Why Were Buying Physical Gold with a $1700 Target
(November 15, 2017 - by Vince Lanci)
For What it is Worth: We are buying Gold in our small family fund. This is a trade, not an investment. Potentially a much longer term trade for us than normal, possibly a 12 month hold as opposed to our 3 day positions. We are buying physical in quantities that will not need to be sold if we are wrong, thus no leverage. We will also be swing trading gold with an upward bias as our indicators dictate below $1260 or above $1306.
Target picking is risky in an asset whose value is largely based on sentiment and prone to being "jawboned" into its proper place. But we believe for various reasons that if Gold does not pierce $1260 spot, its chances of a rally topping between $1450 and $1700 are strong over the next 12-18 months. The wide target range reflects the emotional factor in Gold’s behavior far outweighing supply, production costs, and its lack of fundamentals to measure using tools like EBITDA, PE, and cash flows. And our own analysis is corroborated from several different disciplines from whom we did not seek out to rationalize. It’s a trade, that’s all. But it’s a very good and very rare risk reward trade. it has set up right now. Further, it will either be violently and decisively confirmed (or negated) above $1306 or below $1260.
Why are we sharing this? That same question should be asked of Ray Dalio, Jeff Gundlach and others who announce they are bullish on Gold after they have bought. Our own position is not relevant to the market overall and we do not need to market our tiny positions to create an exit strategy a la George Soros. The premise for the trade happens so rarely its worth writing about, if for no other reason as an exercise in outsourcing our self-discipline on the trade.
Step 1: Volatility is Coiling
When trading short term periods, intraday and intraweek, we use a volatility system for alerts to incipient movement. We risk 1 to make 2 and move on when wrong. It works about 50% of the time. it is net profitable. And best of all, positions that are in limbo are closed expeditiously. This is after all a volatility system. No vol, no position. It’s been cited here many times in the past. When it is right, it is very right. when it is wrong, you are out. Past posts and a 25 year track record of use bear this out from our active days. The bottom of this post goes into more detail on its use.
What we never did at Echobay or its predecessor fund CIS Energy, was use it on long term charts. We certainly looked at them, but only for bias in shorter term trades. Last month we took a serious look at our VBS algorithm on a monthly chart. Here is what we found:
Step 2: How Equity Funds Play Gold
Portfolio managers at large equity funds who have contributed here anonymously use systems that advise them when being in cash as opposed to long stocks is prudent. What is also known is that funds like these punt gold positions with their discretionary in-house money for fun.
They use similar systems for entry and exit, and never risk much in their positions. Gold is a hobby to these guys. As a result, they like to buy and walk away with long term trade orientations and firm stops. This means using long term moving averages to avoid noise. We know this is true. And here is an example of how that type of positions is implemented:
In a recent interview a vocal critic of the Gold industry explained why he was buying Gold
…Gold is poised to close above its 12-month moving average for the second straight month. Going back to 1970, the average monthly return for gold following a close above the 12-month moving average is 1.47%. The average monthly return following a close below the 12-month moving average is -0.15%.
If you used the simplest of trend-following methods, investing in gold when it was above its 12-month moving average, and going to cash when it is below, the results would have been far better than just buying and holding gold. He continues:
The chart below shows when you would have been invested in gold and when you would have been out. Granted, prior to GLD, this could only have been done with futures contracts, or gold bullion, with the former adding a degree of leverage that I would not have been comfortable with, and the latter adding a degree of paranoia that also would have made me uncomfortable.
About Physical vs. ETF: While we agree with the rationale behind GLD vs futures if you are trading and not investing, we feel for multiple reasons the physical gold market is going to open up and become a serious competitor to ETF allocations within 12 months. Specifically, blockchain products are coming, and if properly implemented as a pipeline, owning physical gold not held in trust by a GLD custodian will be as easy as clicking a mouse. You will buy and sell physical Gold that will be yours and verified via the blockchain system.
So for us, physical gold now has the benefit of increased liquidity on the horizon, which means increased transactions and exposure. Which ultimately means decentralization of the Gold market from a few large firms to grass roots stackers, owners, and value preservers. We view emerging technologies as putting physical assets in a position to have their true value unlocked. Whether that be the tea farmer in India who can’t currently get a loan on his land due to government rules, to Silver whose value is somewhat disconnected from its price. The effect will not be unlike when a private company goes public. Accessibility and liquidity creates safety and increases demand. Owning physical metals is like owning a beneficiary of technology down the road.
