Home Market You should buy out of money options in gold; heres why

You should buy out of money options in gold; heres why

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By Aasif Hirani

Gold is melting, but we feel there is no need for panic. Gold prices have taken a hit and have crashed nearly 15 per cent from the peak in just four months. Some of the short-term reasons for pushing gold prices lower are US Federal Reserves monetary policy tightening, trade war tensions, a slowdown in China and other emerging markets and the most important, rising US dollar.

Gold is fundamentally bearish, but sentimentally bullish. Why we are saying sentimentally it is bullish because gold market is oversold.

Investors right now are really bearish on gold. COT report is showing that golds speculative net positions were at just 12,700 at last count, the second-lowest level registered over the past 10 years. Previously when golds net position was below that level was at 9,800, when gold was at the bottom around $1,050 during sell off in 2015.

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One has to remember that record shorts will also have record buybacks. If history is any indicator, the extreme bearishness will be a great counter indicator that prices should recover in near future.

The tailwind for strong US dollar is tightening monetary policy. The tightening is being felt throughout the markets. We feel Feds tightening will likely to slow going forward. There is a likelihood of rate hikes in September and December, but we dont see more than one rate hike in 2019.

Even though the US GDP grew at 4.1 per cent, this was on the base of debt fuelled consumption and an exporters increasing their exports before rate tariff gets implemented. We will see 2018s artificially boosted growth reversing. So Fed wont be able to raise rate hikes. History has also shown that whenever the Fed raises interest rates, a recession occurs afterwards.

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US governments debt to GDP is about 105 per cent. All levels of consumers debt are at record high. If the Fed continues to wind up its balance sheet and tighten its monetary policy then it is difficult to sustain such a high level of debt.

So in long term, we may not see dollar getting significantly appreciated. The current strength in US Dollar is because of trade war, which will provide tailwind as now trade war has become currency war.

To maintain their share in the world, every export-oriented country does not mind their weak currency. Eventually, US dollar gets strong and this nullifies its purpose of implementing tariffs.

Gold is only down about 15 per cent from the highs this year, which constitutes a healthy correction, not a new bear market, and is certainly not the end of the world.

Pessimist sentiments have caused gold to become massively oversold. Using a long call option strategy gives us low risk with high reward.

It is better to buy out of the money call options then buying future, as if gold prices stay at current juncture or fall, all we lose is upfront premium. But if gold prices rally, then we may see an increase in prices in call options.

(Aasif Hirani is the Director of Tradebulls Group. He has 12 years of experience in the finance industry. Readers are advised to consult their financial advisers before taking any position based on these observations)

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