A friend of mine, who is long GLD from approximately the futures equivalent of 1250 texted me this week asking whether he should dump his gold. My answer was that he should wait it out and be patient. Yesterday afternoon I gave him a call and I said I had changed my mind and that he should sell it. Here was my reasoning.
Speed is everything. I am a believer that the direction of gold is determined largely by the difference in the relative speed of the market on down moves as compared with up moves. What does this mean? Right now, as has been the case for some time the most swift moves in gold are to the downside. Is it because someone repeatedly comes in and dumps about 7000 contracts in one fell swoop? Perhaps. But whatever the reason, the bigger sweeps tend to be downward. A trader who sees this in the market is more likely to play from the short side because he knows that if he has a position on and the market sweeps, he is probably a lot safer being short. Over the past few weeks and months we have seen multiple market sweeps of between 8 and 20 dollars. I have often stared in disbelief at the screen thinking my trading system had failed. Each of these times, we have moved downward. A month of profitable trading can be swept away in a second when your talking about moves of that magnitude. Until there is a balance in which way the market sweeps (or simply less quick drastic moves all together), downward movement snowballs because the risk of stepping in from the long side can be that great.
It is not fear of getting caught in a sweep however that made me tell my friend to sell. As a holder of the GLD, he is not playing for 5 bucks the way a futures trader would. To a gold investor, these market sweeps are rather irrelevant. That being said, daily moves are quicker to the downside as well. Gold tends to test the numbers that are obvious. The 1530 area is on everybody's radar, and with the way gold trades you can ascribe a high probability that it will test at some point soon. While I continue to be a believer in the gold story and someone who believes we will probably make new highs in the next year, the likely speed of a down move is too great to risk being long here. My final words to my friend were this:
If we can manage to hold this 1581 number and build a base, then you can always get back in. If the story changes, and the downward momentum stalls, you can note that the environment has changed, and buy back your sales. Given what we are seeing now however, which is all we can really work with despite any long term feelings we might have, being long does not make too much sense. If it is 50/50 as to whether we move up or down next, then you would want to be short, because you will likely get more out of the down move. If I am wrong, and we move higher, I think you can probably buy it back giving up no more than 30 dollars. If we head down to 1530 (50 dollars lower) you have the benefit of watching the market, rather than panicking about where to stop yourself out.
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One thing I have learned is just how hard it is to time change in correlations between markets. In my philosophical mind, I believe that gold should trade inversely with the S&P, as people will once again flock to gold when things are bad. In my practical mind though, I see that gold is trading with the Euro, the Euro has broken 1.30, and the 10 year is now trading with a yield of 1.83%. 1.83% is lower than the stated (and I use the word stated intentionally) rate of inflation of 2%. While practically it makes no sense that we could even be having a conversation about a higher stock market in a world where people will let inflation outpace their income, we just have to accept it for what it is. There is demand for dollars in tough times, and it makes buying gold in dollar terms that much less attractive for now.
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