FMD Capital Management

Forget The Fundamentals On Gold

Written by David Fabian, October 15th, 2013

One of the most truly frustrating things in investing is to see a fundamentally sound investment seem to wither before your eyes.  No matter how much you research a particular security or theme, it sometimes just moves in the opposite direction despite all logical evidence to the contrary.  One of the best ways to explain this phenomenon is that “investing is not logical, it is psychological”.

Never has this been more prevalent this year than with the price action of gold. 

Given the fundamental backdrop of unending quantitative easing, rising overseas demand, depreciation in the US dollar, and a finite supply of the precious metal, it would seem that gold prices should be on the rise.  However, the spot price has continued to run afoul of nearly every significant momentum upswing this year.

This can be even more frustrating when the investment is a non-correlated asset class that does not respond to the same technical or fundamental price action as stocks or bonds.  Gold is known by some to be safe haven that can be a shelter from the auspices of a falling US dollar or rising inflationary effects.  To others, it is simply an investment to be bought or sold depending on the prevailing trend, production costs, or future outlook.

The SPDR Gold Shares ETF (GLD) has been in a persistent downtrend since it peaked in 2012 and every rally has been met with relentless selling pressure.  Hedge funds have shunned it, institutional investors continue to forecast its demise, and retail investors have never been more confused about the future direction of the yellow metal.

According to Index Universe, GLD has seen the largest net outflows year-to-date of any exchange-traded fund that they track.  The total investor redemptions have now top $21 billion through the middle of October.  However, recent quarterly data suggests that the outflows from gold-backed ETFs are slowing, which may be a sign that most of the weak hands have been shaken out of this precious metals sector.

From a technical perspective GLD has made a perfect head and shoulders pattern since it bottomed in June of this year.  That pattern is bearish and adds another level of concern that the next leg will be downward to re-test the 2013 lows.  There is certainly enough negative conviction in the marketplace to warrant another sell off.  However, there is also a very definitive level of support to wager on a modest bounce near these levels as well.

One of the biggest catalysts for a strengthening in the price of gold may well be a selloff in stocks.  If we see further volatility surrounding the debt ceiling deadline or a rapid change in the belligerent enthusiasm for stocks, it may provide a bid for precious metals like gold and silver as a safe haven trade.  Gold tends to strengthen during periods of global uncertainty which is what the current political climate is undoubtedly signaling.

How To Play Gold For The Remainder Of The Year

My recommendation for investors in this space is to play precious metals through small exposure with an eye towards risk management.  The fundamental drivers for gold have not been a factor in supporting prices this year which means that technical and headline driven dynamics will most likely take precedence.  There is still plenty of room for violent price moves in either direction which is why I am cautious about adding exposure right here.  I would prefer for GLD to regain its 50-day moving average and for a more discernible trend to develop before diving back in.

I am continuing to advocate staying away from gold miners because of their heightened levels of volatility combined with compressed margins on production costs.  Speculative investors that want more aggressive exposure may consider using a leveraged ETF for a quick trade with a tight stop loss to guard against downside risk.

Caution is warranted at this stage of the game, but there will be a time when gold prices come back into favor and being on the right side of that trade will lead to healthy profits.  Value seeking investors with a long-term time horizon or those that fear a decline in stocks may want to get a jump on this sector as a way of diversifying their portfolios.

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