Gold & Silver Unusual Option Activity Report

Since the original CARES Act expired at the end of July, gold and silver have been backpedaling. However, as stimulus talks appear to be moving quickly toward a deal, the prospects for gold and silver are more lustrous. The early sign of this was the bullish option activity in the ETF products yesterday.

For some, this is a natural conclusion but for others, they may not have made the connection about gold’s role as a stagflationary asset. Yes, I used the term ”stagflation” and not “inflation.” This is because gold doesn’t generally outperform during more inflationary times like silver can. Gold’s role is capitalizing on a falling dollar.

When the Fed is temporarily able to stimulate the economy with their printing press, frequently, the dollar will lose value against other foreign currencies but will strengthen in real terms. How do I know this? Because gold prices are falling.

Gold History Lesson

For this lesson on gold, we’ll have to go back to late 2011 to early 2016. The global economy was poised to enter recession and in late 2012, global central banks were on the warpath. This path led them to inject liquidity that surpassed the financial crisis in size. Initially, the Federal Reserve’s “Operation Twist” parlayed into QE infinity.

From October 2010 to December 2104, the Fed increased the size of their balance sheet from $2.8T to $4.5T. Over that period of time, gold prices declined from nearly $1800 to around $1200. The price of the S&P 500 increased from around $1180 to close to $1850, and the dollar was flat.

Looking at the chart below, you’ll see this dynamic playing out. Gold prices are represented by the green area graph, the red line is the S&P 500 and the black line below is the price of Invesco DB US Dollar Index Bullish Fund (NYSEARCA: UUP).

(Click on image to enlarge)

Interpreting the Move

How does this happen? Well, the Dollar Index or UUP looks at relative strength against a basket or currencies but with a 57% weighting to the euro. What happens when the European Central Bank is pursuing the same policy? They both go nowhere in relation to each other. Looking at gold, it shows that the dollar was, in fact, strengthening. This is because gold is priced in dollars. The initial impression is that the Fed got out in front of a potential crisis and wanted to own risk assets like stocks.

As QE began to recede, so did the appetite for risk. In this case, gold began to surge in early 2016 as massive liquidity injections meet waning growth. That’s what stagflation is all about.

Gold & Silver Option Activity

There were three trades that stood out yesterday in the gold space. Two of the trades were on physical gold and silver ETFs and one option trade on a stock. Here’s a breakdown of the activity:

• SPDR Gold Trust (NYSEARCA: GLD)
  • 7,500 17 DEC 21 $190 calls bought @ $9.55
  • 7,500 17 DEC 21 $265 calls sold @ $1.51

• iShares Silver Trust (NYSEARCA: SLV)
  • 4,000 8 JAN 21 $26.50 calls BOT @ $0.15 to $0.16

• Kinross Gold Corporation (NYSE: KGC)
  • 11,000 18 DEC 20 $7.50 calls mostly BOT @ $0.04 to $0.06

The GLD trade was a long call vertical that is pricing in a move in GLD to $265 in the next year. The other trades are looking for more of an immediate move higher in the near-term. While I generally don’t like option activity with so little time to expiration like KGC, it does dovetail with the other activity with gold and silver.

Conclusion

The activity that happened yesterday in gold and silver is an early indication of a potential resumption in the bullish trend from earlier in the year. The catalyst is going to be an aggressive Fed, stimulus spending, and a lack of growth due to COVID-related policies. This potential confluence of events could provide a big spark heading into 2021, particularly for gold.