How to Position if you Missed the Gold RallyGold prices have reached another all-time high, supported by strong bullish momentum. However, the composition of buyers has shifted. While central banks fuelled the previous phase of the rally, institutional investors and retail buyers are now leading. Over the past six months, ETF inflows have totalled nearly $5 billion, and asset managers continue to build net long positions, nearing the peak levels seen during the pandemic.
Despite the bullish outlook, higher prices are tempering demand and reducing the potential for future returns. As an alternative, investors can opt for a tactical position using CME Micro Gold futures and the Van Eck Gold Miners ETF (GDX).
RATE CUTS ARE A GOLD DRIVER
Over the past four easing cycles, gold prices have appreciated by 10% following the start of Fed rate cuts. This time around, prices are up 5% since the first rate cut in September. That leaves room for further gains as the Fed cuts further.
Still, it is crucial to consider that gold prices are already trading at an all-time-high. Higher prices are pressuring further gains and consumer demand.
According to Prithviraj Kothari, president of the India Bullion and Jewellers Association (IBJA), gold demand during this year’s festival season in India is likely to be 20% lower YoY in terms of quantity of gold purchased.
CENTRAL BANK BUYING NO LONGER THE DRIVING FACTOR
Since April, the People's Bank of China (PBoC) has halted gold purchases, while Poland and India acquired 24.3 tons and 17.7 tons of gold, respectively, between June and August, exceeding their purchases from March to May. However, the pace of buying from these central banks may be slowing. The latest data from the Reserve Bank of India (RBI) shows a decline in gold reserves by $98 million to $65.6 billion, indicating a slowdown in gold accumulation despite still substantial holdings.
One of the largest buyers of gold this year, Turkey, also slowed its pace of purchases as it acquired just 7.9 tons of gold between June and August compared to 27.6 tons between March and May.
Source: World Gold Council
Additionally, the urgency for central banks to buy gold has lessened. Earlier, rising yields and a strong U.S. dollar prompted increased gold buying. As U.S. interest rates decrease, a weakening dollar is expected.
ASSET MANAGERS NET LONG POSITIONING IS NEAR ALL-TIME-HIGH
Asset Manager net long positioning has increased consistently over the last six months. It is near the highest level since the pandemic and 2016. Crucially, the increase in long positioning has been driven by both increasing longs and declining shorts indicating bullish consensus among asset managers.
SUBSTANTIAL ETF INFLOWS OVER THE PAST 6 MONTHS
Gold ETFs listed in the US have accumulated USD 4.9 billion in inflows over the past 6 months. Inflows have grown by more than USD 1.7 billion since the Fed cut rates in September. While substantial outflows were observed on 8/Aug as global markets fell sharply, the decline was reversed in just 2 weeks.
Gold ETF inflows tend to follow cyclical patterns, and their current levels are relatively modest compared to previous inflow cycles, which have been significantly larger.
Substantial flows to gold ETFs and rallies in gold prices also tend to trigger flows into gold miner ETFs. Though these flows tend to lag flows into gold ETFs by several months.
GOLD MINERS HAVE STARTED TO CATCH UP
The outlook for gold remains mixed. While bullish momentum is supported by the anticipation of a Federal Reserve easing cycle, gold is already near all-time highs, which is discouraging further investment, particularly from retail investors.
A strategic way to capitalize on the later stages of a gold rally is through gold mining stocks. Gold miners typically lag behind gold during rallies, as returns from equities take longer to materialize and involve greater risk compared to direct gold investments. However, the impact of higher gold prices on miners' profitability is clear. In Q2 2024, Barrick, the world's largest gold miner, saw net income rise by 24% quarter-over-quarter, driven by a 13% increase in realized gold prices. Similarly, Newmont's net income increased by 32%, alongside a 12.3% rise in gold prices.
Gold miners are also benefiting from easing cost pressures. While costs remain high compared to last year due to inflation and energy-related increases, they improved in Q2, and further reductions are expected based on company guidance.
The gold to gold miner ratio is a cyclical quantity that has been trending higher for decades but also tends to mean-revert when the ratio edges to far in either direction.
As the ratio is due to cross the 200-week moving average, it may be due for an extended period of decline favouring gold miners.
HYPOTHETICAL TRADE SETUP
Gold remains bullish through the Fed easing cycle and strong investment demand provide momentum. However, higher prices are dampening consumer demand and central bank buying is slowing. Further increase in gold is likely, however, further gains may be limited. Gold prices have already realized half of their average increase following a rate cut.
Alternatively, a position that is long on gold miners also benefits from rising gold prices.
Gold prices, as tracked through gold futures, are highly correlated with gold miners, measured by ETFs like GDX and SGDM, with a correlation coefficient typically near 0.9, though there are occasional period breaks. Since December 2023, gold prices have outperformed SGDM by nearly 20% and GDX by 5%.
As the current gold rally progresses, increased flows into gold miner ETFs are expected to support their prices. Additionally, improving cost structures for miners and higher realized gold prices create positive momentum.
Investors can hedge a long position in GDX by taking a short position in CME Micro Gold futures. This hedge protects the ETF position against potential declines in gold prices. The smaller contract size of CME Micro Gold futures makes them ideal for precise hedging, particularly given the smaller unit size of ETFs like SGDM.
637 units of GDX (at a price of 43.15 as of 18/Oct) are balanced by a hedge of 1 CME Micro Gold futures contract expiring in December. CME Micro Gold Futures require margin of just USD 1,100 while the GDX leg requires notional of USD 27,470.
The position offers multiple income-generating advantages. The GDX ETF provides a net dividend yield of 0.65% (after accounting for the management fee), and the short position in CME Micro Gold futures benefits from contango, which adds approximately 1% per quarter.
The payoff scenarios for this position are provided below:
MARKET DATA
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