I would like to tell you what will happen next in the financial markets.  No, seriously I really would.  Unfortunately, my crystal ball is presently not functioning. In the interest of full disclosure I should mention that it never actually did work, unfortunately I stared into it for a long time before I figured that out.  That was not a happy day.  That revelation led me to establish:

Jay’s Trading Maxim #62: Predicting stuff is hard.  Better to identify the current trend.  If you can’t identify the current trend, better to take the day off.

As I have written about a lot lately (here, here, here, here, here and here) there are a lot of markets “at the crossroads.”  So rather than wasting a lot of verbiage I’m going to save the 7,000 words and show 7 charts instead.  As I alluded to above, I can’t tell you where all of the various financial markets are headed, but I can show you a pretty good way to find out.

Keep a close eye on the markets relative to their respective “line(s) in the sand”.  Interpretation is fairly simple:

Price above red line = GOOD

Price below red line = BAD

All charts are Courtesy of ProfitSource by HUBB)

Figure 1 – U.S. Dollar

Figure 2 – Crude Oil

Figure 3 – S&P 500

Figure 4 – T-Bonds (TLT)

Figure 5 – Gold

Figure 6 – Coffee

Figure 7 – Soybeans

Summary

As far as what happens from here, you’re guess is as good as mine.  But the point is that NOW is exactly the time to be paying close attention.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Typically, I prefer to come up with my own ideas and do my own writing.  But sometimes I come across things that are so well thought out and so well written I figure “why recreate the wheel?”

For Investors

So the first article is about the yield curve.  While the phrase “yield curve” may not trigger excitement, the fact remains that the yield curve is one of the simplest and most useful ways to gauge future prospects for the economy and the stock market.  Just not always in the way most people think.  The 10-yr-2yr spread has been tightening of late, which has triggered a lot of consternation among the pundit class.

So the first article by Liz Ann Sonders of Charles Schwab addresses the reality (and the history) of the yield curve, and is extremely enlightening.  If you follow the economy or the stock market at all, please invest a few minutes and educate yourself about this important – and very misunderstood and misinterpreted – topic by reading the article linked below.

Don’t Fear the Yield Curve Reaper by Liz Ann Sonders at Charles Schwab

For Traders

Technically this second article does apply to “investors” as well as “traders”, but I like it more for people who trade in the financial markets on an active basis.  For many the material may seem like a “refresher”, and maybe it is. But even if so, a refresher is useful in order to help remind oneself about “how trading really works”, and how long-term success is actually achieved (Hint: It has less to do with “signal generation” and much more to do with “money management and risk management”).

So if you trade your own money on any kind of an active basis – again – please invest a few minutes and educate (or re-educate) yourself on this important topic

Losing To Win: 3 Reasons I Focus On Average Loss from Schwab Trading Services

Enjoy.  And learn.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

With crude oil hitting its highest level since November of 2014, the energy sector is suddenly drawing a lot of interest.  But there are few caveats that investors might want to keep in mind before getting too far ahead of themselves.

(BTW: If you enjoy reading JayOnTheMarkets.com – heck, even if you hate reading JayOnTheMarkets.com – please tell others and encourage them to stop by, “Like” an article, link an article, etc..  Thanks, The Management)

Energy Seasonality

Figure 1 (from www.Sentimentrader.com, which is quickly becoming one of my favorite sites) displays the annual seasonal calendar for ticker XLE – the SPDR Energy ETF. While it should be pointed out that it certainly is not like every year plays out like this chart, the primary point is that the “meat” part of year of from the end of January through the end of April is nearing the end of the line.Figure 1 – XLE Seasonality (Courtesy: www.Sentimentrader.com)

XLE Overhead Resistance

XLE has had a terrific month of April, rallying over 14% since the low on 4/2.  And while it has been an impressive show of momentum, a look at the “bigger picture” points to some key levels of potential resistance just ahead.

Figure 2 is a monthly bar chart of XLE with two significant resistance levels drawn (at roughly $78.25 and $80.50). XLE has failed twice previously at roughly $78.40 – in December 2016 and again in January of 2018.Figure 2 – XLE Monthly with overhead resistance (Courtesy ProfitSource by HUBB)

On the plus side, XLE is clearly trending higher at the moment and there is still another 6.4% and 9.4% of upside potential between the current price and the resistance levels drawn in Figure 2.  So short-term upside potential remains.

The only real “warning” I am raising is to pay attention to “what happens (if and) when we get there” (“there” being the $78.25-$80.50 range).

Jay’s Energy ETF Index

I created and follow an index of all manner of energy related ETFs (it combines traditional fossil fuel related ETFs with alternative energy source ETFs). A monthly chart with a significant resistance level drawn appears in Figure 3.Figure 3 – Jay’s Energy ETF Index (Courtesy AIQ TradingExpert)

Figure 4 “zooms in” on Figure 3 using a daily bar chart of my Energy ETF Index.  As you can see, as nice as the latest rally has been, there is a “day of reckoning” looming out there somewhere if the energy sectors keeps going and retests this significant level.

Figure 4 – Jay’s Energy ETF Index; Daily (Courtesy AIQ TradingExpert)

For the record this index is comprised of:

GEX – Alternative Energy

KOL – Coal

LIT – Lithium

NLR – Nuclear

OIH – Oil Service

TAN – Solar

UGA – Gasoline

UHN – Heating Oil

UNG – Natural Gas

URA – Uranium

USO – Crude Oil

XLE – Energy Sector

Summary

Some might interpret this piece as a bearish to neutral word of warning related to the energy sector.  In reality I am pretty agnostic when it comes to energy and (sadly) can’t offer you a “prediction” that would do you any good.

But I will be watching closely to see what happens to XLE and my own index if and when the key resistance levels are tested – especially if that test occurs after the end of the most favorable February through April period.

Commodity related assets – such as energy, especially fossil fuels – appear “due” for a favorable move relative to stocks.  If and when these key resistance levels are pierced we could see an “off to the races” situation unfold.

Until then, be careful about  “bumping your head.”

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Here’s a fun thing to do.  If you want to get somebody to give you a weird look tell them that there is a good chance that commodities will outperform stocks in the next 3 to 8 years.  In the immortal words of Ralph Parker, they will look at you “like you have lobsters crawling out of your ears.”

But a glance at Figure 1 explains why this seemingly crazy notion may not be so farfetched.  Figure 1 displays the Goldman Sachs Commodity Index (GSCI) divided by the S&P 500 Index (SPX).  As you can see, this ratio “goes to extremes” and the move from one extreme to another typically takes a number of years to play out.

Figure 1 – Goldman Sachs Commodity Index divided by S&P 500 Index

Historically, commodities vastly outperform stocks for a period of several years, then everything reverses and stocks vastly outperform commodities.  This ratio recently hit an all-time low as commodity prices fell while the stock market experienced a huge bull market.  This suggests (though certainly does not guarantee) that the next big move will involve commodities outperforming stocks.

Figure 2 displays a monthly bar chart for ticker RJI (the ELEMENTS Rogers International Commodity Index – Total Return) which is an ETF that holds a basket of commodities.  What we see is that a long-term down trending trend line, as well as a key “once support/then resistance” level ($5.27 a share) have both been pierced to the upside.

Which causes me to raise the obvious question “is this a breakout?”Figure 2 – RJI Monthly Bar chart with potential signs of a breakout (Courtesy ProfitSource by HUBB)

Before getting too carried away and making wild-eyed proclamations about how the turn in the GSCI/SPX Ratio has begun, let’s consider a few other “things.”

Figure 3 displays the daily chart for RJI.  The red lines inFigure 2 are the same red lines drawn onthe monthly chart in Figure 2.  As you can see, on a short-term basis there is an obvious “line in the sand/resistance” level at $5.66 a share. Unless and until RJI clears that level it is probably premature to talk about being “off to the races.”

Figure 3 – RJI Daily w/short-term resistance (Courtesy ProfitSource by HUBB)

It should be noted that there are other commodity ETFs available and that they presently paint a slightly different picture.  This is due to the fact that each tracks a different basket of commodities, with varying weights assigned to varying commodities.

Figure 4 displays a monthly chart of ticker DBC (PowerShares DB Commodity Index Tracking Fun) and ticker 5 displays ticker GSG (iShares S&P GSCI Commodity-Indexed Trust (which is designed to track the S&P GSCI Total Return Index).

Figure 4 – DBC Monthly (Courtesy ProfitSource by HUBB)

Figure 5 – GSG Monthly (Courtesy ProfitSource by HUBB)

As you can see in Figures 4 and 5, tickers DBC and GSG appear to paint a slightly different – seemingly less bullish – case for commodities.  Why the difference?  Figures 6, 7 and 8 display the portfolio holdings for RJI, DBC and GSG respectively.  The key thing to note is that RJI is the most diversified of the three.  Also RJI holds roughly 40% of its portfolio in energies whereas DBC and GSG hold roughly 56% and 63% of their respective portfolio in energy related commodities (crude oil, natural gas, etc.).  It should be noted that these holdings and the percentages can change over time.

Figure 6 – RJI holdings

Figure 7 – DBC holdings

Figure 8 – GSG holdings

Summary

*Based on Figure 1 I do believe that commodities may in fact outperform stocks (possibly by a significant margin) in the years ahead.

*Based on Figure 2 I think it is possible that commodities may start gaining significant ground sooner than later.

*However, based on Figures 3, 4 and 5 I am tempering my enthusiasm for the time being.

*If history (referring to the long-term swings in the GSCI/SPX ration displayed in Figure 1) is an accurate guide (and of course in the financial markets it is always important to remember that “yes, this time could be different”) there is no need to try to “pick the turn” in the GSCI/SPX ratio. We can wait for a new trend to develop first before “taking the plunge.”

*But now appears to be a good time to be keeping a close watch on commodities versus stocks.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

It’s not exactly a secret – and it’s a widely misunderstood concept – but in the world of investing sometimes it’s not what you invest in but when that matter most.

Case in point.  What do you get when you combine junk bonds, dividend stocks and intermediate-term treasury notes?

It depends on how you do it.

We will look at two approaches – one approach buys and holds all three with an annual rebalance, the other switches between the three using a set calendar.

Spoiler Alert: The difference is “stark”.

(See Also JayOnTheMarkets.com: The World is at a Critical Juncture)

The Vehicles

For our purposes we will conduct two tests from 12/31/1989 through 3/31/2018 using the following set of monthly total return data:

Junk Bonds: From 12/31/1989 through 12/31/1993 we use Vanguard High Yield Bond fund (VWEHX).  From 12/31/1993 forward we use the Barclays Capital High Yield Very Liquid Index (which is the index that is tracked by the SPDR Barclays High Yield ETF – ticker JNK)

Dividend Stocks: We use the S&P 500 Dividend Aristocrats Index (which is the index used by the ProShares S&P 500 Aristocrats ETF – NOBL)

Intermediate-Term Treasuries: We use the Barclays Capital U.S. 3-7 Year Treasury Bond Index (which is the index tracked by the iShares 3-7 Treasury Bond ETF – ticker IEI)

Test 1 – The “Equal Split” Approach

For this test we simply split our money evenly between junk bonds, dividend stocks and intermediate-term treasuries and rebalance at the end of each year.  Figure 1 displays a graph of the cumulative growth of $1,000 since 12/31/1989.Figure 1 – Growth of $1,000 split between Junk bonds, dividend stocks and intermediate-term treasuries with an annual rebalance; 12/31/1989-3/31/2018

The results look pretty good in terms of consistency.  The total return is +691% (about 7.8% for the 12-month average) with a maximum drawdown of -9.2%

Can these results be improved upon?  (Another Spoiler Alert: Yes, by a factor of about 8-to-1.)

Test 2 – The “Calendar Approach”

With this approach we will invest in only one category per month each year as displayed in

Figure 2 – Calendar Approach Investment Calendar

The results for Test 2 appear in Figure 3 as the blue line.  For comparisons sake, the original line that appeared in Figure 1 appears in Figure 3 as the red line.  Notice a difference?

Figure 3 – Growth of $1,000 invested using Calendar Approach (blue  line) versis Split Approach (red line); 12/31/1989-3/31/2018

The particulars of relative performance appear in Figure 4.

Figure 4 – Performance Comparison; Calendar Approach vs. Split Approach; 12/31/1989-3/31/2018

Summary

For the record I am not “recommending” this as an investment approach.  Like any other approach there a relative pros and cons that would need to be carefully considered before adopting such an approach using one’s actual hard earned money.  For example, these returns involve the use of  index data and do not represent actual trading results and there are no deductions for any fees, etc.

The material presented above is intended simply to highlight:

Jay’s Trading Maxim #44: Sometimes it’s not what you invest in but when that matters most.

Case in point.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

OK, sorry, I guess that was a little dramatic.  Anyway, the major indexes of many foreign countries staged outstanding advances, in some cases since the end of 2015. And while it was undoubtedly a great ride, the nagging question all along the way was, “what happens when these markets start to hit resistance?” The answer appears to be forming as I type.  So it is an important time to pay attention to how things play now, as that may have important implications going forward.

Figure 1 displays four separate indexes that I created and follow – The Americas, Asia/Pacific, Europe and the Middle East.

(click to enlarge)Figure 1 – The Four Major World Market Arenas (Courtesy AIQ TradingExpert)

The Americas (upper left) didn’t quite make it to its old all-time before running out of steam. Asia/Pacific (upper right) broke out to the upside for exactly one week before dipping back below resistance. It presently stands right on the edge (see Figure 2 below).

Figure 2 – Asia/Pacific fails its first test (Courtesy AIQ TradingExpert)

Europe (lower left) also broke out above its 2014 high for exactly one week before falling back (See Figure 3 below).

Figure 3 – Europe also fails its first test (Courtesy AIQ TradingExpert)

My Middle East index bumped its head at a somewhat arbitrarily drawn inflection point.Figure 4 – A key resistance point hanging over Middle East index (Courtesy AIQ TradingExpert)

Summary

So in sum, the “world” stock markets are sort of in a “Hey nice work, what have you done for me lately?” situation.  While I would love to tell you how this will all play out unfortunately I do not possess the ability to do so.

One thing I do know, however, is that the implications are large. If the “world markets” by and large break out to the upside and stage another up leg then the “bull is alive”.  On the other hand, if resistance holds and the majority of markets start to break down, things could get very ugly.

As the world turns…

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

After rereading much of what I have written of late, it occurs to me that maybe I should just write about those markets that are not at a critical juncture, you know, just to save time.

Speaking of which, a long time ago I read an obscure article somewhere that made a compelling argument that the 3 most important commodities in the world are the “Three C’s” – crude oil (runs everything), corn (feeds everyone) and copper (builds everything).  It made sense.  It still does. (Although for the record, times being what they are, I am still concerned that someday the three most important commodities may be canned food, shotgun shells and cabins in the woods, but I digress).

Yes, it makes sense all day, into the evening, overnight and into the early morning. And then you wake up and realize that the author missed the most important “C” of all – Coffee!!

Coffee, the Commodity

Like any physical commodity there are two things you need to know about coffee:

*The price fluctuates based on supply and demand

*After boom comes a bust and vice versa

To put it mildly, coffee has a “history”.  To be more specific, coffee has a history of extremes booms and busts (which is what can make it an outstanding trading vehicle).  Consider Figure 1 which displays a monthly bar chart for spot Coffee prices.

Figure 1 – Monthly Spot Coffee; a History of Big Moves (Courtesy ProfitSource by HUBB)

The good news is that you do not have to be an expert on Brazilian weather patterns to recognize “the way it works” in coffee.  The way it works, generally speaking, is this:

a) Price either collapses into a narrowing, declining range or consolidates into an every narrower sideways’ range

b) All hell breaks loose (See Figure 2)

Figure 2 – Monthly Spot Coffee; a History of Big Moves (Courtesy ProfitSource by HUBB)

Part a) can be very frustrating for anyone trying to “pick tops  and bottoms with uncanny accuracy” and can seem like it will never end as price grinds lower in a trend that seems like it will last forever.

Part b) can be extremely profitable.  And the beauty part is in most cases you do NOT have to get in near the bottom (or top) to ride a pretty darn good trend.

The bad news until more recently is that the only way to trade coffee was to trade coffee futures.  Talk about a wild ride.  As someone who has traded coffee futures in the past, both professionally and personally, let me sum up the experience this way – picture downing three triple espresso’s.  Then a Monster chaser.  Then boarding a roller coaster.  Hands Up!

Bottom line, despite the obvious potential for profit, it is clearly not for everyone.

Ticker JO, the ETF

With the advent of ETFs the marketing people “got busy” and created ETFs to fill every nook and cranny of the investment sphere.  Commodities were included in this onslaught, including ticker JO (get it?) which tracks an index of coffee futures contracts. Figure 3 displays a bar chart for ticker JO.Figure 3 – Ticker JO (Courtesy ProfitSource by HUBB)

Notice anything?

Good News: If history is a guide, coffee is setting up for the next big up move.

Bad News: I can’t tell you when the trend will change.

Good News: We know for sure is that it won’t start at least until the current down trending range is broken to the upside.

Bad News: Just because price breaks above the upper red line I have arbitrarily drawn in Figure 3 doesn’t guarantee that a profitable up move will occur.

Good News: But it could. And as you have seen, when coffee “goes”, it really goes.

Other Good News: Investors can buy coffee just like buying shares of stock via JO.

So grab another cup of – what else – and keep a close eye.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Figure 1 below (Courtesy of NotesFromTheRabbitHole) presents the most important economics lesson you will learn today (or any other day for that matter).  Please take whatever time is necessary to memorize this important concept.

Figure 1 – Economics 101 (Courtesy of NotesFromTheRabbitHole)

Figure 2 presents highlights 8 different major stock market indexes that (at least for now) have held at support, but which remain very much “in play”.

Figure 2 – Major Market Index hold at support (Courtesy of KimbleChartingSolutions)

The implication is pretty simple: If these support levels start getting pierced to the downside, it is time to play defense.  Until then…..

Figure 3 displays the difference between the 10-year treasury yield and the 2-year treasury yield.

Figure 3 – 10yr minus 2yr treasury yields (Courtesy RealInvestmentAdvice.com)

While the current trend (i.e., getting closer to 0) appears ominous it is important to remember that the “trouble” typically does not occur until this measure goes negative.  But attention should be paid.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

If you have read any of my pieces lately you are already aware that as it relates to the financial markets a lot of things are presently at a critical juncture (including my sanity, but I digress).  Today let’s add the U.S. Dollar to that seemingly ever longer list of financial areas that appear to be at a crossroads.  And this one has some large implications simply because a lot of other markets are affected at least to some extent by what happens in the dollar.

Figure 1 displays the Spot U.S. Dollar on a monthly basis.

Figure 1 – U.S. Dollar Monthly (Courtesy ProfitSource by HUBB)

The reality is that there is no one definitive price at which to draw a “definitive” line in the sand.  So I arbitrarily picked two.  There is nothing “magical” about these two lines and a move above or below either does not technically “prove” anything.  Still, as far as this range goes, a lot of previous price moves have “gone here to die” so to speak.

Now this is the point in the article where a skilled analyst would explain in painstaking detail why the dollar is absolutely, positively destined to move higher (or lower) from here.  Sorry, folks I honestly don’t know. But there are two things I do know which might still prove useful:

1) For every prognosticator out there pounding the table that the dollar is sure to move higher there is another (equally slightly crazed) prognosticator averring that the dollar is destined to decline.  And the key thing to note is that they both can make a pretty compelling case.

2) A lot rides on which way the dollar goes from here, because there is no shortage of markets that react – at least in part – to the movements of the U.S. dollar.  This means that alot of trading opportunities will be affected/created by the next big move from the dollar.

A few examples appear in Figure 2 below which displays the inverse nature of the correlation between the U.S. Dollar (using ticker UUP as a proxy) and the market in question (for the record, a figure of 1000 means the market moves exactly like the dollar and a figure of -1000 means the market moves exactly inversely to the dollar).

Figure 2 – Correlations to U.S. Dollar (Courtesy AIQ TradingExpert)

Now the fact that foreign currencies (ticker FXE – which tracks the Euro) move inversely to the U.S. Dollar is fairly obvious.  But note that on this list are:

*Foreign Bonds and U.S. Bonds (BWX and TLT)

*Precious Metals (GLD and SLV)

*Commodities (like coffee, soybeans and crude oil)

*Broad Commodity Indexes (DBC and GSG)

This encompasses a pretty darn wide swath of the trading world.  And every single one of them will be influenced to some extent by which way the dollar goes from here.

As you can see in Figures 3 through 6 (click to enlarge any of the charts), what happens to the U.S. Dollar can matter a lot to what happens in these markets.Figure 3 – Dollar vs. Euro (Courtesy AIQ TradingExpert)

Figure 4 – Dollar vs. Bonds (Courtesy AIQ TradingExpert)

Figure 5 – Dollar vs. Metals (Courtesy AIQ TradingExpert)

Figure 6 – Dollar vs. Commodity Indexes (Courtesy AIQ TradingExpert)

Summary

So the bottom line is that I do not know which way the dollar goes from here.  But I do know that whichever way it goes a lot of “things” will likely go “the other way.”  And everything listed in Figure 2 represents a lot of trading opportunities.

This represents a good time to invoke:

Jay’s Trading Maxim #17: (with credit given to George and Tom at Optionetics back in the day): Investing success involves two “simple” steps. #1) Spot opportunity.  #2) Exploit opportunity.  Everything you do as a trader or investor falls into one of these two categories.

A bunch of opportunities may soon be spotted (assuming the dollar actually ever does get around to deciding which way it wants to go…).

So focus here, people, focus…

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

I saw a headline recently touting the “confirmed upside breakout” for Gold.  As I tend to follow the markets, ahem, somewhat closely, I was a bit surprised that I somehow missed this.  So imagine my confusion when I pulled up a bar chart to see the “confirmed upside breakout” that I somehow missed and saw what appears in Figure 1.

Figure 1 – Daily Spot Gold (Courtesy ProfitSource by HUBB)

Um, not to be trendy but, “dude, where’s my breakout?”  All I see in this chart is serious resistance in the $1,370-$1,380. So was this pundit off his rocker?  Turns out, no not necessarily.  For if we switch to a monthly chart we can see exactly what he was referring to.Figure 2 – Monthly Spot Gold (Courtesy ProfitSource by HUBB)

So, yes it is possible to make the case that gold has “broken out” to the upside.  Still, if you put the two together you get Figure 3.Figure 3 – Monthly Spot Gold (Courtesy ProfitSource by HUBB)

So as with most things in the financial markets – it’s all in the eye of the beholder.  You can look at Figures 1 through 3 and reasonably say:

*Gold has broken out to the upside on a long-term basis so I am bullish

*A long-term trend line was broken but there is significant resistance near $1,370-$1,380 so I am going to remain neutral for now

*The resistance level looks pretty solid; I am going to be bearish until that level is taken out.

Take your pick.

In other words, the gold market right now is whatever you want it to be.  So what to do?  Well, let’s say you are the impatient type (“Hi, my name is Jay”) and you want to be positioned for a big move to the upside, but you have serious concerns about if and/or when that move might occur.  Sound intriguing?

Sorry folks, you’ve just been sucked into another lesson on options trading.

The Ratio Backspread

In Figure 4 we see a bar chart for ticker GLD – an ETF that tracks the price of gold bullion with implied option volatility overlaid in black.  Figure 4 – Ticker GLD with implied volatility (Courtesy www.OptionsAnalysis.com)

You do not have to be an options expert to recognize that IV is presently at the very low end of the historical range. This has several implications. The primary things to know are:

*Low IV means there is relatively less time premium built into GLD option prices, i.e., GLD options are presently “cheap”.

*A subsequent rise in IV should it occur, would serve to inflate the price of GLD options

*Longer-term options are much more sensitive to changes in IV that shorter-term options.  Therefore, if IV does rise, longer-term options will increase more in value than shorter-term options.

So let’s consider a possibility. IMPORTANT: As always I need to point out that what follows is simply an example of “one way to play” and I am in no way “recommending” this trade nor implying that it will generate a profit.  It is presented solely as a means to teach people the relative advantages and disadvantages of various option trading strategies in a given circumstance.  Are we clear?

The trade displayed in Figures 5 and 6 involves:

*Selling 1 Dec31 GLD 119 calls @ $10.60

*Buying 2 Dec31 GLD 126 calls @ $5.23

Figure 5 – GLD ratio backspread (Courtesy www.OptionsAnalysis.com)

Figure 6 – GLD ratio backspread risk curves (Courtesy www.OptionsAnalysis.com)

This trade has 270 days left until expiration and the maximum risk is -$886 if GLD closes at exactly $130 a share on 12/31/2018 (and wouldn’t that be just my luck?).  As you can see in Figure 6:

*If GLD rallies this trade can make a lot of money

*If GLD remains unchanged eventually this trade will lose money

*If GLD tanks this trade will breakeven or experience at most a small loss

Also, if IV rises in the meantime, that would push the risk curves further into positive territory. For example, if IV rose from 12% to 16% (i.e., 33%), the risk curves would look like those in Figure 7.Figure 7 – GLD ratio backspread risk curves if implied volatility increases 33% from current levels (Courtesy www.OptionsAnalysis.com)

Summary

Which way will gold goal from here?  It beats me.

Will GLD implied options volatility increase from here?  It beats me.

Will the example trade above generate a profit?  It beats me.

OK, not exactly the “rip roaring, go to the mattresses, take no prisoners, Katie bar the door” summary you might have been hoping for.  So let me sum it up in a series of questions you can answer at home:

Question 1: Do you think there is a chance gold will rally between now and the end of the year?

Question 2: Do you think there is a chance that GLD implied option volatility will pick up sometime between now and the end of the year?

Question 3: Do you have $886 bucks?

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.