What About Gold?

by Jay Pestrichelli on April 17th, 2012

I’ve been asked this question quite a lot over the past few weeks. I don’t feel the high frequency of the question has been driven by irrational exuberance, like it was in the beginning of last summer or out of fear of the world collapsing, like it was at the end of last summer. I get the sense that it has been more of a general portfolio curiosity like, “Should I have some gold exposure?” or “ Is now a good time to sell my Krugerrands?

My standard response is, “We have clients that have some gold exposure, but typically it is a small, less than 5% of a larger portfolio, so it all depends on what you’re really looking for.” That being said, here is how we think about gold at Buy and Hedge:

  • From a fundamental standpoint, it is difficult to evaluate value of gold. Its not like company that has earnings or growth prospects.
  • Gold has been on a very strong run in recent years and has not correlated to bonds or stocks, so it can provide diversification to a portfolio
  • Gold can be considered its own currency in a way. It reacts to money supply and is considered a safe haven when other currencies get choppy.
  • Many consider gold to be a hedge against inflation and the last few years we’ve seen that trade occur over and over again.
  • We have used the ETF GLD as a proxy for gold vs. buy the futures or actually buying physical gold.
  • Holding gold pays no dividends so we usually create a hedged exposure through spreads vs. actually owning the ETF.

We would consider all of that commentary to be evergreen. Meaning regardless of what is going on in the world all 6 of those bullet points will apply. However, I think the question at hand is more about timing. Is not a good time to buy?

As we’re written before, we’re not market timers at By and Hedge, but we do understand waiting for a value buy. However, as just stated, its difficult to come up with the value of gold. The price is always what someone is willing to sell it for and that’s that.

This makes technical analysis one of the better ways to determine entry and exit points. As this is being written, gold up for the day by about $2 to $1,652, but more importantly the 50 day moving average has crossed below the 200 day moving average. This hasn’t happened since September of 2008 and is typically considered a bearish indicator.

Gold, at that time was about $800 and continued with notable volatility to bounce up to $900 and then drop to $700 all before October of that year was over. That’s when it began the strong run it has enjoyed for the past 3 ½ years. So perhaps there is some more choppiness in the metal as once again that 50/200 bear cross emerges.

Another technical indicator that an investor might decide to consider is the Symmetrical Triangle Pattern. This is when a series of lower highs and higher lows begin to show some consolidation in the charts. Investoedia has a great definition and diagram for the pattern if you’d like to know more.

A rule of thumb I with patterns is if it makes a shape, it is probably a continuation. If its something like a head and shoulders or a double top, it is a reversal. In the case of gold, this triangle pattern would be considered a continuation for the broader pattern and in essence a bullish sign.

Watch for a break-out above the upper trend line to for the next phase of the bullish run. However, if the lower trend line is broken, consider the pattern to have failed and all bets are off.

Take all these factors into consideration when exercising your “Inner Guru” and by all means hedge it based on your risk tolerance. It’s a long way down and no one wants to ride that roller coaster if this car falls off the tracks..The only evergreen bit of advice I’ll give there is to let it breathe a little. Any hedge tighter than 10% is going to be expensive and will probably be in and out of the money a few times before it really reveals itself.

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