This article first appeared on
and in the March issue of
If a picture is worth a thousand words, this ought to be a short
article. Take in, if you please, Figure 1. It's a head-to-head
comparison of the bullishness embedded in gold (red line) and
S&P 500 (black line) options. The chart traces the skew in the
volatility assumptions of puts and calls for each market over the
past 18 months.
See the pricing bias? It's been growing more bullish for stocks
but more bearish for the yellow metal. That's a seminal change
ininvestment outlook, at least for gold. Remember, options are
priced on the basis of
volatility (the contracts analyzed here have three months 'til
expiry). Premiums reflect the fee demanded by sellers for
undertaking performance risk. Naked call writers, for example -- a
lot best described as neutral to modestly bearish -- will insist on
higher premiums whenever near-termprospects turn bullish, making it
more likely that they might actually have to deliver assets.
The shift in market tectonics is reflected in recent
exchange-traded product offerings. When gold was still headed
toward its $1,921 peak, FactorShares 2X: Gold Bull/S&P 500 Bear
) was launched (and profiled in "
How To Spread Out In The ETF Market.
FSG tracks the spread, or difference in daily returns, between
gold and U.S.equities through leveraged positions in futures --
long for gold and short for the Standard & Poor's 500 index.
FSG targets a 200 percent return on the spread. FSG delivered a
handsome 13.4 percent return by the end of its first year. At one
point, in fact, FSG had more than doubled its starting value. Chalk
that up, in large part, to the low correlation (0.02) between the
S&P 500 and Comex spot gold.
Things have now turned sour for theETF , though. As it heads
toward its second anniversary, FSG is down 36.6 percent on the
year. And that metal-equity correlation? It's climbed to 0.28 (see
The shift in gold's fortunes hasn't gone unnoticed by
exchange-traded product sponsors. Sure, short gold funds and notes
have been around for a while, but issuers are now offering more
Recently an exchange-traded note was launched that pairs a
nominal long exposure to SPDR Gold Shares (
) with monthly call option sales. The Credit Suisse Gold Shares
Covered Call ETN (
) carries a 0.65 percent annual investor fee and represents senior,
unsecured debt issued by the A-rated Swiss bank's Nassau branch.
The ETN tracks the performance of the Credit Suisse NASDAQ Gold
FLOWS (Formula-Linked OverWriteStrategy ) 103 Index. The "103" in
the index moniker stands for "103 percent," the strike price --
three percent over GLD's market price -- of the overwritten
Unlike most ETNs, GLDI offers investors a monthly, albeit
variable, cash flow from the nominal options sales and, to boot, a
modest reduction -- that three percent again -- in the risk
associated with a long GLD position. The tradeoff? A give-up of any
GLD gains beyond the monthly overwrite.
The covered call position emulated by GLDI affords investors a
reward-to-risk profile equivalent to that of short GLD puts,
meaning there's a limited profit to be made if gold rises or
remains flat and a substantial loss potential if bullion
More important perhaps is the complementary position undertaken
by Credit Suisse. By issuing GLDI notes, the bank's functionally
long GLD puts -- a decidedly bearish position, though one with
limited risk in the event of an upward spike in gold. That's
Credit Suisse is, in fact, banking (yeah, I know; a pun) on a
weak metal market. No stranger to gold's vagaries, Credit Suisse
has likely read the slowdown in long speculative momentum signaled
by Comex trader commitments. Figure 3 illustrates a dichotomy
between indexed gold prices and the momentum in net speculative
length. Notice that even as gold's value spiked in the summer of
2011, the force driving speculative long positions was waning. Even
now, as gold's eased, bullion is 19 percent higher than two years
ago. Speculative momentum, though, has slowed by ten percent.
Credit Suisse can hedge away any excess risk associated with its
virtual put ownership but that gamble is already self-limited and
further hedged by its cash receipts at the notes' issuance.
Conversely, GLDI holders are fully exposed (or nearly so) to a
decline in gold prices. There's an extraneous hazard, too, for GLDI
buyers -- credit risk. If Credit Suisse slips into bankruptcy,
holders of the ETNs could be wiped out.
The interests of Credit Suisse, to be sure, conflict with that
of GLDI investors. That's no secret. The bank's disclosure
documents explicitly warns buyers: "[T]he the economic interests of
the calculation agent, index sponsor, and other affiliates of ours
are potentially adverse to your interests as an investor in the
Gold's Run Over?
Still, investors and market watchers were surprised when Credit
Suisse published a bombshell report titled "Gold: The Beginning Of
The End Of An Era." The report released in February and authored by
analysts Tom Kendall and Ric Deverell, contends that gold's 2011
peak was a market top signaling the demise of a 12-year bull
Two arguments are laid out in the Credit Suisse report. The
first asserts that interest rates are normalizing after falling to
historically low levels last year. Investors, say the analysts, are
now less likely to seek safe haven in U.S. Treasury paper as the
economy, most particularly the American housing market, improves.
Further, aggressive moves from the European Central bank are easing
Continental fears about the euro.
Historically, gold's prospects brighten in a low-rate
environment, but now that real interest rates are turning up, the
curtain's coming down on the economic crisis, so there's less need
for hedges against collapse or outsized volatility.
Kendall and Deverell then argue that bullion's price has simply
gone too far north (much like the assertion made by Yoni Jacobs in
All That Glitters May Not Glitter For Long.
" "Against any sensible benchmark, gold still appears significantly
overvalued," the bankers declare. "It looks increasingly likely
that [its] 2011 high will prove to have been the peak for the gold
price in this cycle."
The yellow metal is far above its long-term average price, the
report's authors say. "In trend terms, gold has never been this
high for this long." Especially against other physical assets like
realestate , they contend that gold has gone to unprecedented
Inflation Won't Save Gold Bugs
Gold is often touted as an inflation hedge, but an increase in
the inflation rate may be slow in coming, according to Kendall and
Deverell. "It remains highly improbable that inflation will become
a major concern in the next year or two," they say. "The greater
risk is that gold will weaken substantially as economicdata improve
long before inflation expectations move significantly higher."
Neither, say the analysts, is it likely that inflationary
expectations will put a bid under gold's price. Statistically,
there's little evidence of a relationship between bullion's price
and year-ahead inflation expectations over the past 25 years.
And The Other Banks?
Credit Suisse isn't the only financial institution with qualms
about gold's trajectory. Publicly, big banks may still be bullish
on gold, but they're lowering their price targets for 2013.
In February, French bank BNP Paribas became the latest money
center institution to cut its forecast.Goldman Sachs led the way in
December by scaling back its 2013 prediction, after which analysts
atMorgan Stanley ,Citigroup , Deutsche Bank and HSBC slashed their
Still, no other bank has gone public with a forecast like the
Credit Suisse report. Notably, the Swiss bank's analysts don't
foresee a "collapse in the gold price," but rather a "slow slide."
Could that also mean a slow death for GLDI investors?
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