Gold Breaks Out to Highest Level in 6 Years

Gold

The stock market and gold often move in different directions, but both are well up for the year. Both markets have done very well in June as well. Gold is on a real run now.

Back in the old days, investing in gold meant buying gold bullion and storing it. Gold has had a very long history of being a storage of wealth, and this goes back much further than even money itself.

For almost all the history of money, gold has been used to back money with a physical asset. It took a very long time for us to get comfortable with what we call fiat money, money that derives its value from a combination of government decree and market forces.

We’ve moved away from what we call the gold standard, gold backed money, as we have come to realize that this unduly restrains currency and monetary policy and the backing of the government is generally more than sufficient to inspire enough faith in people to use it as a store of value in itself.

Even though the role of gold has lost a little of its luster since we’ve moved away from backing currency with it, central banks still hold a lot of gold in reserve, and gold is making a comeback of sorts on this front as major central banks load up on it more. China and Russia in particular have been buying a lot more gold, with China tripling its gold reserves and Russia quadrupling it over the last 10 years.

These trends do influence gold’s price, and when countries are buying so much of it, this not only increases demand but decreases supply, as this gold is taken out of the market essentially. There is a finite supply of gold and it being taken off the table does make the remaining float more valuable, although we do need the demand for it to increase in order to drive prices up.

This is what we have been seeing lately though, particularly during the current month where gold prices are up an impressive 9% so far in just the last 3 weeks. That’s a pretty good return for a whole year with just about anything, and the run may not be over yet.

Gold is a pretty volatile asset though, and there’s no real way to take advantage of these shorter-term moves by holding physical gold, known as gold bullion. Gold bullion is comparatively illiquid, and in particular, involves high spreads where you are generally down a fair bit the moment you buy gold, because of the markup.

Gold can be bought on the spot market like all commodities, but investors don’t have the size to engage in the huge contracts that are traded, and instead must buy it from a dealer. The good news is that dealer markups have really shrank lately and you can turn around a position for as little as 3% now, where in the past these markups have been as high as 20% or more.

ETFs Have Really Transformed Investing in Gold

The big reason for this is that there is a new sheriff in town, called gold exchange traded funds or ETFs, and they have taken investing in gold into the 21st century, which have really put pressure on dealers to reduce their margins. With ETFs, all you need to do to buy and sell gold these days is just have a brokerage account, and you can enter and exit these positions as easily as trading stocks, and with comparable spreads.

Even a 3% spread with bullion is going to matter to shorter-term traders, but should matter to everyone, especially since there’s no good reason anymore to own physical gold. Gold bullion also involves additional costs such as delivery, storage, and insurance, as well as the time it takes to complete these purchases or sales.

With ETFs though, you can exit a position and get right back in immediately if you want, and although these are moves that are only really made by intraday traders, who trade gold futures and not ETFs, it is comforting to know that you can get in and out of trades in a matter of seconds if you need to.

In spite of what a lot of amateur investors may think, gold is really not an asset that you want to own with a long-term view, and it is certainly one that does need to be managed. We can get away with this methodology with stocks since they go up in value over time, but gold does not have this feature and instead bounces up and down within various trends, and only really appreciates over time by keeping up with inflation, as is the case with commodities generally.

If you don’t like timing your investments, you have no business investing in gold really, even though this is nothing like a rule and there is nothing stopping you from holding untimed gold, other than a lack of good sense. We could argue that nothing should be held this way, but if you at least have a positive expectation over time, you can get away with this strategy most times, but gold does not move like this.

Gold ETFs are actually a very tame way to trade in gold and the real money is made in the futures markets, although that’s where a lot is lost on gold as well, as the stakes are much higher. Few investors trade futures though, as this requires a certain commitment in making deposit minimums as well as a serious amount of trading skill, as well as a separate account.

While quite a few investors may have the means to trade gold futures, they view this as far too risky, and given their lack of ability, it becomes far too risky for them. Futures traders who have been long gold have made a lot of money, and those who have been on the short side have lost a lot lately, as futures trading greatly magnifies the size of our gains and losses.

Trading well involves managing risk first and foremost, and this is especially true with futures trading. Our real advantage is in magnifying both gains and losses and then placing strict limits on our losses while being more liberal with trades that we are ahead in.

It Always Needs to Be About Being in Gold at the Right Time

This means riding the winners up but not riding the losers down, and since gold provides some pretty big rides in both directions, especially when it is trading hot like it is now, there is some serious potential here to make a lot of money if you are good enough. This does not require genius or anything close to it but it does involve both an ability to spot trends and the resolve to execute your trading plan properly.

Gold ETFs do allow investors to speculate on gold without magnifying the risks and returns as leveraged trading does, which both futures trading and contracts for difference or CFD trading offers. The U.S. only allows contracts for difference trading with forex or foreign exchange trading, but several other countries permit this, and accounts can be opened with very small deposits and we can also trade very small amounts until we get the hang of this.

What we do need to realize though is that investing or trading in gold always requires us to manage our positions to some degree, and if we’re managing gold positions, we can also manage our stock positions as well. Therefore, there should always be a comparative analysis done between the assets, to first determine whether it is the right time to be in gold versus stocks, or vice versa.

Gold is on the rise though and could go higher now that it has broken the $1400 an ounce barrier. Whether it does, or how far it goes before it levels off or reverses, does require observation and we certainly don’t want to get in here and just watch it go down like a deer in headlights.

Stocks typically do better but not always, although stocks should still be our go-to investment generally. When stocks aren’t doing all that well, we can then look to other assets such as gold provided that gold is moving in a manner that has it preferable to be in.

This does not mean that we should just prefer gold if stocks are lagging, as they can both go down at the same time, just like they are going up together now. All things being equal, we should prefer stocks though when both are moving up, and be in neither if neither are looking good.

People worry about missing out on moves too much, and the goal of all this is to take advantage of probabilities, which is what investing is all about, whether it be with a stock, gold, real estate, a business, or anything else. This is the single most important thing, to have probability on our side or at least seek to have it on our side, and is also the single biggest thing that investors do not understand, from beginners to the so-called experts.

Gold is more difficult to time than stocks tend to be though, and we need to realize that to do this successfully requires more than just buying on a whim. We can choose whatever time frame we want, within reason, which means the amount of time on average that we expect to hold a position in gold, but we always need to keep an eye on how well or how badly our plan is unfolding and not hesitate to act when we see the probabilities go against us.

We aren’t just limited to the long side with gold though, and while we aren’t limited by this with stocks either, it is just as easy to go short gold as it is to buy it. If we are trading gold with futures or CFDs, there is really no primary side to the trade, as one person takes the long side and the other takes the short side and all trades involve pitting these bets against one another.

If you are trading gold ETFs, all you do is buy an inverse gold ETF if you want to bet on it going down, which are just as easy to get into as standard ETFs which own gold and its shares just get traded among investors.

Adding gold to the things that we consider investing or trading in can be beneficial if we come up with a way of doing this that makes sense, and it’s always about comparing what else we could be doing with the money and looking to ensure that gold is at least seen as preferable.

Gold has run up quite a bit over the last few weeks and while we may be up for entering now, we need to be particularly careful with entering positions after a run-up like this and if we end up being down quite a bit in our position, you should not just be hanging on and hoping it comes back, without a good reason to think this that is.

Otherwise, gold is looking pretty bullish right now, but that’s just now, and things do change. The wise investor will swim with the tide and get out of the water when it tosses them around too much, but if we do this, we can both seek to go after the nice returns that gold can provide without unduly subjecting ourselves to its perils.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.