FxWirePro: Bullish, Bearish Driving Forces Of Bullion Market, OTC Updates And Hedging Strategy

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. 

Bullish Driving Forces: 

i) Investor demand for gold surges as equity volatility fades and rates remain low; 

ii) Inflation comes in hotter than expected working to boost inflation expectations and further lower real yields; 

iii) The US dollar weakens dramatically as other countries rebound quicker from the recession; 

iv) Asian physical buying sharply picks up. 

Gold prices surged to their highest level in more than seven years as the spectre of a deepening global recession continues to support safe haven buying. Spreads between futures and spot prices also remain wide, suggesting liquidity remains tight. The latest wave of buying was sparked by the announcement last week that the Fed will invest up to USD2.3trn in loans to aid small and medium sized business.

OTC Updates: 

The 3m positive skewness of gold options contracts implies more demand for calls (refer 1st chart). These skewed IVs of 3m XAUUSD contracts are still indicating the upside risks, bids for OTM call strikes up to $1,800 is quite evident that reminds us hedgers’ inclination for the upside risks. 

One could also see the fresh negative bids for the existing bullish risk reversal setup. To substantiate the above-mentioned bullish sentiment, risk reversal (RRs) numbers also indicate the overall bullish environment (2nd nutshell). Well, we know that options are predominantly meant for hedging a probable risk event in future.

Hedging Strategies:

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

Thus, we advocated buying 3m XAUUSD (1%) ITM -0.69 delta calls on hedging grounds (spot reference: $1,680 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, in the money call option with a very strong delta will move in tandem with the underlying. Courtesy: Sentry, JPM & Saxobank