There’s a lot to unpack when it comes to the current analysis of gold and precious metals. As you know, gold tends to be a safe-haven type of investment – something investors turn to when they don’t want their money associated with a certain company or government (bond/currency).
After the Financial Crisis of 2008-2009, gold became an extremely popular investment. For a few years there, it seemed like there was a gold-buying shop on every street corner. Gold was bid up, at least in part, by a massive amount of buying by central banks who wanted to back up their currencies with physical assets.
For the last several years though, gold and other precious metals have been trading at less elevated levels. Then again, with the February 5th meltdown, is it possible metals will become more valuable to investors?
Below is the chart of SPDR Gold Shares ETF (NYSE: GLD), one of the most popular ETFs out there and a very common method for investing in gold. You can see gold did spike during the market meltdown in early February, but has since come back down and is hanging out around the 50-day moving average.
Typically after periods of high volatility, investors start moving more of their portfolio to gold or other precious metals. Yet, in this case, gold lost its luster almost immediately after the market stabilized. Hence, while gold was still a quick buy during the crisis, it hasn’t been holding its own as a safety net after the fact.
Part of the reason could be the lack of any real fundamental concerns among investors. Inflation and tariffs (to some extent) are problems, but they take a long time to actually manifest as true issues. On the other hand, it could be that investors are using cryptocurrencies such as bitcoin as a store of value. After all, bitcoin is entirely decentralized.
So what’s that mean for gold? It’s certainly difficult to pick a clear direction for the precious metal, but it may be not be a stretch to suggest gold is going to move quite a bit from where it is – either up or down.
At least one size options trader believes this could be the case by June expiration. The trader purchased the June GLD 126 straddle (buying both the 126 call and 126 put in June) for $5.30 with the stock just below $126. The trade was executed nearly 2,500 times, so about $1.3 million in premium was paid.
In order to make money, GLD has to be higher than roughly $131 or below $121 by mid-June. Above or below those strikes, the position will generate $250,000 per dollar higher or lower. If GLD is at $126 at expiration, the trader loses the entire premium.
Given the uncertain future of gold as a safe-haven, I think this trade makes a lot of sense. However, I’d prefer to cut down the cost of the trade by doing a strangle instead. The only difference is you’re buying out-of-the-money calls and puts instead of at-the-money options in order to cut costs.
For example, buying the June 123 put and 129 call (the 123-129 strangle) only costs about $3.00. So you’re cutting your premium by almost half. Breakeven points become $120 and $132, do it does widen the targets a bit. Still, I think it’s a reasonable trade off to widen out the breakeven points by a $1 in order to cut almost $2.50 off the premium price. Ultimately, it reduces risk more than it reduces return potential – and that’s clearly a good thing.
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Source: Investors Alley
That’s bad news for big, multinational U.S. automakers like Ford Motor Co. (NYSE: F).
An ETF owns shares of stock to match the components of a specific stock index. For example, the SPDR S&P 500 ETF (NYSE: SPY) owns the 500 stocks in the same proportion as tracked by the Standard & Poor’s 500 stock index. The financial products industry has gone nuts with the development of new indexes to carve up the market into sectors and ETFs to track them. Currently there are over 2,000 ETFs listed in the U.S. The majority —78% of assets—of ETFs are based on stock market indexes. Those assets total over $2.4 trillion. ETF trading has become a very big part of what goes on in the stock markets.
There are two ways ETF action can affect the share values of individual stocks. The most obvious and easy to discern is when the weighting of a stock in an index is changed. One high yield example is Energy Transfer Partners LP (NYSE: ETP), a large cap master limited partnership, commonly abbreviated as MLP. In April 2017 ETP completed a merger with Sunoco Logistics Partners LP, another MLP that was a large component of MLP indexes. Because of the merger, ETFs and index funds tracking MLP indexes were forced to sell significant portions of their ETP holdings to bring the size of the positions down to match the index weightings. This merger was the start of a year long decline in the ETP unit value. Later in 2017, Alerian, the provider of the most popular MLP tracking indexes, changed its methodology to cap Alerian MLP Index constituents to a 10% weight. At that time, ETP’s weight was much higher than 10% in the index, so index tracking funds were again forced to sell ETP units, regardless of investment merit. These forced sales of ETP are the source of much of the 25% value decline over the past year. The company’s fundamentals have been steadily improving, but you could not tell by the market price. ETP currently yields 12.5%.
A subtler effect of the ETF boom is that trading of these funds leads to lack of discrimination between the financial results and business prospects. Stocks get lumped together into the ETFs that track specific market sectors. It is tough to figure out whether stock share prices and ETF trading are a chicken and egg dilemma, but it is becoming clearer that increases in ETF trading are tightening correlations, or the tendency for individual stocks and sectors to move up or down in lock step, regardless of a company’s fundamentals. While ETFs account for about 8% of the U.S. stock market value, ETFs are the source of more than 25% of the trading volume. Market observation clearly shows that share prices are greatly affected by short term sector switching by traders. The iShares Mortgage Real Estate ETF (NYSE: REM) provides a couple of examples. Most of the 30 or so stocks in this ETF own leveraged portfolios of residential mortgage backed securities, MBS in industry parlance. This business model is a dangerous game of lending long and borrowing short. This is a group of companies whose finances can be destroyed by a quick change in the yield curve. I recommend against owning any residential MBS focused REITs.
In contrast, the third and fourth heavily weighted stocks in REM are solid companies with business operations that are sustainable through market cycles. In contrast to the rest of the REM portfolio stocks, these two will do even better when short term rates rise. Starwood Property Trust, Inc. (NYSE: STWD) and New Residential Investment Corp (NYSE: NRZ) are very attractive stocks with share prices that have trouble escaping from the trading in REM. STWD currently yields 9% and NRZ is over 11%.
An example of the first type of change is the 1.2 million barrel a day Capline pipeline that is owned by Marathon Pipe Line LLC, a unit of Marathon Petroleum (NYSE: MPC). In 1967, this pipeline began to ship imported oil northward from the Gulf Coast to Illinois and from there oil was dispensed to a number of Midwestern refineries.
Yet, despite all of this good news regarding the critical role pipelines play in the U.S. shale oil boom, the stocks of pipeline companies have been chronic underperformers. When U.S. oil prices collapsed from $100 a barrel in mid-2014 to a low of $26 a barrel in February 2016, the Alerian MLP index of pipeline companies (NYSE: AMLP) fell 60%. Oil has since more than doubled but the index has recovered only 27% as investors seem not to believe the recovery story.
The first MLP on my list is Energy Transfer Partners, with its wide geographic spread of pipelines. It should now begin reaping rewards from its major projects including Rover Pipeline, Bakken Pipeline and Permian Express 3. And its merger with Sunoco should lead to $200 million of cost savings by 2019. I also like its increasing cash distribution, which showed a year-over-year jump of over 40% in the recent quarter.
The second MLP on my list is Plains All American, whose shares have fallen by nearly a third in the last year, but are up about 5% so far in 2018. The uptick may be due to investors seeing that the company is modifying the way it manages inventory and is implementing provisions in the contracts it signs that should reduce chronic earnings volatility.
