The firm recommended buying call spreads in the GLD and GDX ETFs to take advantage of the rich skew on the call side.
“This ‘tilt’ in the basket of hedges that would traditionally be more heavily weighted in equity index protection is driven by gold’s higher correlation to CNH (which could see further devaluation as the trade war persists),’’ he wrote.
With currency brought to the fore of the escalating clash between the world’s two largest economies, it’s difficult to see investor angst only reaching extremes in equities.
“Vol is still underpricing the risk of escalation -- especially a currency war,’’ wrote Bank of America strategists led by Gonzalo Asis. “With much room left to run to match Aug 2015 returns and cross-asset volatility mostly below long-term averages, options appear attractive to position for further stress.’’
Only U.S. equity and oil volatility are above their long-term averages going back to May 2007, according to Bank of America, while foreign exchange vol is just in the 26th percentile over this timeframe. The team believes “the rising risk that the trade war morphs into a currency war” will foster the outperformance of this asset’s volatility much faster than in 2015, making currency-based hedges particularly attractive at this juncture.
The potential for heightened foreign-exchange swings threatens to upend a favored strategy use to generate positive returns in a world awash with negative yields. For instance, the euro-funded Brazil carry trade erased months of gains in the three opening sessions of August.
“We continue to caution that carry trade unwinding via FX-carry or bond-carry is one of the biggest risk at hand,’’ writes Saktiandi Supaat, head of foreign-exchange research at Maybank. “With EUR and JPY’s funding currency status being further enhanced due to their relative ‘cheapness’ amid ECB and BoJ’s willingness to keep monetary policies accommodative, a re-escalation in trade tensions may well see funding currencies (especially more so for JPY) in demand.’’
This story provided by Bloomberg News.