Gold’s drop so far this week has been violent and is somewhat reminiscent of the significant decline we saw in metals prices in 2013. While this week’s drop is nowhere near as large from a percentage perspective, the fact we continue to make new six year lows on a daily basis is significant.

The news that triggered the sell-off was that the Peoples Bank of China announced over the weekend that China’s central bank physical gold buying over the last six years came in at 1,658 tons. This compares with 1,054 tons in 2009. This increase only represents a 58 percent jump in physical gold holdings for the world’s number one producer and number two consumer of the yellow metal.

At worst analysts were looking for China’s gold reserves to at least double in size as it was mandated by the Chinese government in prior years to increase their Gold stockpiles to keep the Yuan somewhat on par with the Euro and Greenback. While that may seem laughable to some, it was always assumed to be the case. However assumptions on what the Chinese seem probable to do with their currency, metals, or even grain acquisitions or endeavors have proven over time as predictable as the weather.

The timing of this release of Gold holdings by the Chinese is most curious to me as Gold had posted new lows last Thursday that had not been seen in five years. If the Chinese would like to increase their Gold holdings in the coming months and years it would only make sense for them to instigate more pressure on physical prices by finally releasing their meager holdings.

When markets opened up Sunday night, large sell orders hit the market and had global Gold prices dropping over $50.00 to the 10.80 level for a short time before prices retraced to just over 1100.0 an ounce on Monday’s close. Technical damage continues on the charts with any rallies looking like selling opportunities. 2015 support levels for Gold come in first at 1111.9 and then 1019.2.   

The talking heads on TV along with major analysts at global central banks are calling for a return to the 1,000.00 level for Gold. They may be eventually correct but when market sentiment is heavily skewed to one side for prices, a move in the opposite direction could be around the corner. Keeping this in mind and to remain agnostic I would suggest a strangle in Gold, using ratio option spreads to take advantage of future price movement.

I therefore propose to buy one September 1050 put and sell 2 September 10.00 puts for a purchase price of $1.80 or in cash value $180.00 plus all commissions and fees. For upside exposure I propose buying the September Gold 1160 call and selling 2 Sep 1200 calls for 2.00 or $200.00 in cash value plus all commissions and fees. The risks on the trade are the prices paid for the options and all commissions and fees. Because the strategy calls for selling an extra put below 1000 and selling an extra call at 1200.0, one would have exposure if the underlying futures price settled above or below these levels at option expiration in late September.

For those interested in grains, Walsh Trading’s Senior Grain analyst Tim Hannagan hosts a free grain webinar each Thursday at 3:00 pm central time. Tim has been ranked the #1 grain analyst in the United States per Reuters and Bloomberg for his most accurate price predictions for soybeans and corn in the years 2011 and 2012. Link for next week’s webinar is below. If you cannot attend live, a recording will be sent to your email upon signup.

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RISK DISCLOSURE: THERE IS A SUBSTANTIAL RISK OF LOSS IN FUTURES AND OPTIONS TRADING.  THIS REPORT IS A SOLICITATION FOR ENTERING A DERIVATIVES TRANSACTION AND ALL TRANSACTIONS INCLUDE A SUBSTANTIAL RISK OF LOSS. THE USE OF A STOP-LOSS ORDER MAY NOT NECESSARILY LIMIT YOUR LOSS TO THE INTENDED AMOUNT.  WHILE CURRENT EVENTS, MARKET ANNOUNCEMENTS AND SEASONAL FACTORS ARE TYPICALLY BUILT INTO FUTURES PRICES, A MOVEMENT IN THE CASH MARKET WOULD NOT NECESSARILY MOVE IN TANDEM WITH THE RELATED FUTURES AND OPTIONS CONTRACTS.