Mark Twain once wrote, “October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.“ If Mark Twain were alive today, he might amend his advice to something like the following, ”Quadruple witching expiry. This is a peculiarly dangerous day to speculate in stocks. The others are the first day of the month, the last day of the month, Fed reserve decision day, large POMO day, no-POMO day, unemployment release day, ECB decision day, and China PMI release day.”
Today is quadruple witching expiry, and although trading is never easy, over the years I have found today is often a good day to do some writing or research, rather than to try to trade (or even interpret) the market action.
However, there are some studies that show that when the equity market is at highs going into option expiration, this usually leads to a few days of weakness in the post expiry trading. I would be weary of trying any longs up here, and would err on the side of writing pink tickets.
The precious metal move
The big news yesterday was obviously the monster squeeze in the precious metals square. I was lucky enough to have cranked up my position the previous day in the aftermath of Yellen’s Q&A. This proved fortuitous as my positions exploded higher.
GDX – Gold miner ETF</a> </div>
I am not good at sitting tight when positions move my way as I tend to overthink everything. Yesterday I purposely forced myself to stop watching the position, and even today, the temptation to ring the register on a piece is filling my brain like the voices inside the head of the Silence of the Lambs’ psychopath.
But when I step back and try to remain analytical, I continually come to the same conclusion. Although the move off the $22 low in GDX is quite dramatic, when you examine a longer term chart, this move is just a drop in the bucket.
GDX – longer term chart</a> </div>
I am not going to bother going through all the fundamental reasons that I love the precious metals (if you are interested read this), but I do want to focus on the fact that there is precious little hedge fund involvement on the long side of this trade. In fact, I was hearing rumours of one hedge fund being carried out yesterday due to a big short position.
Fred Hickey, who writes the famous High Tech Strategist newsletter, also highlighted the fact that he believes there is a large speculative short position in silver that will need to be bought back. I had a look at the CFTC data, and although the net position does not seem to indicate that speculators are massively offside, there has been an increase in both speculative longs and shorts over the last few months. The total short open interest amongst speculators is indeed hitting a very high level:
Silver Speculative Short positions</a> </div>
I am not sure about much, but I do know that the whole “long precious metals is a losing trade” narrative has been embraced by many over the past couple of years. Articles like Barry Ritholz’s “Does it pay to Hold Gold” have drilled into investors’ heads the lack of any fundamental earnings potential from precious metals. Investors have swallowed the story hook, line and sinker. They have abandoned precious metals – favouring to speculate on social media stocks or bitcoin.
I am not some died in the wool gold bug. If the Central Bankers of the world showed some real resolve in maintaining a consistently positive real interest rate, then I would dump my precious metals in a heartbeat.
But Central Bankers are not showing any signs of getting religion towards sound monetary policy. In fact, exactly the opposite is occurring.
The ECB is pushing rates to unprecedented negative levels, Japan is engaging in a QE program so large that if Caligula was a Central Banker, it would make even him blush, and now Yellen & Co. have shown their true stripes regarding their commitment to ultra low rates forever and ever.
And neither is the fiscal debt situation improving. The world wide amount of debt outstanding is once again accelerating. This debt is not economical and will eventually either need to be defaulted on, or more likely, inflated away.
In this environment, precious metals are not a speculative punt, but instead a must have in any prudent portfolio.
I have to admit to being a little surprised at the extent of the precious metal weakness over the last couple of years. Coming out of the 2008 credit crisis, gold mirrored the expansion of the Fed’s balance sheet pretty closely. But then with QE3, it went in the complete opposite direction.
Gold (yellow line) vs Fed Balance Sheet (white line)</a> </div>
I don’t have any good reason to explain the extent of this weakness apart from the fact that even though the Fed was expanding their balance sheet, the long end of the yield curve was actually backing up all the while inflation was declining, resulting in a higher real rate. The price of gold is very sensitive to real rates and this rise was enough to send gold lower.
Gold (yellow line) vs US 30 Real Rate Inverted (white line)</a> </div>
But if I am right about inflation picking up, then this drag will very soon turn into a source of buoyancy. And given Yellen’s willingness to tolerate higher inflation in an attempt to return employment to normal recovery levels, market participants have all of a sudden woken up to precious metals’ attractiveness.
During the past decade gold rose because real rates were kept artificially low. Even though inflation was minimal, gold offered an attractive alternative to the negative real rates offered in the bond market. Contrary to most people’s belief that gold only goes up due to inflation, the last decade was one of the greatest gold bull markets on record.
In the coming years, gold will be attractive not because rates are so low, but instead will return to its former glory as an inflation hedge. Real rates will once again be negative, but it will not be because of a rallying bond market. It will be because inflation has once again returned.
My suspicion is that the 2012/13 gold bear market was merely a correction in a much larger bull move. Prior to 2012, gold had been up every year for something like 10 years. It was due for a pause.
The key is now to remember that although the last couple of years have been torturous for the precious metals bulls, the big picture trend and fundamentals are all still pointing higher.
I think that yesterday was the first day of a much longer term move. I am going to try to leave my position alone. Like a scab, I am going to let it heal by not touching it – that is if I don’t go insane first from my inner voices that are screaming at me to take some profits.