Gold Could Shine In This Uncertain Market
Investors are well aware of the problems with China trade policy, potential trade wars in other regions and conflicts between the Federal Reserve and the President. This could mean gains for gold as Bloomberg reported,
“Just when it looked like gold’s rally was starting to founder, the Federal Reserve and an escalation in the U.S.-China trade fracas have given the metal new life.
Gold, which had been headed for a weekly loss Friday morning, closed at a fresh six-year high after the U.S.-China trade fight intensified and Federal Reserve Chairman Jerome Powell said the U.S. economy faces significant risks from slowing global growth.
Bullion’s rebound comes after mixed economic data and doubts expressed by some U.S. central bank officials on further U.S. interest-rate cuts crimped demand for the metal earlier in the week. With the rebound on Friday, prices have now posted seven straight weekly gains, the longest run since 2011.
“With the macro environment deteriorating, i.e. China ratcheted up tariffs today, Brexit, Hong Kong, and the weakness of European bank balance sheets, you can now add a supportive U.S. central bank,” Jim Wyckoff, senior analyst at Kitco Metals, said in an emailed report. “Fed Chairman Powell indicated the Fed would do what was necessary to keep the economy rolling, adding new momentum to gold prices.”
Trade-policy uncertainty seems to be playing a role in the global slowdown and in weak manufacturing and capital spending in the U.S., Powell said in the text of remarks Friday in Jackson Hole, Wyoming. “We will act as appropriate to sustain the expansion,” he said. That bolstered expectations the central bank will cut U.S. interest rates further.
“That’s a very accommodating statement,” Bob Haberkorn, senior market strategist at RJO Futures in Chicago, said by phone. “They’re going to keep this thing going for as long as they can.”
Traders of fed funds futures jacked up their expectations for the amount of easing they expect from the U.S. central bank this year after Powell’s remarks. The outlook for lower rates may help revive investor demand for gold, which erased a weekly loss. Lower rates are a boon for the metal, which doesn’t pay interest.
A gauge of gold miners climbed to a three-year high on Friday, led by Toronto-based miners Yamana Gold Inc. and Kinross Gold Corp. (NYSE: KL).
KL could be headed to new highs after a brief consolidation within a long term up trend.
A Trade for Short Term Bulls
As with the ownership of any stock, buying KL could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for KL
Every day, we scan the markets looking for trades with low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For KL, the October 18 options allow a trader to gain exposure to the stock.
An October 18 $50 call option can be bought for about $2.20 and the October 18 $55 call could be sold for about $1.02. This trade would cost $1.18 to open, or $118 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $118.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in KL the maximum gain is $3.82 ($55- $50= $5; $5 – $1.18= $3.82). This represents $382 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $118 to open this trade.
That is a potential gain of about 223% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.