Are Silver & Copper Prices Predicting a Global Recession?

Chris Vermeulen & JW Jones –

Silver and copper have recently been going through their own private bear markets. Since the open on September 1st, silver futures have sold off by more than 25%. During the same time frame, copper futures sold off by around 24%. Both metals are extremely oversold, but lower prices are still possible.

Are the bear markets in copper and silver an attempt to warn market participants that slower economic condition are ahead? Are equities going to take a huge hit on slower future growth?

The notion that lower copper prices will precede a stock market selloff is generally an unfounded allegation. Recently Jason Goepfert of produced the follow table illustrating the returns of the S&P 500 immediately following a bear market in copper over the past 25 years:

The chart above is additional proof that a massive selloff in copper does not necessarily have a major impact on the returns for the S&P 500. However, I would remind readers that volatility in commodities generally precedes volatility in equities.

Precious metals may be getting close to a possible intermediate term bottom. Silver and copper futures are extremely oversold based on a variety of indicators. However, the key to future price action likely will revolve around the price action in the U.S. Dollar Index.

The U.S. Dollar Index has been ripping higher throughout most of September. The rally in the Dollar is placing pressure on risk assets such as equities, precious metals, and oil. The daily chart of the U.S. Dollar Index is shown below:

So far the U.S. Dollar Index has been held back by the $79 price level which has been acting as resistance, but if prices can breakout above recent highs it would not be shocking to see the U.S. Dollar Index test the 80 – 82 price range in the near future. A breakout would likely put additional pressure on silver and copper prices. The two charts below illustrate the recent correlation between silver and copper prices and price action in the U.S. Dollar Index:

Silver : Dollar Correlation

Copper : Dollar Correlation

Additionally the S&P 500 could break below the August lows and oil could follow suit if the Dollar continues to work higher above recent resistance. If October turns out to be an ugly month for risk assets as pundits have predicted, then the U.S. Dollar will likely perform relatively well in the intermediate future.

Clearly there is political risk coming from Europe which could alter price action in risk assets in a variety of ways. Financial markets are volatile across the board and large intraday price swings are becoming common place.

In many cases the headlines will have more impact than the fundamentals or the technicals in this type of trading environment. However, the longer term support and resistance levels should hold sway even during times of exacerbated volatility. The weekly charts of silver and copper futures are shown below:

Silver Weekly Chart

Copper Weekly Chart

Clearly the price action in silver and copper in late August and throughout September has been ugly. Both metals are oversold in nearly every time frame, however if the Dollar continues to strengthen we could see deeper declines in both silver and copper prices as illustrated in the charts above.

Currently fundamentals and technical analysis cannot be relied upon solely when making trading decisions. However, the longer term support and resistance levels derived from the charts above give informed traders areas that offer solid risk / reward exits for profit taking and entries for those looking to get long silver and copper.

Trading Conclusion:

The data provided above regarding equity returns after a bear market in copper are sufficient enough to state that lower copper prices do not necessarily project lower domestic equity prices in the United States. With that said, the correlation between the price of copper and the IShares FTSE China 25 Index Fund (FXI) is irrefutable. Lower prices recently in copper are directly correlated in the price action of the FXI China Index fund as shown below:

FXI China Index Fund : Copper

The recent price action in the FXI China Index fund is ugly to say the least. As shown above, if the U.S. Dollar continues to strengthen copper, silver, and the FXI will likely continue to trade lower. Clearly the recent price action in Chinese markets is concerning for domestic equity investors, but an economic statement released earlier today is an ominous signal in the immediate future for U.S. equity investors.

On Friday the ECRI (Economic Cycle Research Institute) came out with a statement that the U.S. economy is headed for a new recession that the U.S. federal government cannot prevent. Data is starting to show signs that a new recession is not only possible, but quite likely in the near future. One of the key underlying assets to monitor for future clues about price action in risk assets is the U.S. Dollar. In coming weeks and months, I will be monitoring the U.S. Dollar closely. I think it would be wise if you did as well. Headline risk is increasingly high!

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This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

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Learning How Delta Creates Profits When Trading Gold

Last week’s articles focused specifically on the option Greek Theta. This week we will shift gears and adjust our focus on Delta, another fundamental tenet of option trading. The official definition of Delta as provided by Wikipedia is as follows:

?, Delta – Measures the rate of change of option value with respect to changes in the underlying asset’s price.

Delta has a significant impact on the price of an option contract(s). When a trader is long a call contract, Delta will always be positive. Likewise, if an option trader owns a put contract long, Delta will always be negative. As option contracts get closer to the money their Delta increases causing the option contract to rise in value rapidly as the option gets closer to being in the money.

Clearly Theta has an adverse impact on a trader who is long a single options position (own options long with no hedge or spread), however Delta is extremely dynamic and is one of the major factors directly responsible for option pricing as the price of the underlying changes throughout the trading day.

If an option is deep in the money, the option contract will have a higher Delta and will generally act similarly to actually owning the individual stock. For a deep in-the-money GLD call that has a Delta of +.80, the first dollar GLD rises by then the value of the GLD call options increases by roughly $0.80 or $80.

If the delta is 0.80, this essentially means that the GLD call option will increase in value 0.80 ($80) for every $1 that the GLD ETF increases. As the GLD option goes deeper into the money, the Delta will typically rise until it nearly produces the same gains as the GLD ETF until the delta asymptotically approaches 1.00 and the option moves in lockstep with the underlying. While my next article will continue to help explain Delta, it is important to understand how Delta can enhance a trader’s return when trading options with a specific directional bias.

While options exist for the gold futures contract, typically if I want to trade gold I utilize the GLD ETF. The primary reason is that the ETF offers liquid options, which makes it easier to initiate spreads and multi-legged orders. If options are thinly traded, the bid ask spread is almost always wide making it more difficult to get a good fill and a good overall price. Most option traders stay away from underlying stocks that have illiquid options.

In order to better illustrate how an options’ Delta can create profits, I will use GLD as an example. Keep in mind, I am not advising any traders to buy or sell options naked. I only trade options using strategies that help mitigate various risks to my capital. Theta (time) risk, volatility risk, and market risk are not being considered as this is merely an example to illustrate the power of Delta.

Recently Gold and subsequently GLD suffered a pretty significant pullback. GLD broke down through a major horizontal trend line and the daily chart was extremely bearish. Just when a lot of traders were preparing to get short GLD, buyers stepped in and pushed GLD’s price back above the support area. The GLD daily chart listed below illustrates the breakdown and subsequent failure and a powerful rally followed.

Let us assume for contrast that an option trader and an equity trader each want to get long GLD. The equity trader buys 200 shares of GLD at $115/share. Assuming the equity trader does not use margin, the total trade would cost around $23,000 not including commissions. The option trader decides to utilize delta and purchases 5 October 107 calls which in our example cost $900 per contract for a grand total of $4,500 not including commissions.

We will assume the October 107 calls have a Delta of 1.00. When a call option has a delta of 1.00, it essentially means that the owner of the call is going to get 100% of the move reflected in the premium of the option he/she owns. Thus if GLD increases by $1, the value of the option would increase $1 all things being held constant.

This is where Delta really shines; it shines even brighter than gold in this illustration. Both the equity trader and the option trader have a profit target of $118/share. A few days later GLD reaches $118/share and both traders close their trades with profits. The equity trader made $3/share which relates to a total gain of $600, or around 2.60%.

The option trader realized roughly 95% of the move, meaning around $2.85. The option trader had five total contracts for a total gain of $1,425 less commissions. The total gain for the options trader was over 31% less commissions.

Keep in mind, the option trader only had $4,500 of maximum risk while the equity trader was risking over $20,000. The option trader made over 100% more money, while risking only 25% of the total capital required by the equity trader. Behold, the power of Delta!

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J.W. Jones is an independent options trader using multiple forms of analysis to guide his option trading strategies. Jones has an extensive background in portfolio analysis and analytics as well as risk analysis. J.W. strives to reach traders that are missing opportunities trading options and commits to writing content which is not only educational, but entertaining as well. Regular readers will develop the knowledge and skills to trade options competently over time. Jones focuses on writing spreads in situations where risk is clearly defined and high potential returns can be realized.