks Andrew for an excellent article. You hit the nail on the head. What is a gold price level below which you would consider buying physical for a 5 year holding period?

What about silver price? In what ratio to gold would you think of holding physical silver?
Andrew Hecht profile picture
I like them both here...silver is always a wild ride...
b
Note that silver is leading the stock market lower - and seemingly now disconnected from Papa Gold
sid gold profile picture
IMHO silver is lacking behind gold and is a reasonable spec
sid gold profile picture
Another excellent article
Thanks
New Low Observer profile picture
After peaking in 2011, gold bottomed just after the Fed started an interest rate increasing policy in December 2015.

Gold has more upside if the policy of rate increases returns.
Andrew Hecht profile picture
Gold moved 2.82 times higher from the 2008 low to the 2011 high as the Fed poured liquidity into the system.
A
What percentage of gold demand is related to individual investor/institutional etf flows and what percentage is CB ... how much does Indian demand offset either of those two forces at higher prices historically?
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