One trader senses panic—but I see calm through the storm.
After gold's dramatic crash two weeks ago, the Gold ETF (GLD) has appreciated this week and retraced some of its losses. The GLD chart shows a large gap down on the morning of April 15th, and filling this gap has been a major technical target for the ETF. Filling gaps is a common technical pattern seen in stocks and commodities.
The theory is that the market needs to test the price levels that were skipped during the thinly traded overnight hours before prices can move on. Sometimes gaps are filled the next day, and sometimes not for years. In the case of a gap down, the upper end of the gap tends to become resistance, which is what we are seeing in GLD right now.
On April 12, GLD's low was $143.43, and that level was tested last Friday. This level proved to be strong resistance though, and GLD did not break through it in any of the subsequent trading sessions.
On Wednesday, GLD made a sharp move lower, bouncing off its lows post-Fed decision. However, while it was down more than 2 percent, one option trader is betting that gold will move still lower over the coming weeks. This trader bought 1,500 June 140-strike puts for $4.25 each.
This is a bearish bet that GLD will be below 135.75, or 3 percent lower, by June expiration. On top of that, however, it is also a bet that options are cheap, since you would need to see quite a bit of a move lower for this trade to pay out.
My guess is that this trader is focusing in on gold's fundamentals. Right now, the fundamentals that people use to trade gold center around two things: the Fed's balance sheet expansion and U.S. dollar strength.
Right now, the market is beginning to try and anticipate that the Fed asset purchases might not necessarily be new purchases; instead, the Fed might just be rolling old purchases. If you examine the monetary base, it has not expanded at $85 billion per month as stated in the past few Fed Open Market Committee statements like the one released Wednesday. For that reason, the U.S. dollar is not quite expanding in supply as people expected it would six-plus months ago.
The other factor that could put pressure on gold is inflation, which was lighter than expected last month, and has been tame all year. Many investors bought gold as a hedge against the possibility of high inflation because of the Fed's policies; however, this has clearly not panned out, which has led investors to reevaluate why they own an asset with zero yield.
This shift in money is seen through the U.S. dollar, which has shown some weakness of late, but remains up a few percent this year. If inflation stays in check, you will see people start to demand owning the currency and not rotating into the likes of gold.
Given these macro factors, our model indicates GLD should be valued at $140 over the next 30 days, so I am not a fan of buying those June 140-strike puts. I do continue to hold a long GLD position, but have sold May 140-strike calls against my position, so I am hoping to see GLD bounce around these levels or move slightly lower to capture the full premium of the calls that I am short.
Should the momentum continue to the downside in GLD, and just as a risk control measure, I do own 10 percent out-of-the-money put spreads. However, I'm hoping that the recent shakeout that has already happened in gold will keep Wednesday's sell-off in check, and that gold settles in around these levels until macroeconomic factors dictate otherwise.