The "Asymmetric Trade" in Gold

Dear Reader,

Gold opened last week at $1,270 per ounce and finished the week at $1,276, about where it is now.

There were some spills and thrills along the way. Gold rallied to $1,287 per ounce last Thursday before hitting one of those “paper gold” air pockets we’re all too familiar with and falling $10.00 per ounce within minutes last Friday.

Still, in all, not much change.

The reason for this is that the market is waiting for Godot, or more precisely the Fed FOMC meeting on Dec. 13.

Starting last Sept. 20, immediately after the Fed’s “pause” on rate hikes, the market began to price in a Fed rate hike for December. Asset classes adjusted in line with those expectations.

Treasuries, gold, euros and yen all fell. Bond yields and the dollar both rose. Tight money was on the way.

The problem is that the markets have now priced in a 100% chance of a Fed rate hike in December. You can’t get any more sure of yourself than that. This means that Treasuries, euros, gold and yen have all found a bottom.

They’re just waiting for confirmation from the Fed in a few weeks. As I said, markets are waiting for Godot.

This sets up one of my favorite trading situations. I call it the “asymmetric trade.”

When something is fully priced, the happening of the event does not move prices. But if the event does not happen, prices move violently to reprice for the unexpected outcome.

This means you have a “Heads I win, tails I don’t lose” situation.

If you take a long position in gold today and the Fed raises rates, nothing happens to the price because the rate hike is already priced in.

If the Fed does not raise rates, gold will spike suddenly and dramatically. The spike could then catch the shorts off guard and lead to short covering that will drive the price even higher.

Heads I win, tails I don’t lose.

Of course, there’s no sense doing this trade if the rate hike really is as certain as markets suggest. Even when a trade is set up asymmetrically around a key event, there’s always the possibility of an exogenous event that could skew the result and cause unexpected gains or losses.

But a rate hike is not nearly a certainty.

In fact, there’s a high probability the Fed will not hike rates. That’s why I like the downside protection of the market consensus leaning the other way.

Why would I fade the consensus?

Because the market is looking in the wrong places for clues to Fed policy. Jobs reports are irrelevant; that was “mission accomplished” for the Fed years ago. The key data are disinflation numbers. That’s what has the Fed concerned, and that’s why the Fed might pause again in December as it did last September.

This week we got PPI and CPI inflation information. While important, they’re not the Fed’s preferred metric. The Fed focuses on PCE core inflation measured on a year-over year basis. That comes out Nov. 30.

Here’s the way to play it…

Buy gold today and then wait to see what the PCE core number is on Nov. 30. If it’s hot (1.6% or higher), the Fed will hike rates. You should be able to unwind the gold trade if you like with little or no harm done.

If it’s weak (1.3% or lower), which I expect, the market will start to reprice for a “pause” and gold will be off to the races.

Of course, I’m not a day trader; I like gold and gold miners for the long run. But sometimes these asymmetric trades are just too good to ignore.

Below, I show you some of the catalysts pushing gold higher, plus one of the most bullish charts I’ve ever seen for gold. Read on.


Jim Rickards
for The Daily Reckoning

The Daily Reckoning