As we all know, two things affect the price of all things tangible and intangible – supply and demand.

On the supply side, Gold stays remarkably fixed. It is mined at a very consistent rate year round with factors such as weather and temperature having much less influence than other markets such as soft commodities. In addition to this, supply can only vary rather gradually from a mining standpoint, given that it takes around a decade to bring a new find into production. However, any seasonality in the gold price must be attributed to variations in supply and demand during different times of the year, since supply could also be increased by non-mining entities, such as investors selling their holdings.

Below is the average monthly trend in gold prices since 1969. To find this, we simply add the returns for each month in every year since 1969 and divide them by the number of observed years – 43.

To construct this graph we create an index for gold prices. Day one of each year is set as the base of 1.00. Each successive day is compared to the previous; if day 2 is higher than day 1, the index rises by the percentage increase over the two days, and vice versa.

At the time of writing in our December update, gold had bottomed from its biggest correction since September. Since then the precious metal has regained some ground, especially in the last few days on the back of the latest Federal Open Market Committee (FOMC) announcement.

After gold prices became heavily oversold in December we saw a buying opportunity and opened this position on the 12th December 2011. We signalled to our subscribers to “...sell GLD Feb 18 '12 $155/$150 vertical put spreads at $2.15 with 10% of our capital allocated to this trade”.

As gold prices recovered the profits on this position grew, so on 27th January 2012 our subscribers received this, “We hereby signal to close our short GLD Feb 18 '12 $155/$150 vertical put spread positions at $0.11”, meaning that we had banked a 71.58% gain in just 46 days.

That means that if you had invested $1000 in this trade, you would have paid for a 6 month subscription more than 3 times over!

Currently the SK OptionTrader model portfolio is up 446.55%, which means a $10000 portfolio invested in accordance with SK OptionTrader signals would now be worth $54,655.11. On average our positions gain 36.68% in 50.48 days, which provides an annualized return of 98.38%. If you would like to see a full record of our previous trades, feel free to check out our trading record. With exciting new opportunities like this arising, now is the perfect time to open a subscription with SK OptionTrader and begin increasing the profitability of your options trading portfolio.

For those subscribers who are too busy to trade their own accounts we are now able to offer an autotrading program with our SK OptionTrader service, as we are pleased to announce that we have entered into a partnership with Global AutoTrading and eOption, therefore auto trading is now available for SK OptionTrader signals.

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Following the publication of our recent research into the behaviour of gold both intraday and overnight, Benzinga Radio very kindly gave us the opportunity to discuss this phenomena via an exclusive interview with Sam Kirtley, which we hope that you find both interesting and informative.

Sam Kirtley first presented the short intraday / long overnight gold trade that has yielded astounding returns since 2001 in two articles: one posted in August 2010 and the other earlier this month . We spoke with him to get further insight on the trade and the new fund that SK Options Trading has in the works. 

In 2010 you first presented the idea of an overnight gold fund, citing your calculations that a $100 million hedge fund, starting in 2001 and going long gold on the PM to AM fix and short on the AM to PM fix, would be worth 2.6 billion dollars today. Talk to us about how you discovered this trade and what you have found out.

We have previously covered yield curve dynamics, for a refresher the following excerpt should aid in comprehension of this article.

“For those readers who may be unfamiliar with how the yield curve works, we will provide a brief explanation. Bonds of different maturities have different yields. By plotting these yields against their maturities we can build a yield curve. The yield curve becomes steeper if longer term interest rates increase relative to shorter term interest rates. The yield curve becomes flatter if longer term interest rates decrease relative to shorter term interest rates. One way to measure the steepness of the yield curve is to look at the difference between the yields at two different points on the curve. For example one may look at the difference between the yields on 2 year Treasuries compared to the yield on 5 year Treasuries. Such a comparison will often be referred to as “2s5s” and is measured in basis points (bps) by subtracting the shorter term yield from the longer term yield. So if one says “2s5s are trading at +225” this means that the yield on 5 year bonds is 2.25% higher than the yield on 2 year bonds. If 2s5s go from +225 to +275 then the yield curve has steepened between those two maturities. If 2s5s go from +225 to +175 then the yield curve has flattened between those two maturities.”

Intuitively, one would expect a flattening yield curve to be bullish for gold. Flatter yield curve = economic weakness = safe haven assets (gold) becoming more valuable, especially if such weakening in the economy is followed by monetary easing, or increased expectations of monetary easing. As with any hypothesis, this one is useless without being tested.

In August 2010 we wrote an article entitled “Proposing An Overnight Gold Fund” in which we explored the potential for launching a fund that held long positions in gold overnight and was short gold during the day. We pointed out that “a hedge fund starting in 2001 with $100m, with the strategy of being long gold from the PM to AM fix, and short gold from the AM to PM fix...would be worth $2.16billion today, before any fees and expenses.” We have been monitoring this trading strategy since then and therefore would like to take this opportunity to update readers on its astonishing progress.

Firstly we will introduce the thinking that led us to investigate this trading strategy. There is much debate within the precious metals industry regarding the alleged suppression, or at least manipulation to an extent, by either central banks or the proprietary trading divisions of large banks, or a combination of the two.

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Long GLD/Short TIP

The first of these pair trades is one based on convergence. Historically US real interest rates have an inverse relationship with gold prices, a relationship which we have written about frequently. The basic premise is that when monetary policy becomes more accommodative, US real interest rates decline and gold prices rise due to the ease in monetary policy. However over recent weeks gold prices have fallen but US real interest rates have remained low and this pair trade is speculating that the two will converge again.

To execute the trade we would use the gold exchange trade fund GLD and the iShares Barclays TIPS Bond Fund, although futures can be used as well. GLD tracks the price of gold and TIP tracks the price of Treasury Inflation Protected Securities. Since gold prices move inversely with real interest rates, it moves with the price of inflation protected bonds, since yield and price move in opposite directions in the bond market. This relationship is demonstrated in the chart below.

The type of trade this affects the most is vertical spreads, where we received a net credit for placing the trade.

We will use the first trade of this type to demonstrate the differences in the methodology.

In this trade we sold a vertical put spread on GLD. We bought GLD Sep-10 $110 puts for $0.68 and sold GLD Sep-10 $111 puts for $0.80, gaining a net credit of $0.12. The spread expired worthless and we banked maximum profits on this trade.

We will begin with a brief introduction for those less familiar with the instruments discussed in this article. A Credit Default Swap (CDS) is a swap designed to transfer the credit exposure of fixed income products between parties. CDS are similar to traditional insurance policies as it obliges the seller of the CDS to compensate the buyer in the event of a loan default. The difference lies in the fact that anyone can purchase a CDS, even if the buyer has no direct insurable interest in the loan. The buyer of the CDS makes payments to the seller and in exchange if the loan defaults the buyer receives a payout.

CDS are increasingly on the radar for all market participants. Whereas just a few years ago they were