By James Helliwell, Chief Investment Strategist
Last month I shared our checklist process that Lex and I use to analyse gold, which suggested owning it with a score of +2. When it comes to trading the yellow metal, you really need to be aware of the myriad of factors determining price (hint: it’s not just the US dollar!). For many people, it is one of the most misunderstood assets out there - and our job is to help you understand it like we do as professionals.
This month however, the score has changed. Even if you have never bought or sold gold before, there are important signals to be gleaned from how this commodity is behaving. For example, a stock investor might look towards mining companies based on this information, or consider the relative performance between rate sensitive sectors such as financials and consumer staples. Or, it may provide a heads up for traditional buy-and-hold portfolio of stocks and bonds on inflation expectations, and risk sentiment. And finally, a global macro trader may trade different currencies based on the outlook for debtor vs creditor nations, and emerging market vs developed market currencies (and don’t worry if this all sounds a bit complicated, as they are all basically the same trade correlated to gold). In summary, due to the complex nature of the gold market, it is highly responsive to numerous factors captured in our checklist.
Our Trading Club shares this approach with you, updated in real-time each month, based on our experience as professional investors. The checklist provides a systematic process that fellow hedge fund managers and traders employ to analyse markets, from which the biggest trading decisions are made. We have similar versions to analyse major currencies, stock markets and other commodities including crude oil, and score each factor +1, -1 or 0 depending on whether they are regarded as positive, negative or neutral for the coming month. The total ranges from +7 to -7, with a positive score indicating a potential buy, and a negative score suggesting that you may look to sell (closing long positions or going short). A neutral score of 0 suggests avoiding trades when there is no clear bias.
Excess liquidity. This is one of the best long run indicators for gold. For many years there has been positive ‘excess liquidity’ in the financial system, measured by the difference between the YoY change in the money supply and the YoY change in US industrial production. Whilst this remains the case, this year the rate of change has been slowing, with the spread rolling over. If this has peaked, and subsequently turns negative, this would be bearish for gold. For now though, the positive level is offset by disappointing momentum, and is awarded a neutral score. (0)
Real interest rate. The real interest rate is another exceptionally good indicator for bullion. Unfortunately this month, the combination of rising US rates and falling inflation (i.e. a rising real rate) is a very bearish signal for 'gold bugs’. If the scaling is to be believed in the following chart, then gold should trade below 1200 (but as you know, our process looks at a number of factors and does not follow any one indicator in isolation). (-1)
ETF Flows. There is negative divergence between the shares outstanding of the large physically-backed gold ETF and the spot metal price. This is another bearish omen for gold, and tends to occur fairly infrequently. ETF investors have been redeeming bullion, as gold has headed higher… Ideally we like to see ETF flows confirming the price action in the underlying market. (-1)
Futures positioning. We view speculative positioning as contrarians. In this case the net position is pretty much neutral, following liquidation of the longs which have driven recent rallies. Although this may be considered positive for gold at the margin, in the context of the prevailing range over the past 10 years thus us hardly extreme. On balance we regard this as neutral, but you could argue the case for a positive score over a very short term horizon. (0)
Options positioning. There hasn’t been a meaningful signal here at any time this year, with the relative demand for equivalent calls versus puts pretty much equal. If it were to advance higher then this would be considered negative for contrarians, but for now there is nothing to be done here. (0)
Short interest. Despite being one of the most surprising charts to us last month following a surge in short interest amongst related mining shares, this month we have seen the level of interest tick down slightly. If short interest is at an extreme, then it may indicate to us that equity market speculators are overly confident of an anticipated decline in gold (bullish for us). Whilst it remains elevated, the move down this month has in my opinion offset this, so we award a neutral score on the checklist. (0)
Seasonality. Finally, something to be optimistic about this month! August has in recent years been the next best month (after January) to own gold. However, this on its own wouldn’t be enough for us to be long - just look at the decline last August (-3%) and in 2008 (-9%). It goes to show why we dont trade anything in isolation and follow a comprehensive process in our trading to stack the odds further still in our favour. Still, this is a positive factor this month. (+1)
Summing everything up, we arrive at a score of -1 for gold heading in to August. This suggests switching to a negative bias in the precious metal during the coming month, following the +2 previously.
Regardless of whether you have ever traded gold, all markets are influenced by the factors captured in our gold checklist and investors in stocks, bonds and currencies are at an advantage over their counterparts with this insight. Join us at the Academy to ensure that you are on the right side of the market and apply this same process to stocks, currencies and other commodities with analysis from myself and Lex van Dam each month.
Have a great week trading,
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