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Gold and Commodities Get Ahead of Themselves

Gold

We hit a new high on the price of Gold today, and in examining the charts of gold, the gold miners, and the basic commodities, they have all gotten ahead of themselves.

As a risk management measure, we are booking some profits on these holdings – selling 20% to 33% of the position, depending on what it is – and locking in the gains we’ve experienced with the plan to buy back when the market is right.

In the chart of gold above, you can see that it is trading outside the upper blue band called a Bollinger Band. This band represents two standard deviations of price and volatility away from the 20 day moving average. Statistically, 90% of all price movement should be inside the two bands, and when prices move to or outside one of the bands, it is getting ahead of itself.

sales-gdx

This chart is of the Gold Miners Index ETF. You can see that it is similarly ahead of itself.

When using the bands, I like to confirm it with a couple of other indicators. The the chart above you can see that the Relative Strength Indicator at the top of the chart (called RSI 7) is showing a reading above 70. RSI is a momentum measure of price movement. Statistically, readings above 70 and below 30 point out short-term highs and lows in price movement. A reading above 70 confirms in my mind the reading on the Bollinger Band that the gold and commodity related investments have gotten ahead of themselves.

DB Commodity Index ETF

The chart above is of the DB Commodity Index ETF. On it you can see the third indicator that I like for situations like this, the Stochastics. It is a momentum indicator and as a rule it changes direction before the price of the underlying security. A reading over 80 indicates that statistically the closing prices each trading day over the previous two weeks has been at the high end of the daily range for an unsustainably long period of time. In other words, the way I like to look at it is that most of the buyer have already made their buys and the sellers are waiting to enter the market.

Based upon the confirming nature of all three of these indicators, we have booked profits in a certain percentage of the gold and commodity investments indicated above along with others (like Fidelity Gold Fund, Prudential Jennison Natural Resources Fund, PIMCO Commodity Real Return Fund, Junior Gold Miners ETF, DB Precious Metals Index ETF which have similar charts to those shown above).

You can’t read the minds of other investors, but these indicators give me a feel for the psychology behind the price movements that runs independent from the fundamentals. And short term, their is just too much hype about owning hard assets as an inflation hedge and the indicators show that prices have moved ahead of their fundamentals.

Our plan is to let the current situation play out – it may continue to move higher before it pulls back. That’s OK since we still have 2/3 to 4/5 of the positions on the books. But when the over-extended situation corrects itself, we will move that money back into those investments.

One question I get is why don’t we sell the entire position instead of just the 1/5 to 1/3 of it. The answer is that sometimes the indicators can be wrong. Over-extended situations can correct themselves in two ways, either by time or by price. With the three indicators in confirmation, it seems likely that a price correction is in the cards, but nothing is 100% certain.

Investment management is a process and not a zero-sum game. Gambling is a zero-sum game with winner take all results. In a process, you manage the situation based upon what you see happening in the market and you don’t make bets on outcomes.

You always read here that you should invest what you see and not what you believe. What I see is a segment of the market that has seen a lot of enthusiasm from investors who have gotten in late and pushed prices up significantly. The intermediate term fundamentals for investing in gold and commodities remains positive, but I see an opportunity to simultaneously manage investment risk and take advantage of a short term phenomenon that should allow us to book some profits now and reinvest that money at a lower price at some point after the over-extended situation resolves itself.


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