The price of gold has retreated roughly $150 per ounce, or 11%, since peaking in April. The cause seems to be the usual suspects; a higher dollar, a lack of significant inflation, a stable stock market and a growing economy. Investors are busy focusing on the practice of chasing high flying assets higher than putting money to work in "safety" assets such as Treasuries and gold (my reference to gold being a safety asset is a loose one). Still, market sentiment is fickle and there are signs suggesting investors might soon have a change of heart when it comes to precious metals. Here are three reasons why now may be a good time to buy gold.
1. Seasonality is positive for gold futures
One of the first resources we consider when looking for trading ideas is MRCI (Moore Research Center, Inc.); here we find helpful seasonal patterns in the commodity markets and even detailed entry and exit dates for futures traders. We would rarely recommend buying or selling futures outright, we prefer to do so with option hedges to mitigate, or limit, risk and provide income. Nevertheless, according to MRCI, going long a December gold futures contract on July 24th and holding through September 6th has produced a profit in 13 of the last 15 years or 87% of the time. The average profit is a whopping $4,029. This is equal to about $40 in price change on a single 100-ounce contract because each dollar move is worth $100 to a futures trader.
I believe it is important to ensure everyone understands that seasonal patterns are merely a guide and are not a substitute for sound technical, fundamental and market sentiment analysis. For instance, although this seasonal trade looks like "easy" money on the surface, there is a scary reality lurking deeper in the data. For instance, the two losing trades sustained an average loss of about $7,745; one of the losing years produced a loss of $2,540 and the other was a loss of $12,950! On the flip side, the average winning trade (basically take the two losing years out of the math) was $5,840. As you can see, while seasonal tendencies shift the odds in favor of the trader, there is no such thing as easy money. Even on winning years, it might have been necessary to suffer through large drawdowns before the trade paid off. For instance, in 2013 the trade would have experienced a paper loss of just under $4,000 prior to turning around and making $6,640 in profits. Not everyone has the confidence and means to hold such a trade to the end. This is exactly why we convert such speculations to option spreads, or futures trades utilizing antagonistic options to hedge.
2. Market sentiment is extremely pessimistic
Being a contrarian at heart, I prefer to be bullish in markets most are bearish and vice versa. At the moment, gold is meeting my criteria. According to the Consensus Bullish Sentiment Index, a mere 28% of those industry insiders polled were bullish gold. The rule of thumb when using the index is to begin looking for contrarian trades when 25% or fewer polled are bullish or 75% or more are bullish. Thus, market sentiment appears to be extremely pessimistic and ripe for a shift. Similarly, according to the Commodity Futures Trading Commission's Commitments of Traders Report, gold speculators are the least bullish they have been all year. Although specs haven't yet gone net short the market, they have reduced their futures holdings to a relatively neutral stance. Both the Consensus Index and the COT Report have led me to believe the bottom in gold might be imminent.
3. Gold is finding technical support
The yellow metal hasn't been ideal for trend trading since finding support in early 2013 but it has been a counter-trend trader's dream. Dips below $1,200 have been relatively rare and short-lived while rallies have habitually stalled in the high $1,300s. Until that pattern changes, there is no reason to assume otherwise. Further, since posting the late-2015 low, gold has been making higher lows in increments of $75 (i.e. $1,050 to $1,125, then $1,125 to $1,200). Thus, there appears to be significant support near $1,200. Should this level give way, $1,125 could be seen but we are not expecting that to be the case. Instead, we believe the path of least resistance will be higher toward $1,350, which is what we have been seeing for years.
Note: There is a substantial risk of loss in trading commodity futures, options, ETFs. Seasonal tendencies are already priced into market values.
This column originally appeared July 25 on Real Money Pro, our premium site for active traders and Wall Street professionals. Click here to get great columns like this every trading day.
