Gold Shines as Nasdaq Declines
Updated
Gold glows as risk blows. Multiple bank failures and shotgun bank marriages are bringing back scary memories of 2008.
Amid gloom, demand for gold blooms. Gold is a resilient store of wealth, offers durable portfolio diversification, exhibits lower volatility relative to equities, and serves as an inflation hedge.
As described in our last paper, among the six ways of investing in gold, CME COMEX's Gold Futures ("Gold Futures") is most optimal among them.
This paper is set in two parts. Part 1 delves into Gold Futures. Part 2 articulates a spread trade case study comprising of long gold and short Nasdaq yielding a reward to risk ratio >1.4x.
COMPREHENDING GOLD FUTURES AND ITS PARTICIPANTS
Gold Futures is the world’s most liquid gold derivatives. Fifty billion USD notional is traded daily on average. This leads to unrivalled bid-ask spreads enabling investors to gain capital efficient exposure to the price of gold. Launched in 1974 and trading over nearly 50 years, Gold Futures offer tight correlation to physical gold prices.
Gold Futures trade 23 hours a day. Trading starts every Sunday 5pm Chicago Time (6am Monday in Singapore) to Friday 4pm Chicago time (5am Saturday in Singapore) providing near round-the-clock access. Gold Futures provide superior capital efficiency with a leverage of nearly 25x at current prices.
Gold Futures come in two sizes. Each lot of the full contract provides exposure to 100 oz. of Gold requiring $8,000 in margins per lot. However, each lot of Micro Gold contract delivers 10 oz. of gold price exposure. Micro contracts which require only $800 per lot in margins provides affordable access to investors while helping hedgers fine-tune their risk management strategies with more precious exposure. When trading spreads, investors can further boost return through margin credits.
Broadly speaking, investors, hedgers, and speculators form the active participants in the gold futures market. Hedgers use futures to manage their overall gold portfolio risk exposure. They use derivatives to lock in price for future transactions or to effectively hedge against price fluctuations.
Speculators participate in Gold Futures with the intent of punting on gold price moves to generate profits. Investors use gold futures for generating return on capital over an extended period. They tend to focus on underlying fundamentals rather than short-term price movements.
All three types of market participants are essential for effective financial market operation. Together they help build deep liquidity pools thereby facilitating robust price discovery.
GOLD IS SET TO OUTSHINE NASDAQ
The Nasdaq Index comprises of one hundred large and most actively traded U.S firms listed on the Nasdaq exchange. The index includes firms from a variety of industries except financials. These include tech, health care, retail, biotech, and industrial companies. The index is weighted by market capitalisation.
During risk-off phases, investors rush to shelter in safe-havens. Gold prices rise. Also, when rates rise, companies whose values hinge on future distant cash flows suffer. As those cash flows get discounted at steeper rates diminishing its present value, share prices plunge.
As risks and rates rise & remain high, Gold will outperform Nasdaq. Validating this view is the positioning of participants based on CFTC’s Commitment of Traders (COT) report dated March 13th. It shows that managed money and speculators are net long on Gold.
COT report of the same date shows that leveraged funds are net short in the CME E-Mini Nasdaq-100 futures. However, asset managers remain net long.
The options market also vindicates the above views. Options on Gold Futures have a put/call ratio of 0.6x which signifies bullishness in gold. For every 10 bullish gold investors, there are only 6 bearish ones. However, for Nasdaq, options exhibit a put/call ratio of 2x meaning that for every 10 bullish Nasdaq investors, there are 20 bearish ones.
Is a long position in Gold Futures a solid trade? Questionable, given that gold has rallied 10% since the start of banking crises. Current gold prices are overbought based on RSI.
If crisis deepen, gold may continue its ascent. However, if market gains comfort from bailout assurances, gold prices will soften. Therefore, a directional long position in gold is beset with risk.
However, as rates continue to rise or remain high, Nasdaq will struggle as growth firms get punished with discounted present value. Hence, this case study argues that a spread trade to long gold & short Nasdaq will deliver a compelling positive yield.
Yes, growth stocks in Nasdaq have outperformed gold over the past twenty years. Yet, these stocks will struggle during times of crisis and elevated rates.
The Gold-Nasdaq Ratio (“GNR”) had a golden crossover in January 2022 as equities came off its peak with rates rising. Since then, long-term (200-day) moving average has been a strong support for GNR.
With GNR trading above this level, it provides investors a compelling spread trading opportunity with strong upside and limited downside.
A long position in CME Micro Gold Futures expiring in June 2023 (MGCM3) provides exposure to 10 oz of Gold with a minimum margin requirement of $800 per lot. Each contract of MGCM3 represents a notional of $19,940.
A short position in CME Micro E-mini Nasdaq-100 Futures expiring in June 2023 (MNQM3) provides exposure to $2 x Nasdaq-100 index with a minimum margin requirement of $1,680 per lot. Each contract of Micro Nasdaq-100 represents a notional of $25,750.
Spread trade requires notional values of each leg to be identical. Therefore, a long position of five lots of MGCM3 is required to offset a short position of four contracts of MNQM3. Margin offsets are available for this spread.
The trade entry, target, stoploss, and reward to risk ratio are set out below:
• Entry: 15.27%
• Target: 16.90%
• Stop: 14.20%
• Profit at Target: $10,172
• Loss at Stop: $7,230
• Reward-to-Risk Ratio: 1.4x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Amid gloom, demand for gold blooms. Gold is a resilient store of wealth, offers durable portfolio diversification, exhibits lower volatility relative to equities, and serves as an inflation hedge.
As described in our last paper, among the six ways of investing in gold, CME COMEX's Gold Futures ("Gold Futures") is most optimal among them.
This paper is set in two parts. Part 1 delves into Gold Futures. Part 2 articulates a spread trade case study comprising of long gold and short Nasdaq yielding a reward to risk ratio >1.4x.
COMPREHENDING GOLD FUTURES AND ITS PARTICIPANTS
Gold Futures is the world’s most liquid gold derivatives. Fifty billion USD notional is traded daily on average. This leads to unrivalled bid-ask spreads enabling investors to gain capital efficient exposure to the price of gold. Launched in 1974 and trading over nearly 50 years, Gold Futures offer tight correlation to physical gold prices.
Gold Futures trade 23 hours a day. Trading starts every Sunday 5pm Chicago Time (6am Monday in Singapore) to Friday 4pm Chicago time (5am Saturday in Singapore) providing near round-the-clock access. Gold Futures provide superior capital efficiency with a leverage of nearly 25x at current prices.
Gold Futures come in two sizes. Each lot of the full contract provides exposure to 100 oz. of Gold requiring $8,000 in margins per lot. However, each lot of Micro Gold contract delivers 10 oz. of gold price exposure. Micro contracts which require only $800 per lot in margins provides affordable access to investors while helping hedgers fine-tune their risk management strategies with more precious exposure. When trading spreads, investors can further boost return through margin credits.
Broadly speaking, investors, hedgers, and speculators form the active participants in the gold futures market. Hedgers use futures to manage their overall gold portfolio risk exposure. They use derivatives to lock in price for future transactions or to effectively hedge against price fluctuations.
Speculators participate in Gold Futures with the intent of punting on gold price moves to generate profits. Investors use gold futures for generating return on capital over an extended period. They tend to focus on underlying fundamentals rather than short-term price movements.
All three types of market participants are essential for effective financial market operation. Together they help build deep liquidity pools thereby facilitating robust price discovery.
GOLD IS SET TO OUTSHINE NASDAQ
The Nasdaq Index comprises of one hundred large and most actively traded U.S firms listed on the Nasdaq exchange. The index includes firms from a variety of industries except financials. These include tech, health care, retail, biotech, and industrial companies. The index is weighted by market capitalisation.
During risk-off phases, investors rush to shelter in safe-havens. Gold prices rise. Also, when rates rise, companies whose values hinge on future distant cash flows suffer. As those cash flows get discounted at steeper rates diminishing its present value, share prices plunge.
As risks and rates rise & remain high, Gold will outperform Nasdaq. Validating this view is the positioning of participants based on CFTC’s Commitment of Traders (COT) report dated March 13th. It shows that managed money and speculators are net long on Gold.
COT report of the same date shows that leveraged funds are net short in the CME E-Mini Nasdaq-100 futures. However, asset managers remain net long.
The options market also vindicates the above views. Options on Gold Futures have a put/call ratio of 0.6x which signifies bullishness in gold. For every 10 bullish gold investors, there are only 6 bearish ones. However, for Nasdaq, options exhibit a put/call ratio of 2x meaning that for every 10 bullish Nasdaq investors, there are 20 bearish ones.
Is a long position in Gold Futures a solid trade? Questionable, given that gold has rallied 10% since the start of banking crises. Current gold prices are overbought based on RSI.
If crisis deepen, gold may continue its ascent. However, if market gains comfort from bailout assurances, gold prices will soften. Therefore, a directional long position in gold is beset with risk.
However, as rates continue to rise or remain high, Nasdaq will struggle as growth firms get punished with discounted present value. Hence, this case study argues that a spread trade to long gold & short Nasdaq will deliver a compelling positive yield.
Yes, growth stocks in Nasdaq have outperformed gold over the past twenty years. Yet, these stocks will struggle during times of crisis and elevated rates.
The Gold-Nasdaq Ratio (“GNR”) had a golden crossover in January 2022 as equities came off its peak with rates rising. Since then, long-term (200-day) moving average has been a strong support for GNR.
With GNR trading above this level, it provides investors a compelling spread trading opportunity with strong upside and limited downside.
A long position in CME Micro Gold Futures expiring in June 2023 (MGCM3) provides exposure to 10 oz of Gold with a minimum margin requirement of $800 per lot. Each contract of MGCM3 represents a notional of $19,940.
A short position in CME Micro E-mini Nasdaq-100 Futures expiring in June 2023 (MNQM3) provides exposure to $2 x Nasdaq-100 index with a minimum margin requirement of $1,680 per lot. Each contract of Micro Nasdaq-100 represents a notional of $25,750.
Spread trade requires notional values of each leg to be identical. Therefore, a long position of five lots of MGCM3 is required to offset a short position of four contracts of MNQM3. Margin offsets are available for this spread.
The trade entry, target, stoploss, and reward to risk ratio are set out below:
• Entry: 15.27%
• Target: 16.90%
• Stop: 14.20%
• Profit at Target: $10,172
• Loss at Stop: $7,230
• Reward-to-Risk Ratio: 1.4x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Note
Central banks buying gold at record pave in the first two months of 2023, according to a report by the World Gold Council’s (WGC) Krishan Gopaul. In January and February, central banks collectively bought a net 125 tonnes of the metal, the highest amount for the year-to-date period since banks became net buyers in 2010.
usfunds.com/resource/central-banks-are-buying-gold-at-a-record-pace-so-far-in-2023/
Full Disclaimer - linktr.ee/mintfinance
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