COMPREHENDING GOLD FUTURES AND ITS PARTICIPANTS
Gold Futures is the world’s most liquid gold derivatives. Fifty billion USD notional is traded daily on average. This leads to unrivalled bid-ask spreads enabling investors to gain capital efficient exposure to the price of gold . Launched in 1974 and trading over nearly 50 years, Gold Futures offer tight correlation to physical gold prices.
Gold Futures trade 23 hours a day. Trading starts every Sunday 5pm Chicago Time (6am Monday in Singapore) to Friday 4pm Chicago time ( 5am Saturday in Singapore) providing near round-the-clock access. Gold Futures provide superior capital efficiency with a leverage of nearly 25x at current prices.
Gold Futures come in two sizes. Each lot of the full contract provides exposure to 100 oz. of Gold requiring $8,000 in margins per lot. However, each lot of Micro Gold contract delivers 10 oz. of gold price exposure. Micro contracts which require only $800 per lot in margins provides affordable access to investors while helping hedgers fine-tune their risk management strategies with more precious exposure. When trading spreads, investors can further boost return through margin credits.
Broadly speaking, investors, hedgers, and speculators form the active participants in the gold futures market. Hedgers use to manage their overall gold portfolio risk exposure. They use derivatives to lock in price for future transactions or to effectively hedge against price fluctuations.
Speculators participate in Gold Futures with the intent of punting on gold price moves to generate profits. Investors use gold futures for generating return on capital over an extended period. They tend to focus on underlying fundamentals rather than short-term price movements.
All three types of market participants are essential for effective financial market operation. Together they help build deep liquidity pools thereby facilitating robust price discovery.
GOLD IS SET TO OUTSHINE NASDAQ
The Nasdaq Index comprises of one hundred large and most actively traded U.S firms listed on the Nasdaq exchange. The index includes firms from a variety of industries except financials. These include tech, health care, retail, biotech, and industrial companies. The index is weighted by market capitalisation.
During risk-off phases, investors rush to shelter in safe-havens. Gold prices rise. Also, when rates rise, companies whose values hinge on future distant cash flows suffer. As those cash flows get discounted at steeper rates diminishing its present value, share prices plunge.
As risks and rates rise & remain high, Gold will outperform Nasdaq. Validating this view is the positioning of participants based on CFTC’s Commitment of Traders ( ) report dated March 13th. It shows that managed money and speculators are net long on Gold .
The options market also vindicates the above views. Options on Gold Futures have a of 0.6x which signifies bullishness in gold . For every 10 gold investors, there are only 6 ones. However, for Nasdaq, options exhibit a of 2x meaning that for every 10 Nasdaq investors, there are 20 ones.
However, as rates continue to rise or remain high, Nasdaq will struggle as growth firms get punished with discounted present value. Hence, this case study argues that a spread trade to long gold & short Nasdaq will deliver a compelling positive yield.
Yes, growth stocks in Nasdaq have outperformed gold over the past twenty years. Yet, these stocks will struggle during times of crisis and elevated rates.
The Gold-Nasdaq Ratio (“GNR”) had a golden crossover in January 2022 as equities came off its peak with rates rising. Since then, long-term ( 200-day ) moving average has been a strong support for GNR .
With GNR trading above this level, it provides investors a compelling spread trading opportunity with strong upside and limited downside.
A long position in Micro Gold Futures expiring in June 2023 (MGCM3) provides exposure to 10 oz of Gold with a minimum margin requirement of $800 per lot. Each contract of MGCM3 represents a notional of $19,940.
A short position in Micro E-mini Nasdaq-100 expiring in June 2023 (MNQM3) provides exposure to $2 x Nasdaq-100 index with a minimum margin requirement of $1,680 per lot. Each contract of Micro Nasdaq-100 represents a notional of $25,750.
Spread trade requires notional values of each leg to be identical. Therefore, a long position of five lots of MGCM3 is required to offset a short position of four contracts of MNQM3. Margin offsets are available for this spread.
The trade entry, target, stoploss, and reward to risk ratio are set out below:
• Entry: 15.40%
• Target: 16.90%
• Stop: 14.20%
• Profit at Target: $9,270
• Loss at Stop: $8,130
• Reward-to-Risk Ratio: 1.14x
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This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
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