The Gold Trade: I Tried To Warn You

| About: SPDR Gold (GLD)

I've written several articles over the past year or so, the most recent of which is here, regarding trading gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) with less volatility and, hopefully, greater profits than simply holding the metals. There have been plenty of naysayers and those who'd rather hold gold or silver outright and that's totally fine. However, I've got what I would consider to be proof of my strategy of trading the ratio of gold to silver in order to find ways to not only make money, but experience less overall volatility in the process. I've been recommending being long gold and short silver via the popular ETFs, GLD and SLV, and in this article, I'll take a look at what that strategy would have done over the past 13 months.

Below is a graph of what I've been recommending in terms of gold and silver since the beginning of 2013. This chart depicts what a $10,000 hypothetical investment in gold (red line) and my long gold/short silver ratio trade (blue line) would look like from January 2013 until today. The results are very interesting and I also think this lends further credibility to the idea that there are more profitable ways to trade gold than to simply hold it.

For this exercise, I charted the value of a $10,000 investment in holding gold from the beginning of January last year until today, exclusive of fees. For the ratio trade, I graphed getting long gold and short equal amounts of SLV, exclusive of fees, for the same time period as above. While these returns wouldn't be exactly replicated by real life, it is close enough to use for this exercise. It also doesn't include any sort of trading around the ratio as recommended by my previous articles, which would have increased returns. This is simply depicting a buy and hold strategy of my ratio recommendation.

What we see here is fascinating. When tapering became a topic of discussion in May of last year, we see gold take a serious nosedive; on the chart, you'll see the value of the investment fall from more than $9,000 to just over $8,000 in short order. This is the problem with simply holding gold; you are subject to whipsaw movements in the gold market, and while those sometimes work out in your favor, they often don't and you get enormous drops in the value of your holdings.

Look at the corresponding area for the ratio line; while gold was tanking, silver was falling even faster, and thus, the ratio trade actually showed a very tidy profit during that period of extreme duress for gold. This is the power of the ratio trade; you don't necessarily care which direction gold goes as long as gold outperforms silver. This leads to risk adjusted returns that are superior in my mind to simply buying gold and hoping for the best.

Of course, there are periods where the opposite is true; silver can outperform gold and the ratio trade can lose money. We see last summer that gold performed very nicely by itself but silver outperformed for a period. This led the ratio trade to lose money pretty quickly, but if you followed my articles, you'd know that there are levels where you want to keep the trade on and where you don't. This was a period that was pretty well telegraphed (see my linked article above for details) and you could've gotten out of the ratio trade if you wanted. Regardless, since the ratio began to flash a signal for getting long gold and shorting silver, you would've done pretty well.

Putting on this ratio trade isn't for everyone and I recognize that. However, simply dismissing this strategy is short-sighted as the data prove it can make money. In particular, periods of volatility for the precious metals are when this strategy shines, as we've seen in 2013. If you follow the GLD/SLV ratio, you can profitably trade gold and silver while experiencing less volatility than just holding precious metals. During periods of telegraphed signals from the ratio, you can make lots of money when people who simply hold gold or silver are seeing the value of their holdings decline.

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.