The Gold Rally - Fools Gold or The Real Deal
November 21, 2005
GOLD. The mere mention of it is enough to get most people excited. At its base level, nothing more than an easily sculpted yellow metal. But ornaments, jewelry, and coins made of gold have been seen as signs of wealth and power in nearly every stage of human civilization. And it is becoming more and more a sign of wealth in the last two years of modern civilization, as the price of gold has appreciated almost $300 per ounce since the beginning of 2001.
As Gold surged to new 18 year highs today, hitting $489 an ounce, the buzz of excitement for all those Gold lovers continues.. A Gold Rally ! ! It is often said that good traders need a short memory, but the excitement of gold is generated by those who have a long memory, all the way back to 1979. (We don't know what kind of trader that makes them.)
Much of today's infatuation with gold (from an investment standpoint) comes from the year 1979. In that year, gold was trading at $210 an ounce, then proceeded to rise all the way to $850 per ounce in 1981, before plunging back to roughly $300 per ounce a year later. This was nothing short of the most dramatic rally in commodity history, with a single gold contract appreciating more than $64,000 in a two year time span. For an investment requiring less than $1,000 in margin requirements, the rally represented a 6,300% increase and was truly the American dream. The subsequent fall to $300 is often the forgotten part of the tale, yet should be the most important.
Ever since that famous rally, speculators in gold have acted like the second California Gold rush was on every time Gold moves higher, pouring money into gold futures and gold based investments. These investors have inevitably been wrong more than they have been right, earning them a reputation of wild eyed, beyond the edge fanatics looking for $1000 per ounce Gold, and the nickname Gold Bugs. Professional investors, meanwhile, continued to sell Gold against small traders through much of the past 20 years, creating big losses for so called Gold Bugs.
The problem has been a steady decline in the demand for gold ever since 1980. With little to no industrial value, and the signal of banks world wide that they were selling their gold reserves, Gold has been in a steady decline since the 1980s, failing to make higher highs in each of its sustained rallies.
But the current gold rally seems a little different, as it appears to be driven by more than the memories of the often wrong gold bugs. There are now two Exchange Traded Funds (ETF) which were launched specifically to provide small retail investors an easy way to invest in Gold, the streetTracks Gold Shares, symbol: GLD, and the iShares Comex Gold, symbol: BGI. Whether its the sign of a top in gold or a sign that there will be more demand to drive prices higher is yet to be seen.
The basis for any belief that gold can sustain such a rally lies in the belief that gold may challenge the dollar's dominance as a safe haven in times of uncertainty and rising inflation. We can easily see that we live in times of uncertainty any time you turn on the TV, and the effect China is having on rising commodity prices is evident, making this is a very real possibility. Other sources of demand are the growing middle classes of Indian and China, who are believed to prefer to hold tangible assets such as gold as opposed to stock and bond portfolios. There is also the chat room belief that gold is the new currency of organized crime and terrorists, given the increased scrutiny and regulations surrounding money laundering after 9/11, and that demand from those sectors is helping to drive prices higher.
But if increased productivity and the recent bout of interest rate increases keep inflation in check, is there any more room for Gold to rally. Long term bonds are pricing in expectations for very low inflation - quite the opposite of Gold. Which asset will be right?
The basis for gold falling back to somewhere in the $300 - $400 level is that gold has little to no economic value. National currencies are no longer based on a gold standard, and Copper and Silver are better electrical conductors. That leaves just two groups as drivers of the price of gold. One, the consumer and what they're willing to pay for gold jewelry, and two, the nervous investor with a safety deposit box full of gold coins. With gold jewelry accounting for a very small percent of gold demand - any further upside in Gold will have to be driven by investors who have lost faith in stock, bond, and real estate investments.
This investor has long recommended staying away from the gold rally, but this recent rally and a possible close over $500 per ounce soon has many, including myself, reconsidering. Gold will not be returning to the levels it saw in 1979 (about $1,500 when adjusted for inflation). Most of those who remember 1979 and believe in fools gold are already long, challenging the much stronger and smarter commercials.
Trading Systems and Gold
With the big run up in Gold the past four years, we have fielded call after call from investors wanting to trade Gold with various trading systems. The most popular move is to insert Gold as one of the commodities in a diversified portfolio of multiple commodities for a trend following system to operate on, despite the developer and Attain not recommending portfolios containing Gold.
Unfazed, many investors push on, thinking things have changed for Gold due to the recent rally. That may be, but you have to have some pretty think skin to want to get involved with Gold in a trading system after viewing the results below. From a trading system standpoint, having Gold in your trend following system portfolio has been about as profitable as buying gold over the past 10 years. Not very. Across eleven different trend following systems, only one system was profitable in the Gold since 1990, with the average single contract gain/loss across all trend following systems being a loss of negative -$24,662.
The most likely reason for trend followers poor performance over the past ten years is that the market was a poster child for choppiness. The market had a range of only about $50 between 1993 and 1996, and until this most recent upmove hadn't had a trend to speak of. The secret of SEMA4's success trading the Gold market - weekly bars. Taking a longer term approach has saved the system from the choppy up and down conditions in this market. But in the end, whatever form of investment you use, Gold doesn't seem to be a good investment.
- Jeff Malec
IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can
carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for
everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading
losses are material points which can adversely affect investor returns.
Feature | Week In Review | Chart of the Week |
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Feature | Week In Review | Chart of the Week |
Bulls continue to dominate the US Stock market as SP cash futures closed at their highest levels since June 2001 on Friday. The US futures markets followed suit with SP futures climbing +1.00%, NASDAQ futures gained +1.45%, and Midcap 400 futures gaining +1.05% last week. Russell 2000 futures did not follow the trend remaining near breakeven for the week. Overseas, Nikkei futures have not shown any signs of slowing down gaining another +10.66% last week ! !
Elsewhere US Bonds and foreign currencies had a slow week with US Bond futures gaining only +0.50%, while the Dollar Index remained unchanged against it’s competitions. There was as mall amount of movement from the Japanese Yen which fell -1.00%.
Energy prices continue to fall despite colder temperatures sweeping across the US. Last week Crude Oil futures fell -2.17%, Unleaded Gas futures dropped -2.37%, Heating Oil fell -1.50%, and Natural Gas moved -1.35% lower.
Perhaps the most exciting sector last week was the Metals sector which saw nearly every market rally. Rumors that a rogue Chinese trader will be unable to deliver on his numerous long positions has caused metals investors to fear that Copper supplies will dwindle which caused futures to rally +3.69% last week. Overseas in London the London version of the Copper contract was up +2.31%. The supply concerns spilled over into Palladium which was up 6.78%, Platinum which was up +1.46%, and into Gold which rallied +3.58% to close the week at 18 year highs. .
Finally, Sugar futures bounced back gaining +4.45% last week.
*Day Trading**
With the S&P and Nasdaq trading at four and a half year highs, it only makes sense that some of the short term models are attempting to call the top and profit from a sharp sell-off. Unfortunately for those systems, the U.S. stock market continues to trade higher and only those systems willing to join the bulls were able to profit on last week’s advance.
Compass SP once again positioned itself atop the list for day traders with profits of +$925 on two trades. Fellow Mariner Trading system Clipper eRL had similar success and profited +$310 per contract. Electric Daybreaker II ES was more active than usual, trading five times for profits of +$300. RC Success ES was bullish for the week as well, profiting on two of three long trades for gains of +$160. Helix ES was very involved as usual and made +$100 on ten trades. Finally, R-Mesa eRL had modest gains of +$90 per contract.
Other systems were caught short or got long near the highs taking away from their bottom line for the week. Impetus eRL traded twice for a loss of -$34 per contract. Electric Daybreaker NQ had one trade near break-even for a small loss of -$40. RC Miracles ES reversed its position to short on a few occasions which led to losses of -$592.50 for the week. Daybreaker SP initiated two short trades last week while everyone else was going long, and paid the price losing -$916.68. Electric Daybreaker II eRL had five trades for the week yielding a loss of -$1025 per contract. R-Mesa SP attempted to short the market on three occasions last week for losses of -$1537.50. It did, however, reverse to long on Thursday to soften the blow of the previous losing trades.
**Swing Trading**
Though the past week maintained the general upward trend of equity markets from the past month, volatility and volume remained relatively low, leaving equity index swing systems mostly content to hold their long positions.
Athena eRL from Roker Capital Systems closed out a long position for a profit of +$180 and then went long again to book a +$510 winner. Meanwhile for Axiom Index eMD it was just another profitable week as it tacked on another $800 to its long entry from 10/28 before closing out the position on Friday for a total profit of +$3944.10 on the trade. Axiom eRL on the other hand had a rough week as it gave back several points on the long position it started the week with before closing it out for a +$918.70 winner and reversing to short for a loss of -$700. It did reverse back to long and is now holding +$980 in open trade equity. Axiom Index ES added +$612.50 in open trade equity to the very impressive long trade it got into on October 28th.
Another Trading Visions system, Delphi, traded twice each in EMD and ERL for losses of -$130 and -$200 per contract, respectively. Delphi ended the week long both markets, earning +$1150 in EMD and $1050 in ERL in open trade equity.
Eclipse eRL, like Axiom Index ES, decided not to fix what wasn't broke and maintained its long position in the Russell 2000, tacking on another +$370 and moving its stop to lock in around half of its current open trade equity of +$3706.70.
Other equity swing systems to trade during the week were SeasonalST ES which lost -$292.50 and Tzar NQ which reversed to long for a loss of -$750 on its closed out short position and ended the week up +$570 in open trade equity.
In the bond markets, MESA Bonds and MESA Notes enjoyed the continued up trend which buoyed their long-lived long positions(say that ten times fast), while the Jaws Narrowneck Portfolio was active, trading a total of 6 times and losing -$3050.
Finally, Axiom CL 90 from Trading Visions rode lower oil prices to a profit of +$3500 as it rolled its short trade to the January contract.
**Long Term**
Trendfollowing systems and Trend Following CTA’s continued their 4th quarter comeback last week, as rallies in the metal and stock indices helped propel these types strategies to new yearly highs. One CTA that has stood out of late is Meyer Capital Management. Meyer, who has a well established 7 year track record, has struggled this year with choppy non-trending market conditions. However, if recent performance is any indication Meyer investors just might finish 2005 in the black. This month alone Meyer is up 15% due to its positions in the foreign currencies, metals, and stock indices — most notably teh Nikkei index which was up 10% last week alone.
Trend following systems have also benefited from the recent long term trends in the metals markets. Systems have been taking advantage of upward trends in markets like platinum, palladium, copper, and gold for impressive gains. One system that has done exceptionally well is Andromeda from Petros Development. The system has enjoyed resurgence of late in markets like the Nikkei and Japanese Yen. But most recently the system has been showing off its muscle in the metals markets with long positions in Gold for gains of +$3300.00 per contract, Platinum for gains of +$2755.00 per contract, and Palladium for profits of +$5860.00 per contract.
Other systems with well established metal market positions include Axiom LT which is long in Palladium for gains of +$6400.00 per contract and Aberration Plus which is long in Palladium for profits of +$5860.00 per contract while also holding a long position in LME Aluminum for a loss of -$65.00 per contract. Finally, SEMA4 Symmetry continues to hold on to an impressive long gold trade for profits of +$2610.00 per contract.
SEMA4 also owns last weeks only closed out trade as the system was stopped out of a long Crude Oil trade for a loss of -$10,880.00 per contract after going long near the top of the oil rally.
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IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can
carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for
everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading
losses are material points which can adversely affect investor returns.