Trading Gold Futures Amid Global Trade TensionsCOMEX: Micro Gold Futures ( COMEX_MINI:MGC1! ) #Microfutures
The United States will be implementing new tariffs on Saturday, February 1st, including 25% tariffs on Mexico and Canada as well as a 10% duty on all goods from China. These countries are the Top 3 U.S. trading partners, contributing to 40% of all goods and services imported into the US in 2023, collectively.
On Friday, gold prices surpassed the key $2,800 mark for the first time ever. Spot gold rose 0.6% to $2,810.55 per troy ounce, after hitting a record high of $2,817.23. The record rally is fueled by a flight to safety as trade tensions rise.
Gold futures are trading at a premium to spot gold prices. The lead April contract of the benchmark COMEX gold futures settled at $2,833 on Friday.
Looking back, the trade tensions between the US and China have intensified since 2018. This time, higher tariffs will be applied globally, not only to competitors of U.S. interests, but also to close allies such as Canada, Mexico and the European Union.
Lessons from the US-China Trade Conflict
How would the global trade conflicts shape up? Uncertainties remain elevated. Luckily, the US-China trade conflict provides us historical lessons with present-day relevancy.
Let’s have a quick review of the major timeline of key events:
• July 6, 2018: The trade conflict begins as the US imposes 25% tariffs on $34 billion worth of Chinese goods. China retaliates with tariffs on an equal amount of US goods.
• August 23, 2018: The US imposes additional 25% tariffs on another $16 billion worth of Chinese goods. China responds with tariffs on $16 billion worth of US goods.
• September 24, 2018: The US imposes 10% tariffs on $200 billion worth of Chinese imports. China retaliates with tariffs on $60 billion worth of US goods.
• December 1, 2018: A temporary truce is agreed upon during the G20 summit, with a 90-day period for negotiations.
• January 15, 2020: The "Phase One" trade deal is signed, easing some tariffs and committing China to increase purchases of US goods.
Gold prices responded quickly at each stage of the trade conflict, creating ample trading opportunities. On June 7, 2022, I published “Event-Driven Strategy Focusing on Global Crisis” on TradingView, based on my own trading experience from 2018-19. A link to this write-up is provided here for your information:
In summary, I observed patterns in gold prices while the trade conflict was progressing, and designed event-driven strategy based on Game Theory. Here are the highlights:
• US initiated new tariffs; Gold prices went up (“Risk On”)
• China retaliated with new tariffs; Gold prices went up further ("Risk On”)
• US and China announced trade negotiations; Gold prices went down (“Risk Off”)
• Negotiations broke down followed by new tariffs; Gold prices went up (“Risk On”)
• Negotiations resumed; Gold prices went down (“Risk Off”)
• Trade agreement was reached; Gold prices went down sharply (“Risk Off”)
The “Fight-and-Talk” could go multiple rounds, pushing tariffs to higher levels. Just how high?
China previously maintained a 12% import tariff on U.S. pork products. In its first round of trade retaliation in 2018, China imposed an additional 25% tariff on US pork. A month later, another 25% was added. Pork tariff went up a further 10% in the third round of retaliation, making the total tariff on US pork at a mind-boggling 72%!
As shown in the chart, gold responded in an observable manner following each key event. This repetitive pattern made it possible to set up trades in anticipation of the next moves.
The Sequence of Next Moves in Trade Conflicts
Learning from the previous experience, we could simulate a series of scenarios when new tariffs are imposed on goods from Canada, Mexico, China and the EU.
• US initiates new tariffs; Gold prices go up (“Risk On”)
• The other country retaliates with new tariffs; Gold prices go up further ("Risk On”)
• The two countries announced trade negotiations; Gold prices go down (“Risk Off”)
• Trade agreement is reached; Gold prices go down sharply (“Risk Off”)
In my opinion, the countries involved would retaliate but may want to avoid a costly trade conflict dragging on. With the brutality of the last trade conflict still fresh in mind, trade deals could be reached more quickly. From a trading perspective, the Fight-and-Talk patterns could be repeated multiple times, making our event-driven strategy reusable.
Given that Canada, Mexico, China and the EU are the biggest U.S. trading partners, the price swing in gold could be more volatile. Conflicts with smaller trading partners, such as Taiwan and the Southeastern Asian countries, may not trigger big moves in gold.
The CFTC Commitments of Traders report shows that on January 28th, total Open Interest (OI) for Gold Futures is 577,505, up 15% from the level last November when the U.S. election was held. Interest in using gold for trading or hedging goes up with the escalation of risk.
“Swap Dealers” own 363,051 contracts, making them the largest trader category to own gold futures positions.
• Swap Dealers have 29,725 in Long, 272,549 in Short, and 60,777 in Spreading
• The long-short ratio of 1:9 indicates that “Smart Money” is overwhelmingly bearish
There is another supporting factor for a bearish view:
A key driver in gold prices is the geopolitical crisis. President Trump announced that he planned to meet with President Xi of China within the first 100 days in office. A meeting between President Trump and Russian President Putin is also being planned.
As we know, bullion is a preferred asset during times of turmoil. We may soon see the geopolitical risks unwinding, which will send gold prices sharply down. This could happen when Russia and Ukraine end their military conflict with a peace treaty.
Trade Setup with Micro Gold Futures
If a trader shares a similar view, he could express his opinion by shorting the COMEX Micro Gold Futures ( AMEX:MGC ).
MGC contracts have a notional value of 10 troy ounces. With Friday settlement price of 2,833, each April contract (MGCJ5) has a notional value of $28,330. Buying or selling one contract requires an initial margin of $1,150.
The MGC contracts are very liquid. On Thursday, MGC has a daily trade volume of 126,712 contracts and an Open Interest of 30,633.
Hypothetically, a trader shorts April MGC contract and gold prices pull back 5% to 2,691. A short futures position would gain $1,420 (=142 x $10). Using the initial margin as cost base, a theoretical return would be +123% (= 1420 / 1150). The risk of shorting gold futures is rising gold prices. Investors could lose part of or all their initial margin.
Traders could express the same view with the standard COMEX Gold (GC) futures or the newly launched 1-ounce gold futures, which represent just 1/10 the size of a Micro Gold (MGC) futures contract and 1/100 of GC futures contract.
To learn more about all the Micro futures and options contracts traded on CME Group platform, you can check out the following site:
www.cmegroup.com
The Leap trading competition, sponsored by CME Group, will begin at TradingView on February 3rd. I encourage you to join The Leap and compete to be the best in CME Group futures trading and win a share of $25,000 in cash prizes or an additional six months to your TradingView subscription.
www.tradingview.com
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
