Don't Freak Out Over Gold - Stay Rational, Not Emotional

Includes: GLD, JJC, OIL, SHY
by: Richard Bloch

Carlos X. Alexandre writes that “Gold 'Believers' Appear Distraught Over Dollar Strength,” although he didn’t seem to quote anyone who appeared distraught.

And most of the commenters didn’t seem all that distraught. I did sense some haughty “serves you right goldbugs” vibes, but who could possibly be distraught other than those who bought gold this year? Anyone who bought a year ago, two years ago, three years ago (well you get the idea) is sitting on some nice profits -- even if gold moves all the way down to its 200-day moving average around $1500.
Why is gold so emotional – among bulls and bears alike? Nobody gets emotional about shares of Apple (NASDAQ:AAPL) [okay, bad example, make that Procter & Gamble].
Yet the emotional aspects of gold contrasted interestingly with another article that appeared the same day, Roger Nusbaum’s piece on the stock market, “The Market Is Freaking Out: Here's Why You Shouldn't.
Quoting Roger

If I say to you that "markets correct downward every so often and sometimes these can be fast and quick moves that scare people, but markets and the stocks that comprise markets come back at some rate of speed and that the decline will not wipe you out," what would you do with that?

If the S&P 500 was at 1550 and everyone was feeling pretty good, then most people would say that "well of course the market goes down 20% now and then, the volatility is just fine." Now as the market feels like it is down a lot people tend to forget the rational voice that knows markets do go down as they are now.

So do gold investors realize that gold is a highly margined asset and that when margin requirements are changed, gold falls off a cliff? I think to a large part they do. But margin requirements are sometimes actually reduced. It all depends on volatility.
Here’s a chart of the initial margin requirements and gold prices going back to 2009. (Click charts to enlarge)
John Lounsbury published a similar chart in an informative article on September 20 But let’s take it a step further. Here’s a look at initial futures margins in terms of the gold price. In other words, how much leverage you’re allowed to use when trading gold futures.
For example with the margin hike last week at last week’s gold price, traders were not allowed to go beyond a 18x leverage ratio as of late last week. That’s not an unreasonable level considering that the leverage ratio has not been allowed to go much higher than 25x, which is where it stood back in early August.
These charts show that gold has certainly fallen sharply against the US dollar index and US Treasuries [as measured by the iShares 1-3 year Treasury ETF (NYSEARCA:SHY)] in the past few months as of last Thursday.

You could certainly be emotional about that if you were short the dollar and long gold, but gold has held up pretty well against the S&P 500 (NYSEARCA:SPY), copper, and WTI crude oil.

So why all the emotion over gold? I'm not sure, but I suspect many investors in gold should take Roger’s advice on the stock market and apply it to gold – not getting emotional over a commodity that probably won’t totally collapse in a low-interest rate climate.

Until interest rates rise, I think non-futures buyers around the world (who don’t use leverage) will probably still be slowly and surely accumulating gold as I pointed out last month. But don’t get emotional and bet the farm. With high volatility, average in a little each month. In my view, that’s the rational thing to do. Disclosure: I am long GLD.