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Commodities: A Golden Strategy

By Andy HechtCommoditiesOct 01, 2021 03:29AM ET
www.investing.com/analysis/commodities-a-golden-strategy-200603551
Commodities: A Golden Strategy
By Andy Hecht   |  Oct 01, 2021 03:29AM ET
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This article was written exclusively for Investing.com.

  • Gold has been bearish since August 2020
  • Following the trend removes stress and allows the market to work for you
  • Turning profits from short positions into gold
  • Monetary and fiscal policies support gold for at least three reasons
  • Buying physical gold is the only way to guaranty you own the precious metal

Gold has been disappointing since reaching an all-time nominal high at $2063 per ounce in August 2020. Since then, the trend has been primarily bearish, but each time gold looks like it will cascade lower, it recovers. Conversely, when it seems like it is ready to make a run for the highs, selling appears to push the price lower. 

Over the past months, the $1800 per ounce level has emerged as a pivot point for the yellow metal. As of Sept. 29, the price of the active month December COMEX futures contract was well below the pivot point. 

I am a gold bull, but I do not subscribe to the almost religious allegiance to the yellow metal. There is a vast difference between understanding and embracing gold’s role in the financial system and the angry fever expressed by many gold bugs who seem to get angry when the price drops. They point to manipulation and other factors when a decline means that sellers are more aggressive than buyers. The bottom line is that there is manipulation in all markets, so deal with it and adapt.

My gold strategy is simple. I follow the prevailing trend using a systematic, algorithmic approach that is short as often as it is long the precious metal. My short-term orientation is completely agonistic. However, all of the profit I extract from my trading is plowed back into the metal as I use it to buy physical gold. 

Gold has been bearish since August 2020

Since reaching the all-time high in August 2020, gold’s trend has been bearish.

Gold Daily
Gold Daily

Source: CQG

The weekly chart shows a series of lower highs in gold over the past thirteen months. Weekly price momentum and relative strength indicators are below neutral readings and falling, highlighting the bearish technical trend. 

Meanwhile, the total number of open long and short positions declined from 550,509 contracts on the day gold reached its peak on Aug. 7, 2020, to 490,856 contracts on Sept. 28, 2021. The drop of 59,653 contracts or 10.84% is not typically a technical validation of a bearish trend in a futures market, but it is hard to argue with the adverse price action.

Another reason to pause is that gold has made higher lows since reaching $1673.30 on the continuous futures contract during the week of Mar. 8, 2021. During the final week of March, it fell to a higher low of $1676.50. In August, the low was at $1692.60 on the continuous contract, which is the current technical support level to watch on the downside. Gold was trading below the $1725 level on Sept. 29 and trending towards a test of the August low. 

The bottom line is that gold has been in a bearish trend for over one year, and the trend in any market is always your best friend. 

Following the trend removes stress and allows the market to work for you

I follow a simple principle that took over four decades to refine when trading in any market. I allow the market to work for me instead of working for the market. The price of an asset is never wrong because it is the level where buyers and sellers meet in a transparent environment. Prices trend higher when buyers and more aggressive and lower when sellers dominate buyers. 

In his 2004 work, author James Surowiecki demonstrated that groups make better decisions than individuals. Surowiecki’s principles apply to markets. Markets reflect the wisdom of the crowd. Following the crowd or the price trends tends to be the correct approach to trading as the price flows reflect collective wisdom. 

Meanwhile, trading or investing can create lots of stress. I have found that trend following reduces that stress and allows me to remove fear and greed emotions from the decision-making process. In gold, I go with the flow and follow the path of least resistance on the long and short sides. I embrace hold’s history but am agnostic on the price direction, only following the herd of buyers and sellers to achieve an optimal result. 

Turning profits from short positions into gold

I am not a gold bug but embrace gold’s role as a store of value and the most significant reserve currency. I am not alone; central banks, monetary authorities, governments, and supranational institutions all hold gold as an integral part of their reserve assets. Over the past years, they have been net buyers of gold. 

I always take my short-term profits from trend-following trading and use them to increase my physical holdings of gold bars and coins. I do not sell the physical metal as I view it as a legacy asset for future generations that will continue to be the store of value it has been for thousands of years. 

Monetary and fiscal policies support gold for at least three reasons

I may be agnostic about the path of least resistance of gold’s price over the coming days, weeks, and months, but I am bullish for the long term. Monetary and fiscal policies have weighed on the value of all fiat currencies, and I expect monetary and fiscal policies to support gold for at least three reasons: 

  1. Central banks and governments have become addicted to low interest rates. As debt levels grow, increasing rates cause debt servicing to increase. As the US debt moves towards the $430 trillion level, each 25 basis point increase in the Fed Funds rate will cost an extra $75 billion in debt servicing costs.
  2. Even if the central banks tighten credit, government spending continues to skyrocket. The US is now debating a $3.5 trillion budget and $1 trillion infrastructure rebuilding package. Fiscal stimulus will continue to overwhelm the Fed’s monetary policy over the coming years, leading to either rising inflation or stagflation. In either case, prices will continue to rise. 
  3. Tax hikes will not scratch the surface when it comes to rising debt. While the Biden administration has promised that the fiscal initiatives will not increase the debt levels, I believe that is a financially irresponsible leap of faith. Rising debt in the US erodes the dollar’s value. As the US dollar is the world’s reserve currency, other fiat foreign exchange instruments are likely to continue to follow the dollar on its bearish path. The rising costs of goods and services are proof of the decline of fiat money. The rise of the cryptocurrency asset class is a threat to the government’s control of the money supply. Even if cryptos do not survive, they have made a commentary on the declining value of money. Fiat currencies derive value from the full faith and credit of the governments that issue the legal tender.  

Gold is a metal with intrinsic value validated by governments worldwide. Gold has been a store of value for thousands of years. Current policies are likely to support its price for the long term. At the turn of this century, gold reached a bottom at $252.50 per ounce. Over the past two decades, every significant dip in gold has been a buying opportunity. The dips can last for long periods, which is why I follow the trends. The dips have been golden opportunities to buy, which is why I shift profits from fiat currencies into the precious yellow metal.

Buying physical gold is the only way to guarantee you own the precious metal

There are many choices for gold investors. Unleveraged and leveraged ETF and ETN products track gold’s price. Futures and options contracts allow market participants exposure to gold’s price without holding the metal. Gold mining shares are investments in companies that extract gold from the earth’s crust. However, they are all derivatives, while the only direct route is the metal itself. 

There are no guarantees that ETF and ETN products will perform and track the gold price in a crisis. Futures and futures options could diverge from gold if the exchanges and regulators decide to alter the rules of the contracts. Gold mining companies could lose their luster if governments decide to nationalize mines or if other problems arise. Gold bars and coins are the only way to ensure that a gold investment is golden. 

I use all of the derivatives in my pursuit of following trends. When the trend is my friend and yields profits, I plow them directly into the metal, which is a strategy I have followed for decades. 

Commodities: A Golden Strategy
 

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Commodities: A Golden Strategy

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Comments (14)
Jason Patcher
Jason Patcher Oct 03, 2021 4:34AM ET
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nice article, thank you
Balopi Kebapetswe
Balopi Kebapetswe Oct 01, 2021 1:55PM ET
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Quite a 'realistic' and decisive article...Thanks.
Farrukh Dall
Farrukh Dall Oct 01, 2021 10:05AM ET
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insightful
frendy glasser
dejong099 Oct 01, 2021 9:44AM ET
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Interesting strategy, biggest take away for me is the notion of treating the physical holding as legacy.  That is, the idea isn't to trade it like other investments.  The challenge I have found when purchasing the physical bars and coins are the enormous premiums that sellers are asking for.  Occasionally, I find gold selling at a 4% premium, but usually only in larger sizes (like a 10oz bar). On the other side of the trade is selling, physical gold is not liquid unless you take a sizeable discount.  The author here doesn't care about these issues as they are insignificant over a generational timeframe.  To wit, my dad bought a bunch of 1oz gold coins (and silver) over his lifetime that we only found after he died.  I don't know what he paid, but at the current price of gold, I'm sure it is a good profit.
Alan West
Alan West Oct 01, 2021 9:33AM ET
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Gold isn’t a currency. I can’t go out and buy things with it.
my name
my name Oct 01, 2021 9:04AM ET
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"...US debt moves towards the $430 trillion level" PROOF? SOURCE?
Meru Pet
Meru Pet Oct 01, 2021 9:04AM ET
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what do you see yourself with a chart analysis?
Rob Hatcher
Rob Hatcher Oct 01, 2021 8:21AM ET
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Do you include gold coins as physical?
Chris Guy
Chris Guy Oct 01, 2021 8:14AM ET
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As a group we should all pull into NUGT and buy. Please, lol. I'm holding a bag of smelly ********
Vinicius de Brasilia
Vinicius de Brasilia Oct 01, 2021 8:10AM ET
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Andy, when you say physical gold would you includ IGLN or GBS and GBSS (assests at XLON - LSE) as well?
Vinicius de Brasilia
Vinicius de Brasilia Oct 01, 2021 8:10AM ET
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Andy??
Nick Name
Nick Name Oct 01, 2021 7:52AM ET
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The
Ivan Dalion
Ivan Dalion Oct 01, 2021 7:06AM ET
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I think you mean the world debt is reaching 430 trillion, not the US debt?
Ivan Dalion
Ivan Dalion Oct 01, 2021 7:06AM ET
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And it's still a 100 trillion away from reaching that, so I don't understand what you mean by "us debt is reaching 430 trillion". Nonsense.
hamid hamid
hamid hamid Oct 01, 2021 5:46AM ET
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excellent , thank you Andy It was very helpful
Epiphron FT
Epiphron Oct 01, 2021 4:20AM ET
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Great article! Thanks Mr. Andy.
Amie Inconnue
Amie Inconnue Oct 01, 2021 3:53AM ET
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Thank you for the article, Andy! A question: is there a way to minimize the cost of buying and holding gold? Won't insurance or bank safe cost eat into physical gold holdings over time?
 
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