Back in August of 2011 as Gold was cresting $2000 an ounce we penned a missive on our website about the pending correction of a “parabolic spike”. That played out well as prices subsequently declined to $1550 an ounce. Just recently we updated that analysis in our weekly newsletter which covered the technical analysis of the markets in general including the shiny metal. Gold has been on a tear outperforming the broad markets as concerns about Greece and a rush for returns by mutual funds and hedge funds have driven gold higher. In the month of January alone the S&P 500 moved higher by a little over 4% while gold surged ahead by 11%.
So, now is the time to jump back in – right? Not so fast. Newton’s 3rd law of Physics states that “…every action has an equal and opposite reaction” and large movements in price in one direction have a responding directional move in the opposite direction at some point. One of the charts that we like to look at in this regard is the deviation in price over the last 60 days. Price has an elasticity and can only move so far in one direction before “gravity” will begin to pull it back in the opposite direction. This is why using moving averages are very important technical tools for any trader’s tool kit. As prices move up and down over time moving averages, such as the 50 day or 200 day, give a better idea of both the current magnitude of a movement in price as well as the most likely retracement of that move.
The problem for most investors is that they tend to get sucked into the excitement of a movement whether it is in equities or gold. For example, Gold is currently approaching very overbought levels in the market and now people are starting wondering if now is the time buy. While gold is rallying currently – it is rallying in the context of negative, or bearish, trend. There are two rules that any investor should adhere to in the overall market whether it is equities or gold. When markets are trending bullishly, a rising trend, investors should by dips, or declines in price, to previous levels of support. In negative, or bearish trends, investors should be selling rallies and raising cash. As the markets gyrate between bullish and bearish trends these two rules will keep average investors from making the most classic of all investment mistakes – “Buying high and selling low.”
We use weekly moving averages, rather than daily, to help reduce portfolio turnover and volatility as we look for changes in directional trends rather than short term trading opportunities. Currently, the two moving averages that we use, the 13 and 34 week moving averages, have crossed each other with the shorter duration moving average going below the longer. This is a classic signal that dictates profit taking from the recent run up in price as the price action is still likely negative. The last time this occurred was during the 2008 correction in gold prices which clipped 30% of valuation off of the metal. I am NOT saying that this will happen again, however, it is important to note that for investors these types of technical signals can typically provide clues as to future price action. Therefore, for individuals wanting to add gold to their portfolio, today is most likely not the day as a further price correction is needed to work off some of the excess recent price movement. In order to “buy low” we will have needed to have sold some at a higher price previously. The process of buying low and selling high is not a novel concept – it is just one that is rarely followed. The opportunity to add more exposure will come as the price action improves – but today that case cannot easily be made.
Gold remains in a long term secular bull market. However, that does not mean that gold cannot have massive corrections in price along the way. The problem for most investors is that are emotional beings. When prices rise they convince themselves this is the time to buy as “greed” overtakes logic. Likewise when prices decline and “fear” leads to panic selling rather than bargain basement buying. As investors we only have one job with gold, as it pays no dividend and has no earnings, which is to buy it at one price and sell it at hopefully a higher price. It is speculation in its purest form.
Therefore, applying some form of price analysis to your investment strategy is key to your long term success in owning the precious metal. Just remember your goal is to buy low and sell high. The key is complying with those goals in the right order.