Last week as gold prices sustained a brutal selloff, volatility in the options market failed to respond leading Erik Norland, senior economist at CME group, to believe prices could still head lower.
“It would not surprise me to see prices below $1,000 [per ounce] in 6 or 12 months,” said Norland, who suggested that investors became complacent during the past several months of sideway price movements.
The summer months historically bring lower volatility, said Joni Teves, an analyst at UBS.who noted that volatility hovered at record lows of around 15 percent two weeks ago and 8.7 over the last 30 days. But this most recent price slide might prompt suddenly anxious investors to use options to rebuild long positions, which would lead to an uptick in options volatility.
On Monday last week, as Asia opened and gold registered a 5 percent decline, gold 3-month futures options implied volatility – a tool to measure current and historic volatility – shrugged off the ascent with the index peaking at 17 on Thursday before falling to end the week.
Additionally, the volatility index – an investment tool that tracks the implied volatility of the S&P 500 index options – was relatively flat the entire week before rising on Friday. The index is commonly referred to the as the fear gauge because volatility spikes in turbulent periods, notably the 2008 credit crisis.
The serene conditions could be problematic as a rapid price movement in gold is normally accompanied by an exponential increase in volatility. As the two move in unison – particularly in a down market – the correlation moves closer together in a positive relationship.
“When (volatility) is high and markets are falling you will see that everything moves together, commodities, equities, metals, etc.,” a trader said.
The focal number is 30 for market observers. In the past five years, volatility spiked over 30 percent and each time gold made a quick ascension or decline.
“If we have a sharp [gold] selloff, it could be easy to imagine we could seeing a doubling [of volatility] to 30 percent,” Norland said.
Investors, meanwhile, have been liquidating their long positions in recent weeks with managed money or hedge funds net short on gold for the first instance on record. But with gold falling rapidly, options provide insurance or hedging against price positions.
“Although gross long positions on the Comex are at their highest since December 2009 at nearly 23 ounces, gross short positions hit an all-time high on July 7, just shy of 18 ounces and remain close to that level,” David Bloom, a strategist at HSBC, said. “The surge in short positions has possible ramifications for prices and market volatility.”
The net long fund position (NLFP) in gold fell sharply by 19,545 contracts or 40 percent to 28,279 from 47,824 contracts in the week ending July 21, according to the latest Commodities Futures Trading Commission statistics. Over the same period, gold prices sold off by 4.59 percent.
In response to the record shorts, one market observer notes the positioning as the end signal for the bearish downturn and remains long on the precious metal.
“This accumulation of short positions is, we believe, unprecedented and the time for being short of gold is now absolutely passed while the time for being long is upon is,” Dennis Gartman, editor and publisher of The Gartman Letter, said.
(Editing by Tom Jennemann)
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