Note that investors should judge political decisionsbased on constraints, rather than on preferences. Constraintsalways determine the action.[7]
Figure 1. Global Grain Trade
The current geopolitical conflict in Ukraine spells bad news not just
for Ukrainians but for the outlook for investors, too. Over the
weekend, the US and western allies said:[3]
They
will place sanctions on Russia’s central bank and remove some of the
country’s lenders from the Swift global financial messaging system, in
their harshest response yet to the invasion of Ukraine.
Sanctioning
the Central Bank of Russia could prove devastating — the true "nuclear"
option in the West's financial arsenal.
Russia currently holds about $640 billion in reserves. About 32% held in euros, 22% in gold, 16% in dollars, and 13% in Yuan.
As Elina Ribakova, deputy chief economist for the Institute of
International Finance, said:
Sanctioning
Russia’s central bank is likely to have a dramatic effect on the
Russian economy and its banking system, similar to what we saw in 1991 (see Fig. 1).
As James Mackintosh warned that "investors should pay close attention to the long-run shifts that Russia’s move will intensify, because they probably mean more inflation and slower growth. They come in three parts:[1]
More military spending expected
Which means less spending on other parts of the economy
Less globalization expected
It meanshigher energy prices and domestic sourcing, which could hurt profit margins
Geopolitics is scary again
More countries may want to secure nuclear weapons as a nuclear deterrence
Geopolitical tension also has a tendency to spread
Figure 3. Oil and Natural Gas Trades in Asia (Source: @Albert Park)
Impact of the Russia-Ukraine War on Asia’s Economies
The Russia-Ukraine war will increase food prices:
Russia and Ukraine supply 22% and 18% of global wheat and barley exports, Ukraine supplies 15% and 12% of global rapeseed and corn exports, and Russia supplies 12% of global fertilizer exports.
In addition,
Russia and Ukraine together produce 1/3 of palladium and the vast bulk of the neon used in semiconductor production
The latest sanctions will also affect trade in metals likealuminum, nickelwhere Russia is a major producer
The impact of the Russia-Ukraine war on Asia’s overall trade is expected to be limited, as Russia and Ukraine account for only 2.5% of Asia’s imports and 1.5% of Asia’s exports. Developing Asia also accounts for only 5% of FDI in Russia.
However, the biggest impact of Russia-Ukraine war on Asian economies will be higher oil and gas prices, which will fuel inflation and slow growth in energy-importing countries, but help net exporters (see Figure 3).
Figure 4. Cost of living expected to rise sharply in many countries as energy & food prices skyrocket (Source: @Gita Gopinath)
It is also interesting to see that @MrBlonde_macro has posted the below analog chart (2022 vs 2018) which also says that the real bottom of market probably is not in yet. So, it's worth monitoring.
Figure 2. Analog of stock markets of 2022 vs 2018 (Source: @mrblonde_macro)
The real rate is the return after inflation—generally regarded as the 10-year Treasury minus the CPI. Why do the real interest rates matter for gold? Here are the reasons:[1]
Holding cost
Includes storage and insurance of gold
Opportunity cost
Instead of holding gold, investors could be lending it (or the cash spent) out. The higher the real interest rates, the larger are the opportunity costs of investing in gold.
And the lower real interest rates, the smaller are the opportunity costs, so people are more eager to hold more gold.
In particular, the negative real interest rates are gold's real friends (the 1970s or the post-Lehman era are the best examples).
Figure 1. Gold and real-yields (inverted) have decoupled from their historic relationship (Courtesy of stockchart.com; 02/16/2022)
Gold—a Geopolitical Hedge of Last Resort
However, historically gold tends to increase during rate hike periods when gold’s negative
correlation with long term real rates also tends to break down (see Figure 1):[2]
This
is already happening with gold displaying resilience to the most recent
increase in US 10 year real rates. In our previous research, we argued
that this has to do with the fact that the rate hikes themselves can
lead to fears of a growth slowdown and recession and therefore boost
demand for safe haven assets, such as gold. This means if inflation
fails to slow down in the second half of 2022 and the Fed is forced to
hike more than currently expected, gold should be resilient as this
would increase fears of a potential recession. And Goldman believes
believe that gold is a geopolitical hedge of last resort.
Warning
But, gold investment is complicated[4] and its market could be very volatile as @SuburbanDrone had warned on 02/21/2022:
For now I'm ignoring these futures oscillations due to various Ukraine rumors.
On the topic of gold, I'm not bullish at these levels (see Figure 2), recent out-performance notwithstanding.
Figure 2. Long-term Gold Price (Courtesy of stockcharts.com)
Suffice to say, my main plan (i.e., Lyn Alden Schwartzer) throughout this period is to mainly hold scarce assets- things like productive cash-producing companies, commodities, real estate, and hard monies, rather than being too heavily invested in fiat currency or bonds at any given time other than for some liquidity and optionality.
In 2021,$SPXoptionsmake up 16% of the $SPX market cap. To hedge a book of $SPX options, the primary risk-management technique is delta hedging, which is when option traders start messing about in the equity markets.
Some may recall the Gamestop ($GME) saga that took place earlier this year - Much of this bizarre and explosive move was attributed to Gamma Exposure (GEX), which was a prime example of how the mechanics of gamma exposure can influence market action in a very powerful way.
An option's price can be influenced by a number of factors that can either help or hurt traders depending on the type of positions they have taken.[1]
Successful traders understand the factors that influence options pricing, which include the so-called "Greeks"—a set of risk measures so named after the Greek letters that denote them, which indicate how sensitive an option is to time-value decay, changes in implied volatility, and movements in the price of its underlying security. For example, two of the four Greeks are:
Delta—is a measure of the change in an option's price or premium resulting from a change in the underlying asset.
Gamma—measures delta's rate of change over time, as well as the rate of
change in the underlying asset. Gamma helps forecast price moves in the underlying asset.
Delta Hedging
In general, hedging is a strategy used to reduce risk. An investor hedges a position in a particular security to minimize the chance of a loss. The nature of a hedge, though, also means the investor will give up potential gains as well.
Delta hedging is a strategy in which an investor hedges the risk of a price fluctuation in an option by taking an offsetting position in the underlying security (stocks or futures).
To
initiate a delta hedge you need to first understand what delta is, how
it works, and know the delta value for the option you hold.[4]
Assume a call option has a delta of 0.5. That means the
price of the call option will increase by 50 cents for every $1
increase in the price of the underlying stock that the call option is
written on. Now suppose you have purchased a call option
on that stock for $5 and the price of the stock is $60. If the stock’s
price rises to $65, then the options price will rise to $7.50.
An investor can hedge delta risk, for example, by buying the call option, then short-selling
the underlying stock. The amount of the underlying stock that must be
sold to exactly offset the delta risk is based on the delta..[5]
If
the delta is 0.5, then the investor needs to sell half of the number of
securities that are covered by the call option contract. Since a typical option contractcovers 100 shares of the underlying security, the investor would need to short 50 shares of the underlying stock to have a delta-neutral position.
The amount of delta-hedging needed is mainly dependent on this thing called gamma.
In our daily observations of (bizarre) market moves, we frequently analyze the delta-hedging of option positions by dealers (or market makers), i.e. gamma, which has emerged as one of the dominant drivers of risk assets. But why is gamma important, especially in option-expiration weeks?
Gamma has the potential to be one of the most important non-fundamental flows in equity markets (particularly when “short gamma” causes volatility to accelerate), but tracking gamma is complex and dynamic..[6]
You can find out spotgamma which shows the gamma exposure at the current spot level in 2 ways:
Current Spot Gamma Exposure—where Total Gamma Exposure blue line crosses the current spot red line
Occurs at around -$19Bn in this chart and it means that Option dealers need to SELL $19Bn worth of $SPX index for each 1% move DOWN, and BUY $19Bn for each 1% move UP.
Zero Gamma Level (or Gamma Flip)—where Total Gamma Exposure blue line crosses zero
On the chart, it occurs at around 4,574 $SPX level.
This is the Zero Gamma level, where the dealer gamma exposure flips from positive to negative.
Above this level, dealer hedging flows are stabilizing and add liquidity to the market.
Below this level, dealer hedging flows are destabilizing and add to the volatility instead.
At this level, flows are zero, as delta doesn't need re-balancing due to spot moves.
Cboe offers trading across multiple asset classes and geographies,
including options, futures, U.S. and European equities, exchange-traded
products (ETPs), global foreign exchange (FX), and multi-asset
volatility products.
Commodities are frequently more volatile thanstocks. They were are often subject to gaps and limit moves, which occur when a commodity opens up or down its maximum allowed move for the session. As shown in the below chart, @SuburbanDrone has chosen Average True Range (ATR) to represent WTI Crude Oil's volatility.
In this article, we will cover the basics of ATR. (or Realized Volatility used in commodities market).
Average True Range (ATR) is an indicator that measures volatility. It was developed by J. Welles Wilder who designed ATR with commodities and daily prices in mind.[1]
A volatility formula based only on the high-low range would fail to capture volatility from gap or limit moves. Wilder created Average True Range to capture this “missing” volatility.
ATR Values Are Not Comparable
ATR is based on the True Range, which uses absolute price changes.[1]
As such, ATRreflects volatility as absolute level. In other words, ATR is not shown as a percentage of the current close. This means low-priced stocks will have lower ATR values than high price stocks. For example, a $20-30 security will have much lower ATR values than a $200-300 security.
Because of this, ATR values are not comparable.
It is important to remember that ATR does not provide an indication of price direction, just volatility:[1]
ATR is not a directional indicator like MACD or RSI, but rather a unique volatility indicator that reflects the degree of interest or disinterest in a move.
Strong moves, in either direction, are often accompanied by large ranges, or large True Ranges. This is especially true at the beginning of a move. Uninspiring moves can be accompanied by relatively narrow ranges.
As such, ATRcan be used to validate the enthusiasm behind a move or breakout. A bullish reversal with an increase in ATR would show strong buying pressure and reinforce the reversal. A bearish support break with an increase in ATR would show strong selling pressure and reinforce the support break.
