Six Reasons to Buy Gold or Invest In Gold
Paul 0. Martin
Senior Staff Writer
1. Gold’s Price Behavior Does Not Suggest A Bubble Top
Gold’s rise from under $1,000 an ounce to over $1,420 over the past six months appears dramatic but in fact is only a 0.7 standard deviation move for gold prices, per Credit Suisse.
The average standard deviation move of other bubbles—Japanese equities in 1986, the tech boom in 1999, and gold in 1979—is 5.3. Gold’s 180% spike in 1979 was a 10.3 standard deviation move, more than 14 times the magnitude we see today.
Technical Evidence: Upward Momentum Is Extremely Strong
If you look at a weekly (or monthly) chart for gold, the long term trend is very bullish, and long term trends don’t change quickly. Every indicator continues to suggest strong upward long term momentum that places the odds firmly on the side of more upside.
GOLD WEEKLY CHART FROM 2/2008
These indicators include:
•Gold remains firmly within the Double Bollinger Band buy zone, the area bounded by the upper 1 and 2 standard deviation Bollinger Bands
•Every shorter term moving average has crossed above the longer term moving averages, which are also rising. In the above chart the 10 week (blue) EMA (exponential moving average) has long ago crossed over the 20 week (yellow) rising EMA, which itself crossed over the rising 50 week (red) EMA, which itself long ago crossed over the rising 100 (purple) and 200 week (orange) EMAs.
In sum, such long term momentum suggests more of the same until proven otherwise, and lessens your risk of loss as long as your planned holding period is in months or years, not days or weeks.
Such strong momentum will not be broken quickly, so when it ultimately does start to weaken you’ll probably have time to close your positions without major losses, especially if you take profits on parts of your position when gold starts violating key daily and weekly support levels
2. Gold Lacks The 3 Ingredients Of A Classic Financial Bubble
Rodney Sullivan, co-editor of the CFA Digest, researched the history of markets and bubbles going all the way back to the 1600s. He found three key patterns in the 47 major financial bubbles that occurred over that time period.
Financial Innovation: A new investment opportunity appears, initially benefitting society. For example, low interest rates feed a boom in housing prices, adding to household net worth and making home ownership more accessible via easy credit.
Investor Exuberance: mainstream individual investors pile into the asset, further feeding rising prices. Again, the housing boom in the early decade is a classic case. Leveraged Speculation:
The established price uptrend encourages greater risk taking via leverage, i.e. borrowed funds that investors are unable to repay when prices in the underlying asset start to fall. At the peak of the U.S. real estate boom, use of excessive credit was rampant. Individual home buyers were leveraged 100:1, Fannie Mae 80:1, and Wall Street investment firms over 30:1.
3. Gold Is Under- Owned, Not Overbought
Eric Sprott, CEO of Sprott Asset Management, has given a compelling presentation arguing that gold as an asset class remains under-owned, not overbought. Key points include:
Despite a 30% increase in gold holdings during 2010, gold ownership as a percentage of global financial assets has only risen to 0.7 percent. While that’s a large increase from the 0.2% level back in 2002, the majority of that increase is due to an increase in gold’s price, not ownership levels.
Actual new investment into gold since 2000 is only about $250 billion vs. the roughly $98 trillion of new capital that flowed into other financial assets over the same time period.
The bar chart below from CPM Group shows gold as a percentage of global financial assets over time. Since 1968, when gold represented nearly 5 percent of financial assets, it has fallen to under 1%. Sprott wrote that “it is surprising to note how trivial gold ownership is when compared to the size of global financial assets.”
GOLD IS NOT OVERBOUGHT, REMAINS A SMALL PERCENTAGE OF GLOBAL FINANCIAL ASSETS|
The pie chart below from Casey Research further illustrates gold’s relative unpopularity, showing that gold and gold stocks remain only a minute proportion of the holdings of large institutional investors like pension funds.
GOLD UNDER-OWNED, NOT OVERBOUGHT, BY PENSION FUNDS
4. Ongoing Debasement Of The US Dollar – Short Term
In the near-term, hard asset prices are being buoyed by continued downtrend in the US Dollar vs. other major currencies. This is especially helpful for gold, because it is THE primary currency hedge and thus benefits more than other assets from a weakening US Dollar.
Per BCA research (via Frank Holmes), the Trade-Weighted Dollar Index (DXY) remains near the lows of November 2009, and is only 8 percent above the key March 2008 low. BCA attributes U.S. dollar’s weakness to four factors: •Federal Reserve balance sheet expansion via QE2
•The combination of low real interest rates, steeply upward-sloped yield curve, and rising inflation expectations that should continue in the US and elsewhere.
•The Euro has and retains its higher short term yield advantage. Remember that the EURUSD alone accounts for nearly a third of all forex trade, thus these two currencies tend to push each other in opposite directions like children on a seesaw. When one rises, the other is usually forced lower.
•Willingness of Chinese authorities to allow for Yuan (RMB) appreciation when the U.S. dollar is weak
No one believes that any of the above factors are likely to change in the foreseeable future. So the likelihood is for more USD weakness, which is bullish for gold, which is priced in dollars.
5. Ongoing Debasement Of The US Dollar & Other G4 Nations’ Currencies- Longer Term
When you have a long term combination of increased deficit spending, rapid money supply growth, negative real interest rates, then the inflation rate is higher than the nominal interest rate, and gold tends to perform well in that country’s currency.
So far we have not seen rapid money supply growth in the U.S., but the other two factors have been key to gold’s strong (but not bubble-like) uptrend.
The USD isn’t the only currency facing continued loss of value. Excess debt levels in the G4 mean that their currencies also face shrinking purchasing power, which in turn feeds the demand for gold from holders of these currencies as well.
Per a Credit Suisse report, the combined $6.3 trillion of excess leverage (aka debt) in the G4 economies (U.S., Euro-Zone, Japan and the UK) means that their central banks must keep real interest rates down to abnormally low levels. While the ECB has begun to raise rates, they remain historically low and it’s far from clear that the ECB will be able to get rates above 2% in the coming years, especially if rising oil prices continue to bleed growth from most of the EU and threaten default or restructures (partial defaults) of the PIIGS block nations
You can see from the chart below (via Reuters/Credit Suisse), which looks at US short term rates, that short term interest rates below 2% are bullish for gold prices.
Gold Rises When Short Term Rates Remain Below 2%.
The key takeaway point is that when the real Fed funds rate is below 2%, gold tends to rise. No one sees the US, Japan, or UK raising rates anywhere near 2% in the foreseeable future. The ECB may hit 2% over the coming year, but that’s far from certain, as noted above.
Again using the US as an example, the chart below shows how gold prices rise with rising deficits Current projections from the Congressional Budget Office [CBO] have the U.S. federal deficit at $1.5 trillion. Blogger Frank Holmes overlaid the rise in U.S. federal debt with the price of gold.
Rising Deficits Mean Rising Gold Prices
You should note that gold’s long term rally began in 2002, about the same time US federal debt began to balloon. Gold played catch up at first, but the two have correlated closely. Since 2002, gold prices have risen 308 % vs. a 119% increase in US federal debt, suggesting that gold prices tend to rise at over twice the rate of long term deficit growth
However lawmakers in Washington, D.C. show no signs of taking decisive action to cut the US deficit, so this fundamental prop under gold prices should remain in place and strengthen going forward.
6. Other Long Term Sources Of Rising Demand For Gold
Emerging Market Populations
Gold is a more popular store of wealth in emerging markets than in the developed world, and the purchasing power of emerging markets is rising as both populations and per capita incomes rise.
Rising Demand From Export Based Economies Diversifying Out Of The US Dollar
Both central banks and sovereign wealth funds have been diversifying out of the USD. Much of that cash is going into hard assets, especially gold. Much is also going into the Euro, though we believe this is temporary because the Euro-zone in its current form simply lacks the conditions needed for a successful currency union.
So how high can gold go? Opinions vary widely.
For the coming year, most see gold prices stable as the worst case scenario for gold and more likely higher. Credit Suisse sees gold at $1,550 per ounce by the end of 2011.BCA research says gold should stay in the $1,400-$1,600 range in 2011.
Longer term forecasts get more bullish, with Rob McEwen, former gold analyst and founder of GoldCorp, saying gold could hit $5,000/ ounce in the next 3-4 years.
A Simple, Controlled Risk Way To Buying Gold:
As a natural follow up to our 2 part series on the fundamental reasons why the long term gold uptrend is likely to continue, here’s an example of how to actually play this trend. Here we’ll show you an example of trading gold via weekly or monthly binary options. You may not be familiar with binary options, but you should be. Binary options are often ideally suited for trading strong trends because they simplify trend trading while limiting risks. The key is just to find a long term established trend on a monthly chart, and you’re almost done. The below illustration applies to any long term trend, like that of the AUDUSD.
How To Play The Trend With Binary Options
When you can find a really established long term trend on a weekly or monthly chart like the one we see below, weekly or monthly binary options are one of the simplest, highest return ways to play the trend while limiting your downside risk due to: •Weekly or monthly expiration forces profit taking and regular re-evaluation of the trend
•Fixed loss, no matter how much the asset drops
NB: We love trading long term trends because they are more reliable and stable than shorter term trends. That means the trend is more likely to continue, raising your odds of winning. You’ll need to use a broker that offers weekly and monthly binary options. Most only offer hourly or daily expirations. Only eztrader and anyoption.com offer weekly expirations, and only anyoption.com offers monthly expirations.
Here’s the monthly chart for gold shown below:
GOLD MONTHLY CHART MARCH 2008 – APRIL 2011
All that traders had to do was:
•Identify the strong trend. Longer term trends are more reliable than shorter ones, so weekly or monthly charts are a good starting point for identifying strong trends. There are a few binary options brokers that offer weekly expirations, and at least one, anyoption.com, offers monthly expirations.
•Buy identical sized monthly call binary options at the start of each month, for example, $100.
•Make sure that the amount risked, $85, was not more than 1-5% of their trading capital. That’s the extent of the risk management needed.
If traders used no indicators other than the Double Bollinger Bands and followed the simple rule of not going long until price enters the area bounded by the upper 2 Bollinger Bands, they’d have achieved 15 winning trades out of 19 months, a 78% win rate, and earned over 35%.
For those unfamiliar with using and interpreting Double Bollinger bands, see: 4 RULES FOR USING THE MOST USEFUL TECHNICAL INDICATOR, DOUBLE BOLLINGER BANDS for details.
Here’s the math behind that, which assumes 19 trades of $100, in order to easily illustrate how a 78% win 70% payout on winning trades and 15% payout on losing ones.
Payout Per $100
19 $100 Calls Amount Trade Total Total Gain % Gain
$100 15 $170 $2550
100 4 15 60
1900 2610 $710 37.36842
For those not familiar with this brilliant indicator, see 4 RULES FOR USING THE MOST USEFUL TECHNICAL INDICATOR, DOUBLE BOLLINGER BANDS.
I know what you’re thinking.
Buy And Hold Might Did Better: Cliff, gold rose over 40% during this period of September 2009 – April 2011, so why not just buy and hold? You could, but there’s never a guarantee that the trend will continue. The expiration forces a more conservative regular profit taking, and prevents traders from remaining too long in a dying trend. They’re forced to take profits at expiration and then re-evaluate the trend.
You Shouldn’t Ever Rely On One Indicator: Of course not. I’m merely showing how even an excessively simple use of just one indicator can be enough if one only selects very strong, proven trends. Indeed, traders using additional indicators in combination with the above might well increase their odds by timing their entries better, perhaps winning even during the down months by entering around the lower wicks of the candles, thus still winning because price closed higher than it was at the entry point.
The monthly expiration forced a more conservative profit taking each month. It also eliminated the at times complex exit strategy planning, and also the emotional stress traders endure when trends start to go against them, as they debate whether to take profits or give the overall trend a chance to resume
No Planning Optimal Entry Or Exits, Profit Taking Or Stop Losses
Of course, there are still some risk management issues. For example, position sizes should still never represent more than 1-5% of account capital. Also, the more skilled one becomes at identifying support/resistance points, the better traders can time entries during the life of the binary option and further put the odds in their favor.
Stay tuned for further articles on long term trends we’ve seen that are ideally played via weekly or monthly binary options. Hint: take a look at a weekly or monthly chart of the AUDUSD, a great candidate for repeated purchases of call options at the start of the month. Just check a few trend indicators, like the Double Bollinger bands. As long as the asset remains firmly in the buy zone, buy a call at the beginning of the month and you’re done. If it’s in the sell zone, buy a put option.