Blue Belt Market Update: Short Gold

"dark gold"
Since the last edition of my weekly in September 2013, not a great deal has changed in the markets.  This is supportive of my belief that the markets rarely warrant looking at, except as a form of occasional entertainment.  Here is a look at some then and now numbers in various markets of interest:

market update March 2014

Still, I have continued to follow the markets on a weekly basis, partly out of habit and partly to look for trading opportunities.  One aim of my blue belt life is to cover a portion of my living expenses using the skills I developed over my 9 years as a bond trader.

One of the problems I had trading for an institutional market-making desk was that the emphasis is heavily skewed toward short term trading gains.  This is not a criticism of the business – we are put into large positions by customers and need to reduce risk quickly.  Rather, it is a nod to the fact that only a small subset of people are suited to day trading.  Most people, probably more than 90%, should take a longer view of the market.  My personality is suited to macro position trading – that is, taking long and short positions in major indices, currencies, or commodities, and holding them for a period of weeks to months.  My preference is to avoid leverage and stick to the core markets: S&P, 10y bonds, gold, etc.  This method allows me ample time to consider positions, and keeps risk reasonably low so that I can spend my time making music and my capital on long-term investments.

So what trading opportunities are we looking for in the macro market these days?  I follow a system based on sentiment analysis with a sprinkling of technical and fundamental value analysis thrown in for good measure.  I call it EVT analysis, for Emotions, Value, and Trend.  We look to trade when emotions reach an extreme in the opposite direction of the current trend, and we look to trade aggressively when good value is also present.  Here are my handy EVT trading grids:

EVT grid 1

EVT grid 2

Referencing the trend column from the main markets I follow above, this means we are looking for excessively bearish sentiment in US stocks as an opportunity to buy, and bullish sentiment in gold and US Treasuries as an opportunity to sell.  Right now, sentiment in US stocks is sky high (and has been for over 2 years) in the context of a bull trend – with valuation stretched I’m neutral stocks in the trading account.  Sentiment in gold, on the other hand, turned bullish as a result of the Russia/Ukraine situation.  The accompanying 17% rally also took gold to expensive valuation, so that was an opportunity to sell it short.1  Let’s take a look at some charts of the gold etf, GLD2 (from Mar 24):

Gold's bear trend

  A two-year bear trend in gold, with A and B marking major peaks and troughs (chart from Barchart Trader,

Gold 1y daily chart

  Price action in the last year, a possible head and shoulders bottom (chart from Barchart Trader,

As we can see, GLD is firmly entrenched in a downtrend, and will be so technically unless prices rise above $137 for a sustained period.  There is a technical case for a breakout above that level, as we see a potential “head and shoulders” bottom, denoted by the three red arrows.  Based on a technical projection, if the price breaks above the red resistance line, we could see prices rise to $154, which would also conveniently fill the falling-knife gap lower from April, 2013.  While I expect that gap to eventually close in the next stage of gold’s secular bull trend, recent short-term euphoria will most likely revert to pessimism and lower prices.

Through a combination of technical issues, prioritizing other things, and fear of putting on my first trade, I managed to miss the window of peak euphoria, just after Russia invaded Crimea.  GLD traded to a high close of $133 before giving back half of its Q1 gains in just two weeks.  Right now, at $124.5 and neutral sentiment, in a fairly mature bear market, there is no compelling reason to sell GLD aggressively.  Instead we establish a “core” short, which we will buy back if sentiment becomes depressed again or if the trend changes.

Trade: sell GLD short at $124.5
Take-profit: reversion to excessive bearish sentiment
Stop-loss: weekly close above $137

That’s it for now.  I look forward to picking back up this weekly tradition of the last several years (disclaimer: weekly is a loose term).  Until next time, good luck and good trading!

1 Bullish sentiment in US bonds also increased, but not as much as in gold.  In addition, speculative long positions in gold futures contracts increased substantially, while they remained subdued in treasuries.

2 I use GLD as it is liquid, does a very good job of tracking the price of gold, and price charts for it are more accessible than those of the spot gold price.