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FxWirePro: Gold Price Dynamics And Delta-Hedged Options Trades Ahead of Fed

Markets have a lot on their calendar for this week, with Fed, ECB the UK general election and the upcoming deadline on the US tariffs and yesterday seemed to be a day in waiting mode. 

Last Friday’s data releases dispelled start-of-the-week worries. The November US jobs report crushed expectations as hiring jumped, earnings rose and unemployment returned to a half-century low. The strong gain in hiring and labor income, along with firming equity markets, should continue to support solid consumer spending and evidence suggests the resilience of households is poised to endure.

According to the University of Michigan consumer sentiment survey also released last Friday, the economic outlook of US households has improved significantly so far in December. The stronger pace of hiring this fall should be cheered on by Fed policymakers, who are set to meet this Tuesday and Wednesday. No further action this year from the FOMC is likely. Indeed, market odds favor the Fed’s federal-funds target holding at the current 1.50% to 1.75% range through at least the middle of next year.

We expect this to be confirmed by the FOMC’s dot-plot. While there will likely still be some dots looking for a hike next year, we believe a large majority of the Committee will be looking for no change in the policy rate for the coming year.

The market is still pricing in one final 25bp cut later next year, and we agree as without monetary stimulus we think the Fed’s inflation credibility could be tested (we pencil in one more ease in 2Q’20). The bigger point is that interest rate hikes are also unlikely, even if growth surprises to the upside. After the upbeat jobs report, US stocks and Treasury yields rose while gold sold off, offsetting some of the jitters about trade from earlier last week. With the recent leg lower, our model based on real yields is showing gold largely fairly valued at the current spot price. 

While the precious metals underwent a major regime change in May, when gold sprang to life amid the May US/China trade outburst. 3M gold vols jumped 5vols and silver 10vols as spot moved up 15% and 25%, respectively. The vol reaction was in line with our prior analysis. Owning gold vol used to be an underwhelming proposition during the US/China trade episodes in 2018 due to quick reversals and vol seller’s downside pressure. The May - Sep gamma outperformance pushed the YTD P/L into positive territory even as the broad-based Sep/Oct FX/Precious vol sell-off jeopardized those gains. 

While Gold and Palladium are already far into an internal 3rd wave rally of greater scale, we see great catch-up potential for Silver and Platinum, which are still in the very early stages of it. In line we see the Gold/Silver spread trading significantly lower.

What is more eye-catching is the 2019 gamma outperformance, in our view. Bucking the long-term strongly negative trend, 3M delta-hedged straddles are up 1.6vols YTD. Theta friendly long gamma / short vega calendars were particularly efficient in exploiting the gamma performance. 

Ahead of Fed’s monetary policy that is scheduled for this week, we advocate buying delta-hedged 1Y XAUUSD 1*2 ATM/25D strikes ratio call spread @12.2ch vs 15.25/16.25indic, vega notionals, spot reference: $1464 levels) . Courtesy: JPM

By Niranjan Patil
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