ETF Update: Gold's Risk and Reward

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 |  Includes: AAXJ, BA, EBAY, FXI, GDX, GEX, GRMN, GS, KBE, KIE, KOL, RSX, XLF, XOP, XRT
by: Jeff Miller

There is always a lively debate about gold, whether one is a trader or an investor. This week there is disagreement between our two trading models, Felix and Oscar. Both models see potential reward, but the risk is too great for Felix.

Background

Traders all seek rewards but they have differing appetites for risk. It is important to find a method that suits your personality and needs. Our trading systems are basically Trend-following, but also include recognition of Cycles and a touch of Anticipation. The system reviews a universe of over 270 ETF's. We have a smaller trading universe, The NewArc 55, chosen for trading properties. We follow two versions of this method, designed for two clients with different needs.

  • Oscar believes in the long-term strength of the economy and the stock market. He has a lovable and irrepressible enthusiasm. When things go wrong, he steps back for a bit, but soon tries again. He expects to do better than others during good times. Oscar understands that this approach involves more risk. Oscar is opportunistic.
  • Felix also has a positive long-term outlook, but he is something of a fussbudget. He is much more cautious, with an emphasis on capital preservation. He is perfectly willing to step aside from the market when there are signs of danger. He knows that he will miss some moves, but that is OK. He scores big gains when the market moves lower and he escapes the loss.

There is more detail in this article. We also have free reports, available upon request to etf at newarc dot com. These reports describe how we use the system, compare results from Oscar and Felix, and contrast the method with our long-term trading approach.

Gold Mining Stocks

We trade gold mining stocks via the Van Eck Gold Miners ETF (NYSEARCA:GDX). I am not going to review the specific ETF characteristics today, since we have already discussed GDX extensively in the following articles:

Today I want to focus on why Oscar and Felix might see this situation differently. Let us start with the chart (click to enlarge).

Gdx april-18 2010

I added a few common technical indicators for general interest. In response to some questions, I have suggested that Oscar and Felix are not black box models. We know and discuss the basic approach and elements. Humans make the final trading decisions. Since the exact calculations are proprietary, we might call this a "gray box."

Both models assign solid ratings to GDX and the sector rose rapidly in the ranks during the last week, something you can see in the table below. A sector can go into the Penalty Box for several reasons, including but not limited to the following:

  • A large spike in volume
  • A very wide trading range in a single day
  • What Vince calls a "whoosh" (gotta love this scientific talk) indicating an unusual move

Essentially, we have studied conditions where our predictive methods are not as accurate. By putting sectors in the Penalty Box when the future is murky, we try to stay in our trading sweet spot.

In the case of GDX, Felix flagged it to the PB on April 7, coinciding with a big move, extra volume, and moving past the top Bollinger band. I do not know which specific element was the reason. Once in the PB, it takes a few days before the sector is eligible to come out.

The key to doing this is careful research and good measurement of relevant indicators. The rules are chosen to fit our method, but any trader could benefit by following the same process.

Other Viewpoints

We are always interested in the opinions of those in the ETF expert community. There are some interesting comments on GDX.

ETFdb explains how GDX is attractive to investors who are worried about the possibility of simultaneous inflation and deflation.

Prieur du Plessis likes GDX for technical reasons, not unlike ours.

24/7 Wall St. argues that "gold needs a breather" and there will be better entry prices.

ETF Daily News sees a continuing strong uptrend.

According to the WSJ, some believe that Friday's weakness in gold was related to John Paulson's large holdings and his role in the SEC action against Goldman Sachs (NYSE:GS).

Weekly TCA-ETF Rankings

We are currently only 16% invested in our ETF programs. We are happy to report and discuss performance with interested investors. We also offer a report on how we use the models, and a weekly email update. (Write to etf at newarc dot com). Our actual trading is a combination of both models and some weekly timing.

For the moment we are publishing the ratings list as of Thursday's close in our weekend update, a one-day delay. We are not recommending these sectors, since investor needs and risk tolerance varies. We hope everyone finds the ratings to be a useful supplement to their own work.

Here are the current rankings for both Oscar and Felix (click on each to enlarge).

Felix 041510

Oscar 041510

Bonus Coverage

Vince did some interesting testing. He checked out his findings using groups of stocks and time periods totally unrelated to the development of the model. This is a very professional approach -- and a very unusual one.

He tells me that we can expect Felix to provide excellent ratings for individual stocks -- not just sectors. We have decided to share the top pick in the Dow and the top pick in the NASDAQ 100. These are three-week forecasts. For the moment I am not going to do any further analysis, but I will post the top pick each week. At some point I will do a recap.

DJIA: Boeing (NYSE:BA) was a small loser, but continues as the top pick. Nearly all DJIA stocks are in the PB.

NASDAQ 100: eBay (NASDAQ:EBAY) Most of the 100 are in the PB. EBAY has a rating of 39. Garmin (NASDAQ:GRMN) was a small loser last week, despite the extraordinary $1.50 dividend.