Commodities: Gold At A Crossroads

Includes: ABX, AU, GDX, GLD, IAU, NEM
by: Carlton Chin, CFA

As gold surged towards the $1900 per ounce price level over the past few months, there has been growing interest in gold as part of a well-diversified portfolio – and as a safe-haven investment. Indeed, the gold positions of large and well-respected institutional investors such as the University of Texas endowment, and hedge fund manager, Paulson & Company, have been in the news.

Interestingly, many of these headlines came around the time when gold was rallying towards its all-time highs in the $1900 range. We note that many of these large investors have already profited from their stakes in the precious metal. Since peaking at around $1900 per ounce in September 2011, gold sold off rapidly to $1550 within a few weeks. Gold has been consolidating mainly in the $1600-$1800 range since that time. Where will gold head from here? In this article, we look at gold – which stands at a crossroads, as we prepare for 2012.

Gold Investment Vehicles

How do investors invest in gold? Some investors prefer gold stocks such as Newmont Mining (NYSE:NEM), AngloGold (NYSE:AU), and Barrick Gold (NYSE:ABX). With the growth of ETFs, gold ETFs such as SPDR Gold Shares (NYSEARCA:GLD), iShares Gold Trust (NYSEARCA:IAU), and Gold Miners ETF (NYSEARCA:GDX) have been growing in popularity.

Others, such as the University of Texas endowment, prefer buying the actual physical commodity such as gold bars. Some investors prefer the liquidity of exchange-traded futures markets. No matter what investment vehicle investors use, they are seeking exposure to gold as a specific asset for diversification benefits – as well as earning nominal returns. In addition, some look towards gold as a safe haven play or even a proxy for currencies.

Gold’s Path

After spiking near $900 per ounce in 1980, gold declined and then built a very long-term base in the $300-$490 per ounce range from 1981 to 2004. Gold began its major upward move at the end of 2005, when it finally crossed into the $500 per ounce range.

Since that time, gold moved up fairly rapidly to an all-time high of just above $1900 per ounce in September 2011, before selling off to its current level of $1600. Some industry professionals look at gold’s inflation-adjusted price, which hit an all-time high of about $2400 (2010 US dollars), reached in 1980. Please see the chart below.

Gold Long-Term Chart

Gold Long-Term Chart

Source: Wikipedia (RealTerm)

Since reaching a peak of more than $1900 per ounce in September, gold declined precipitously to $1550 – or about -20% in just a few weeks. Over the past few months, gold has consolidated mainly in a relatively wide range of $1600-$1800. Where do we go from here? Let us take a look at some views on gold’s trends in various time frames.

Portfolio strategists and long-term investors would not be wrong in saying that gold is still entrenched in a major, long-term, upward move. On the other hand, the sharp sell-off of -20% is not insignificant. The short-term trend is definitely downwards, with gold well off its recent highs and currently trading near its recent lows – on both daily and weekly charts.

Gold Short-Term Chart

Gold Short-Term Chart (Source: CME Group)

CME Group

Trading Models

Our CTA’s proprietary trading models cover the gamut of time-frames, which include long-term and short-term trend-following. Briefly, our futures trading strategy can be described as:

  • intermediate to long-term trend following, with
  • pattern recognition and machine-learning components, and
  • (short-term) risk management approaches that help set us apart from others.

In particular, some industry professionals like the fact that our pattern recognition and short-term risk management components have a slight mean-reversion flavor. Here, we review some popular trading models which cover the spectrum of time-frames from long-term to short-term.

Long-term strategies such as the S&P’s Indices remain long gold, although other long-term indices such as the NewEdge Trend Index have turned bearish. Shorter-term strategies such as the classic Donchian Strategy (5-day and 20-day moving averages) are currently short gold.

Here’s a look at various trend directions based on various time-frames. In particular, we’ll look at trend direction based on daily, weekly, and monthly charts.

  • Daily chart: bearish
  • Weekly chart: bearish
  • Monthly chart: generally bullish, although some would argue that gold is near recent monthly lows.

Full disclosure: We do not currently have a gold position for our CTA’s client accounts.

Gold: Diversification Play

Although we have discussed gold’s potential short-term direction, we note that longer-term investors and portfolio strategists may have different objectives. These investors may want to remain bullish on gold because they are interested in gold for diversification reasons and its reputation as a safe-haven play. As we mentioned in another article, some portfolio strategists may prefer passive strategies and focus on diversification as a key objective.

Outlook for Gold

As we prepare for the New Year, what is our outlook for gold? As intermediate-to-long-term futures traders, our outlook remains bullish, but the bullish case has started to crumble. As usual, we will follow our computer models and trading strategies to give us direction.

As our clients and investors know, we apply a “barbell” approach to help us maximize “forward information.” Systematic and computerized trading strategies keep us disciplined – and market action will dictate our positions. Currently, our models remain bullish as they look to re-enter the precious metal, but this will change with continued downward pressure.

Happy New Year!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Long commodities and managed futures.