14.02.202010:06 Forex Analysis & Reviews: Gold: a break for correction?

Gold, which caused a lot of noise in 2019, reached a maximum of $ 1,610 per troy ounce at the beginning of 2020, but then stopped in its upward movement. There were several reasons for the slowdown in the growth of the precious metal, including the growth of the dollar, the signing of the first phase of the trade deal between the United States and China, the seasonal factor for the celebration of the New Year on the lunar calendar. However, the main reason for the slowdown in price growth was the loss of interest of traders in the futures market for investments in precious metals, as indicated by the COT (Commitment of Traders) Report on obligations of traders.

In just the past two weeks, Open Interest which is an indicator of the activity of traders, their desire to buy declined by almost 18 percent - from historical maximums of 1 million 190 thousand contacts to 1 million 003 thousand. When money leaves the market, what growth is there? In addition to the fact that money flowed out of the futures market, the main buyers of gold, the so-called Money Manager, took profits and closed their purchases. In just four weeks of January, their long positions decreased from 290 to 252 thousand contracts, and short positions increased from 28 to 40 thousand contracts. Thus, some large speculators, earning from fluctuations in quotes, decided to try their luck from lowering the price of gold, began to sell futures and buy options for falling prices.

At the same time, the operators of the so-called Producer, who insured exchange rate risks, also left the gold market, and this is a symptom in which a price increase becomes unlikely. Swap dealers, surrounding the risks of falling value of their collateral, also left. Meanwhile, traders of the Non-Reportable and Other Reportable groups decided to keep up with their exchange comrades and cheerfully pull an asset that suddenly became insignificant.

Actually, the logic here is simple - for the price to increase, someone must buy an asset, and someone must sell it. The more willing to buy, the more willing to sell, and then a trend forms in the market. If there are no buyers or their number is decreasing, the price cannot rise a priori, it can only decrease or, at best, be in the range. The whole question is the speed of asset decline, which is proportional to the outflow of capital from the market - the more money leaves, the faster the price decreases. However, the main thing is that sellers' profit does not come to the markets and among which, there will be a lot of speculators who want to make money on the decline. If this happens, then the price may simply collapse, as it was last year, for example, with coffee, but for now this is not our case.

The second interesting point is that when the trend falls asleep on the market, option sellers wake up. This is considered their time. Option sellers are a special caste. It is believed that the seller of the option receives limited profit, but at the same time may receive unlimited losses. Therefore, options are sold mainly by large players who can afford it. Possessing significant resources, option sellers defend their positions in an effort to keep the futures price at the point of maximum loss for buyers or to prevent price escalation for particularly large option barriers so as not to lose the premium received for the option. Most often, option sellers succeed and sometimes not, but the determining factor here is the strength of the trend, which is reflected in the Open Interest indicators, which are known to us from the Trader Obligations Reports - COT. Generally, According to statistics, option sellers receive money in 78% of cases, respectively, buyers lose money. That is why the option bar chart is of such interest to us.

As we know, from the latest reports - COT - money leaves the gold market, which means that option sellers at least have the opportunity to hold option barriers and not release the price for them. As a maximum, option sellers, by the time the option contract expires, will send the price to the zone of maximum pain for buyers, called the MP point - Max Pain. In this context, we will consider the distribution of Open Interest by option strikes - the most liquid OGHO option contract in March at the current time (Fig. 1).

Figure 1: OGH0 Option Contract Open Interest

In the diagram below, you can see four main option barriers, consisting of Put options and Call options. The point of maximum pain for Max Pain buyers is located at the level of 1535. Closing of this option contract, for April GCJ0 gold futures, will occur on February 25.

As you already know from the first part of this article, money leaves the gold market, and it is highly likely that the Gold price will not exceed the level of 1650 by March 25 and will most likely not exceed the level of 1600 dollars per troy ounce. I assume with certainty that it will be so, but the market can always shame any sage, which is why traders put stop orders in case of an unfavorable situation. Gold is a trending product and it may never return to the point where you wanted to record a loss, but decided not to.

Now, the ratio of Put and Call options is 0.77, which means that most traders expect a price increase, but in the current conditions of capital outflow from the gold market this is unlikely. However, barriers from Put options located at 1550 and 1500 will keep gold from a deeper decline, and if the reliability of the level of $ 1,550 per troy ounce personally raises questions for me, then the level of 1500 is very likely to survive until February 25.

Thus, we got a fundamental picture of the expected dynamics of gold for the next two weeks, where the main scenario that we can take for execution is a decrease in the price of gold with targets of $ 1,550, $ 1,535 and $ 1,500 and the upper limit, for which gold sellers need to fix losses, at $ 1,600.

However, before you rush to sell gold, I would especially like to emphasize the need to follow the signals of the trading system of the trader and reduce the size of the opened lot. Selling gold is a risky operation against the strongest fundamental trend in the expectation of a slight correction, so the most conservative strategy is to buy from an advantageous position with goals located above the level of 1600. Always be careful and follow the rules of money management.