Investing In The Gold Market 2014

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 |  Includes: AGOL, DGL, DGLD, DGP, DGZ, DZZ, GLD, GLDI, GLL, IAU, PHYS, SGOL, TBAR, UBG, UGL, UGLD
by: EconMatters

Investing in the Gold Market 2014

2013 in Review

It was not a good year in 2013 for Gold Investors by any measure, whether it was central banks, John Paulsen or commodities funds with large Gold positions 2013 was a year they anticipated would have turned out differently; considering the large amount of currency debasement and money printing carried out on a world-wide scale by most countries in one form or another.

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When in Doubt - Think in Terms of Value

This just goes to show that despite favorable fundamentals investors always need to think in terms of price when getting involved with a market. Buying the highs and all-time highs works until it doesn't, and you better have a plan in place when it doesn't given you are buying an all-time high. This is the value of technical analysis, it can provide a plan for when to get out of the position, at what point the trade become invalidated; that you are on the wrong side of the market.

The goal is to make money in the market, not have some ingrained belief structure regarding the market that must be proved right eventually or your self-worth or ego takes a huge hit and is invalidated. It doesn't really matter if the market should be going the other direction, the fact that it isn't going in your direction is the only thing that matters in investing and trading.

2013 Trade: Short Gold & Long Equities/Yield

In 2013 the trade was to get out of Gold and put these funds to work in the equities market, further exacerbated by the need for yield which is nowhere to be found in Gold and plays a strategically important component in how many of these carry trades were structured to optimize leverage, positive carry, yield and overall returns given the dynamics of low interest rate borrowing and certain investor friendly currency opportunities in 2013.

2014 & Fund Flows

Therefore, the question for 2014 is some of this capital going to rebalance out of equities and look for a home in precious metals? Well, let the charts tell you what is happening in regards to fund flows, no need to be a superhero and stick your neck out trying to be a market sage or oracle. Just let the technicals tell you which direction the market is going with regards to fund flows in 2014.

Futures, ETFs, Options & Physical Investing Instruments

We will use the futures market as a guide but it is quite easy to find the same technical patterns in GLD, the SPDR Gold ETF, for those wanting to play the Gold market via that route. For the physical buyers, there is still some merit in utilizing the futures technical patterns to your advantage and optimizing entry and exit points as even central banks could better time the market with their purchasing strategies.

The goal for all participants should be to maximize profits, regardless of the investing method; it does no good to be sitting on substantial losses just because you have a longer time horizon in the physical market.

If you bought large purchases of the physical at $1900 an ounce because Europe was imploding and the Euro was going extinct you are not feeling too good about your portfolio sitting on a $700 an ounce deficit. Think in terms of how much more Gold you could have in your physical portfolio if you timed the market better and received a more proportionately good historical price for the precious metal.

Portfolio and Asset Allocation Strategy: Last 4 Years

In looking at the charts in comparing the S&P 500 versus Gold returns for the last four years, Gold is roughly up 10% over that period, while the S&P 500 is up 63%. The two instruments crossed paths in April of 2013 going in opposite directions, but the more crucial point of demarcation may have started in October of 2012 around the time the Bank of Japan started fueling the carry trade that emerged from the intensive efforts to weaken the Yen by the BOJ which kicked off the search for yielding assets to invest.

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Key Technical Levels

The 2013 Gold chart looks very bearish and depending upon the Fed tapering decision in December, and the language around such an event, no one is going to be too excited about going long Gold until they get some visibility on that front.

I can see several scenarios where what I will call the Paulson lows of 2013 are tested quite strongly with major downgrades of Gold by some of the big banks after the Fed announcement, it all depends on that event.

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I personally would be looking to get involved in the Gold market if we get major damage to the $1180 area of support, and it is obvious that some funds are being forced to liquidate positions. It all depends on how hawkish the language is around the tapering event and how the market responds, but if we get several bearish downgrades after the December Fed meeting by some big Investment Banks, then I will start looking for possible liquidation entry points to scale into long positions.

Value Investing in Gold: Physical Market is Preferable Instrument

Forthrightly, I would use the carnage in the futures market to buy the physical metal, I would ideally be looking to buy around the $1000 an ounce level, not sure Gold will fall that low but once traders start pounding upon markets, potential longs step away, markets can fall farther than one would rationally anticipate ahead of time. It all depends on what the Fed Speak is, but throw in some market over-reaction, and I could get a bargain at $1000 an ounce in the physical market on a crazy liquidation cycle.

I anticipate that many buyers of the physical around the world, especially in China and India would come in with this strategy as well, probably providing substantial near-term support at this level; thereby causing shorts to cover and then we test the upper resistance levels of $1200, $1330, $1400 for a long trade with investors taking profits as they gauge the environment and the breadth of the trade to the upside.

$700 Gold - 6 Year Support Level

I really don`t see any near-term scenarios where the $700 area of support is seriously tested, but this is the 6 year level of support for the Gold market, and even with major fed tightening, and raising of the fed funds rate, this would probably be offset by inflation signs in the economy and data; so this level should realistically never be tested near-term.

The only scenario that I could envision this level being approached is one where the Japanese Yen weakens all the way to the 125 area against the dollar, the US Fed remains insanely dovish for 2014, and equities fueled by cheap money and the carry trade, causes the Gold market to crash in the search for yield and higher returns in an overcrowded trade that just goes parabolic dumping anything that even remotely resembles a commodity.

2014 Gold Market - $400 Trading Range

The most likely scenario in my mind for 2014 is that Gold remains in a tight trading range from whatever level is eventually tested to the downside $1100, $1080 etc. and $1350, $1450 to the upside in a short covering rally.

Gold: Longer Term Perspective

Longer term one would think with all this currency devaluation and massive money printing that inflation is going to rear its ugly head sometime in the next 15 years, once the effects of the deflationary forces have finally been outpaced by the forced inflationary tools of central banks and normal asset scarcities in the economy.

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It is logical to think at some point that the US has a major inflation cycle that comes into play and is explicit in nature where it even shows up in the CPI & PPI Data. This is where Gold could really take off depending on how behind the curve the Fed and Central Banks are around the world to react to this inflation cycle.

$2000 Call Options

If this happens Gold could start to really take off again for investors with $1550 being the key resistance level to watch, once this breaks with conviction $1800 is a mere formality in my opinion. Moreover, once the $1800 an ounce level is breached with strength start buying some $2000 an ounce calls as this is the next round number, and traders will likely bust through the previous high in the $1930 area with no real resistance until the $2000 round number area.

And once the $2000 level fails to hold to the upside, this is truly uncharted territory, and let the market tell you where it stops trending. Once daily and weekly highs start occurring regularly, the investor should just stay in the trade to the long side, with stops being moved at key levels to protect profits and stay in the trade until the trend is clearly broken to the upside.

$2500, $3500, $5000 Gold in Future Inflationary Cycle

I would clearly think it is possible to hit the $2500 level sometime over the next 15 years, it all depends upon how the fundamentals of the economy play out, and how the deflationary versus inflationary forces eventually resolve themselves, and how central banks react to these dynamics with monetary policy measures. Maybe even $3000 and $3500 to $4000 an ounce are possible for Gold prices in my lifetime; it all depends upon how the dynamics and divergent forces come together in the final soup that drives the market.

Instruments in Mitigating Risk - Gold Investors

In regards to instruments and strategy regarding how to play in the volatile Gold market, obviously futures are the riskiest; and you just have to utilize stops at key technical trade invalidation points in both directions. You can always get back into the trade but markets, and futures markets especially will always go lower, take that next leg down that nobody thinks is possible, you have to get stopped out at key levels if you are going to use futures.

GLD is much safer from a long standpoint, just don`t buy on margin, and you can probably take a little extra heat if you believe that you have a price that is good enough to be in the money quite nicely once the shorts cover in the market.

But even then make an exit plan, as markets become broken for many reasons, and you have to get out regardless of long-term views on the market. Map these out ahead of time, where on the charts is this trade broken for you?

The physical market is the safest once you get beyond reputable sources and quality products, and my choice for long-term exposure to the Gold market. But even then I am a relative value investor in the metal; I never buy at the all-time high in the market - especially in the physical market where my holding time is longer - just because it is a hot market. I am much more price conscious in the physical market, i.e., I have to get a good relative price to the recent historical context - but my valuation maybe different from yours and vice versa.

Longer Term versus Shorter Term Duration

Furthermore, I am much more likely to use the futures market to trade the metal on a shorter term technical basis, get in and out of the trade as dictated by the price action. Therefore, in my opinion the holding timeframe and trading strategy dictates which instrument is best suited for the given strategy.

GLD Gold ETF Instrument & Options Strategy

The GLD SPDR mirrors the futures contract for all intents and purposes, so for exact technical levels just pull up the two charts and draw your corresponding entry and exit points for trading and investing given this analysis and your given trading strategy.

Options on the can be excellent hedges for reducing the volatility in your Gold portfolio, or clearly defining your risk parameters. However, I prefer to use options only at extreme levels and months in the future where I analyze that market makers have mis-priced these options relative to several scenarios where I can safely be in the money at some point over the next 3 months on a near-term trade and 6 months out in a strong trending market that has considerably more room to run.

I don`t like being the sucker, and it takes a lot of due diligence in options to make sure you are getting a good price that will more than offset the market makers built in insurance buffers. Be very careful with options they are often a Sucker`s market play in my opinion.

Final Thoughts

The last piece of advice for the Gold market is don`t fall in love with the ideology behind the market, too many traders lose money in Gold because of the fundamental mindset going into the market. Keep an open mind; leave the ideology musings for others, your job is to make money on an investment. Let the market tell you where it is going, which is the right side of the trade, where trades become invalidated, and where to take profits on a position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.