FxWirePro: Driving Forces of Bullion Market, OTC Indications & Hedging Strategy

With real yields likely rising, we see gold coming off its 3Q’20 peak to average $1,880/oz in 4Q’20.

After maintaining a bullish view on gold prices for over two and a half years, we turned

neutral on bullion at the end of July. A forecasted rise in real yields over the medium

term is the main driver of our more bearish gold view.

Well, from a price perspective, 4Q’20 could be payback time for silver. As investors begin to cool on gold after real yields likely find a firmer consistent floor, silver will likely be hit doubly hard given its smaller market size and reduced liquidity.

Take quick glance at some bearish driving forces:

i) The global economic growth momentum recovers much stronger and earlier than expected sending US Treasury yields higher;

ii) The extreme equity volatility returns with gold being sold once again to raise cash;

iii) Central banks actually begin selling gold amid high prices and soaring budget deficits;

iv) The inflation expectations drop amid a prolonged economic slowdown driving real yields higher.

OTC Updates:

The 1m positive skewness for both call and put options contracts of gold implies that the hedging sentiment for the underlying bullion price remain well-balanced on either side (refer 1st chart). These skewed IVs of 1m XAUUSD contracts are still indicating the upside risks as well as downside risks, bids for OTM call strikes up to $1,980 is quite evident that reminds us hedgers’ inclination for the major uptrend risks, while bids for OTM put strikes upto $1,800 would mean that bears are also positioned for potential downside risks.

One could also see the fresh negative bids for the existing bullish risk reversal setup for 1w tenors. To substantiate the above-mentioned bullish sentiment amid short-term hicups, risk reversal (RRs) numbers also indicate the overall bullish environment (2nd nutshell).

Hedging Strategies:

Considering all the above fundamental drivers and capitalizing on prevailing OTC indications, we advocate longs in gold via deep ITM call options as they look to be the best suitable at this juncture.

Thus, we advocated buying 3m XAUUSD (2%) ITM -0.69 delta calls on hedging grounds (spot reference: $1,887 levels). If expiry is not near, delta movement wouldn’t be 1-point increase with 1 pip in the underlying movement, which means if the spot moves 1 pip, depending on the strike price of the option, the option would also move less than 1. Thereby, deep in the money call option with a very strong delta will move in tandem with the underlying. Courtesy: Sentry, JPM & Saxobank