Gold Is Good

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Includes: AAAU, ASA, BAR, DGL, DGLD, DGP, DGZ, DUST, DZZ, GDX, GDXJ, GDXS, GDXX, GGN, GHS, GLD, GLDI, GLDM, GLDW, GLL, GOAU, GOEX, IAU, IAUF, JDST, JNUG, NUGT, OUNZ, PHYS, PSAU, QGLDX, RING, SGDJ, SGDM, SGOL, TGLDX, UBG, UGL, UGLD
by: Villi Grdovich
Summary

Solid gains since December 2018 may deter investors from considering a holding in gold at this time, but the upwards trend is likely to continue, and downside risk is low.

Our proprietary signal has a good track record and is positive, while speculative activity foresees no imminent reversal. Historical articles on Seeking Alpha indicate that a reversal would be identifiable.

Our view is that holding GLD is adequate exposure to this sector, but contrarian investors may consider large and small mining stocks to have better upside potential at this time.

The Medium-Term Signal for Gold is Positive

From a behavioural economics point of view, investing in gold now presents difficulties. Gold has had a good run-up, so the "easy money" has been made. Theories about price drivers abound, but accuracy is an issue. There is no doubt that the gold price is volatile and could reverse quickly as history shows. However, the world economy is attracting negative sentiment and therefore gold may continue to be attractive. What is the real risk?

We wrote an article on 15 March 2018 which explained that our signal for a sector revival in gold was uncertain at that time, and we undertook to write another article when we thought that a stronger uptrend signal was developing.

The signal is based on risk/return metrics of sector-based funds, and the methodology is to rank this metric. What we found was that when the gold sector rises to a top rank, it generally signals the start of a positive run, or at the least, a low probability of being drawn into false positives. The signal is not necessarily a predictor, but it seems to avoid any significant drawdown. We are not revisiting the nuts and bolts of this methodology here, just the results.

We illustrate the signal superimposed on the gold price in the graph below. The first signals registered in late 2018 and were consistent throughout January 2019. It appears to be robust.

Source: Villi Grdovich

In the 15 March 2018 article, we suggested that investing in physical gold was less risky than investing in gold miners. Our caution on the gold price was justified then, and our picks for gold miners were not that good, which proves the point. On this basis, there is a justification to consider a long position in GLD (or the physical) now rather than in the miners.

Supplementary Information

The mantra following the presentation of an investment idea is usually to "do your own due diligence". If this due diligence is to be partially based on Seeking Alpha articles, then how do we determine which articles have merit.

In respect of GLD, our greatest concern is a fast reversal to a medium-term trend which has more to do with some backroom financial engineering system, of which we are totally unaware. So, we reviewed Seeking Alpha articles with an open mind and tried to identify authors who had consistent methodologies which might be relied on to produce acceptable results around reversals.

The methodology was to catalog the authors and the publish date of articles on GLD from around June 2013. Then we accessed articles at what were critical turning points and made a judgment on the accuracy of the prediction and whether the methodology behind the predictions was consistent. For those authors who seemed to us to be worthy of further investigation, we looked at the history of publication of each individual author over the period to see whether we had a "stopped clock" effect.

We do not wish to be seen as judgmental here, so we present one piece of information about Author X who we think provides actionable views which are complementary to our aims. We have identified the publication dates on the GLD price graph below.

Source: Villi Grdovich

In our view, the methodology employed by Author X was accurate for December 2018, August 16 and August 18. Where there might have been equivocation, it didn't matter to us because our signals indicated to be out of the market.

So, what is the current state of play? Our indicator supports a long GLD position, and Author X and a few others see no imminent reversal.

Gold or Gold Miners?

Our analysis suggests that on a size factor, the risk/return for investing in individual stocks is analysis intensive for little gain. Medium-sized stocks have performed in line with GLD in this latest run, due mainly to specific factors affecting a few stocks such as AngloGold (NYSE:AU) and B2Gold (NYSEMKT:BTG).

The following graphs show the risk-adjusted relationship between GLD and medium and large miners, noting that the risk/reward pattern for the large, small and exploration factors are similar.

Source: Villi Grdovich

Source: Villi Grdovich

If a persistent bull market is to develop, then it is hard to argue that the place to be is in the lagging sectors because the current underperformance is unusual.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GLD over 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.