Excell with Options: Will gold lose its luster?
Executive summary
Rich looks at an April short call spread vs. long put to explore the possibility of an out-of-consensus move lower in the price of gold.
Gold investors commonly share a perception that the purchasing power of fiat currencies will decline due to factors such as inflation, expansionary monetary policy, and the rising national debt.
In fact, if we look at the performance of gold under various central bankers, the move higher under Chairman Powell looks similar to the moves under Arthur Burns or Ben Bernanke, who were thought to be very dovish central bankers, than under Paul Volcker or even Alan Greenspan, the former who are considered the most hawkish of central bankers. In spite of Powell having one of the fastest rate-hiking regimes in history (except under Volcker), the market has still seen the chairman as quite dovish.
Perhaps, the liquidity being provided to the struggling banking system only exacerbates that view among the precious metals community.
Image 1: Gold price under different central bankers
However, having traded precious metals for a Swiss Bank back in the 90s, I always found there were different drivers to the flows I was seeing in the gold market. For many investors, the move into or out of gold had much more to do with the real rates available in the economy. The higher the real rates, the worse gold would do. The lower the real rates, the better gold would do. Perhaps, this is not inconsistent at all with the view above, in that low or negative real rates have the potential to de-base a fiat currency.
In this chart, I use the real rate as determined by the 10-Year TIPS market, taking the inverse, and compare it to the price of the generic front month Gold future. There is a very tight relationship for the past 17 years, which became quite disconnected in the last nine months or so. Gold prices have continued higher even though real rates have gotten much more positive (negative on this inverse graph).
Image 2: 10-year real rate from TIPs market vs. gold
That is very intriguing to me and if I had to guess it is because the yield curve itself has really changed shape pretty materially, going to one of the deepest inversions we have seen in quite some time. Unfortunately, there are now 2-Year TIPS but if I create a real yield in the 2-Year using CPI and 2-Year Treasuries, there is a more volatile relationship that still largely holds. Real rates in 2-Year have stayed negative (this chart is also inverse, so they appear positive on this graph) supporting the move higher in gold.
This explains much more of the late 2022 move higher in gold. However, it still does not explain why gold is still so high even though real rates in 2-Year is much less negative than they have been. The move higher in 2023 as real rates got more positive still stands out to me.
Image 3: CPI less 2-Year Treasuries vs. gold
Naturally, I want to ask what could be driving this? My opinion would be institutional holders understand the link between real rates and gold, but perhaps retail traders do not. As such, I chose to look at the shares outstanding in the GLD ETF, with the notion that perhaps money flowing into the GLD ETF is driving Gold futures higher.
There is a very tight relationship over the past 10 years, however, there is also a disconnect in the price of gold and the flows into or out of the GLD ETF.