FxWirePro: Uphold long hedges in CME gold far-month tenors

The US dollar should strengthen further if the Fed hikes twice more this year, the US 10yr treasury yield rose from 2.93% to 2.98%, while 2yr yields rose from 2.49% to 2.52%. Fed fund futures continued to predict a rate hike on 13 June and another by year end.

While our bullish stances on precious yellow metal is essentially a leveraged bet on the weakening dollar—an upside option with the limited downside that we believe is highly likely to move into the money.

Based on our historical analysis, in the unlikely event the dollar rallies through the late cycle (only 1 out of the last 6 cycles), the resulting gold losses were relatively tame (8%).

However, on the flip side, over the 5 cycles when the dollar weakened over the last quartile of expansion, gold prices increased over 40% on average even before the subsequent recession dynamics pushed prices even higher. To us, this looks like a relatively cheap upside option.

The downside scenario looks both relatively unlikely on a historical basis and has only returned moderate losses when it did come about in the 1991 cycle.

Alternatively, the more likely upside scenario for gold has returned multiples of this potential loss. With our forecasts still calling for a resumption of a synchronized global growth and hence a resumption of the medium-term trend lower in the dollar, we consequently maintain our bullish view on bullion.

Initiated longs in CME gold for Dec’18 delivery at $1,352.80/oz. Added an equivalent unit at $1,327/oz in May 2018 for a new entry level of $1,339.90/oz. Trade target is $1,540/oz with a stop at $1,273/oz. Courtesy: JPM

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