Two events near the end of the year have been bullish the dollar. The election of Donald Trump and the Republican plan for taxes has been bullish. The decision by the FOMC to raise rates, and more importantly the announcement for more rate hikes than had been expected added to the dollar rally. Interest rate differentials between the US, Europe and Japan have widened markedly. The greenback has hit its highest level since 2003. A stronger dollar usually is bearish for raw material prices. Our Futures expert, Pete Mulmat, joins the guys to explain how this impacts two very liquid Futures contracts, Gold (/GC) and Crude Oil (/CL) and also offers a trade idea or two for your consideration.
The US dollar is the reserve currency of the world. It is the benchmark for the pricing of most commodities. Gold and Crude Oil are no exception. As an example, OPEC price targets are always stated in dollars and Crude is always traded at its dollar value. Both Gold and Crude have an inverse correlation to the dollar. As the dollar gets stronger they tend to get weaker. Crude started out weak and hit its lows early in the year. It then grew stronger. Gold also rallied during the year. Gold though hit its highs in early July with Futures rising to $1387 per ounce. It has since given back some of its gains. Crude is near the yearly high. Rumors of an OPEC cut and then confirmation of an agreement on November 30, 2016 by OPEC and non OPEC nations to cut production strengthened Crude prices.
Gold and Crude have a 1 year correlation of 0.42 but the 1, 3 and 6 month correlations are all close to zero. That makes for an interesting Pairs Trade. Pete displayed a chart showing that the ratio of the price of Gold to the price of Crude is at a low extreme. He then adjusted the notional value of each Futures contract by its 30 day Implied Volatility (IV). The notional values were very close leading to a 1:1 Pair Trade. Pete laid out his trade idea of long 1 February Gold (/GCG7) and short 1 February Crude (/CLG7) on a table. The total margin for the trade was $10,120 (although there are smaller sized contracts). Pete also included a trade using options to take advantage of Theta (time decay) but Tom thought IV was a little too low for it to make sense.
Watch this segment of Closing the Gap - Futures Edition with Tom Sosnoff, Tony Battista and our Futures expert Pete Mulmat for an interesting discussion on what is influencing the Gold and Crude Oil markets and two possible trade ideas for you to think about.
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