“The trend is your friend” is one of the oldest sayings in investment circles. The idea is that you should buy markets with recent positive returns. This should lead to greater profits than buying against recent price directions – or than trading in and out and trying to pick short-term tops and bottoms.
In the the age of sailing ships, merchant vessels would sail with the trade winds at their backs. In the same way, “trend following” investors try to pick the right time to buy a market or a security – and hold it until the trend comes to an end.
I don’t think that trend following should be the centerpiece of anyone’s investment strategy. Jumping on the bandwagon of what’s popular today is usually a great way to lose a lot of money. Quickly.
But in some ways, trend following is an extension of another old investment saying: “Cut your losses and let your profits run.” Huge profits – often over many years – can result from this strategy. And sometimes the trend can support a lot of other very good reasons to buy an asset.
Used in conjunction with other approaches to the market, trend following can help make a good investment a great one.
Gold’s trend is still up
Since the price of gold peaked on July 6, it’s fallen 8 percent. Meanwhile, the XAU index (which represents the share prices of gold mining companies) has fallen 27 percent. Despite the recent declines, they’re up 19 percent and 81 percent, respectively, since the beginning of the year.
Anytime that the price of an asset that you own falls, it hurts. Even if you’ve followed your stop-loss levels, it’s awful to watch your profits fade.
But I think the current pullback in gold is an opportunity to climb onto a trend that has much further to run. Fearful gold speculators will sell into near-term price weakness. Smart gold investors will use the current weakness to enter the market or add to positions with an eye to long-term profits.
How can you spot a trend? And how can trend following gold investors navigate the current gold market and reap big profits?
Trend following is an investment style that tries to identify markets or securities with price momentum. The accepted wisdom is that, in such instances, the recent direction of a price change will continue. True trend followers do not try to predict when a trend will end. Instead, their goal is to hold until the momentum ends.
One of the easiest measures of a long-term trend is the 200-day simple moving average. This is the average close of a security’s price over the last 200 days.
On a price chart, the 200-day moving average (200-day MA) is plotted creating a “moving” average line that changes each day. If the price of the security rises, the moving average will show an upward sloping line. If the price of the security falls, the chart will show a downward sloping line.
Plotting the “slope” of the 200-day MA is a simple way to answer the question: “Is the market in an uptrend?” If the 200-day MA is higher than the previous trading day, then the slope is positive and the trend is up. Likewise, if the 200-day MA is lower than the day before, then the slope is negative, and the trend is down.
Over the years, this simple indicator would have served gold investors well. It should not be used as a stand-alone indicator, but it can be a very useful support to an investing strategy.
Right now, despite its recent decline, the 200-day MA suggests that the trend of gold is up. Investors who like gold’s fundamentals should view the current pullback to the 200-day MA as a buying opportunity.
Sitting through pullbacks in the last gold bull market led to 100 percent gains
Below is a chart showing gold after the 2008 market meltdown. The slope of gold’s 200-day MA turned positive in December 2008. Investors buying when the uptrend began and selling when the 200-day MA turned negative about three years later would have nearly doubled their money.
However, gold trend-followers who hung on for the long term and earned big gains had to sit through some uncomfortable corrections. This included a nearly 9 per cent pullback from November 2009 through to January 2010. Focusing on volatile price action and reading news headlines about “the end of the gold bull market” would have shaken weak holders out of their positions.
The price of gold could still continue to fall, of course. But the fundamentals that have been behind the precious metal’s rise in 2016 still lend support to the technical picture of gold.
Here’s a review some of the reasons that I think gold will continue to rise in coming months:
- Zero interest rates. Gold’s surge in February of this year – which started the uptrend – coincided with the Eurozone’s and Japan’s accelerating negative interest rate policy (NIRP). By charging people to hold money in bank accounts, central banks hoped to encourage savers to put their money to work by buying things and investing in the economy. So far, this hasn’t worked. This matters to gold because a traditional reason for failing to hold gold (and silver) is that they don’t generate income. But in a world where investors must pay to keep their money in a bank account, precious metals are attractive by comparison – especially when prices keep going up.
- Gold as an alternative to fiat (paper) currency. NIRP and quantitative easing by central banks since 2008 are making paper currency less valuable. Printing money dilutes the value of a country’s currency. (No one knows where this ends – or what happens when the global economy becomes addicted to the adrenaline of more cash. Gold has been a tangible repository of value since ancient times. Its value as an alternative currency is likely to increase.
- Market bubbles are inflating. NIRP is causing distortions and bubbles in many global markets. Faced with minimal or negative interest on bank deposits, investors are chasing returns in markets around the world. This drives asset prices to levels that are unwarranted by underlying economics. The “free money” being printed by central banks is inflating market bubbles in many equity and real estate markets. When bubbles pop, gold will be one of the safest places to hide.
- China and the Muslim world are gold buyers. As we discussed previously, China has been aggressively accumulating gold over the last few years. Look for China to accelerate buying into the current weakness, helping to firm the gold prices. Also, as the status of investing in gold under Shari’ah law is clarified, more of the world’s 1.6 billion Muslims may enter the gold market.
- Brexit worries and global uncertainty. Gold’s recent highs came after the UK’s vote to withdraw from the EU. Since that spike in global fear and uncertainty, Brexit concerns have ebbed but could be ready for a resurgence. However, Britain’s withdrawal is likely to get increasingly messy. There are now fears that other countries could look to exit the EU. Worries of Europe’s biggest bank going bust are a wildcard with far-reaching implications for the global economy and markets. In the past, gold has been great insurance – and it has risen while other markets have fallen in times of uncertainty.
- The Trump effect. While the diminishing presidential chances of Donald Trump may have added to gold’s recent decline, any relief from a Hillary Clinton presidency is likely to be short lived. As we’ve written, Donald Trump’s popularity reflects an underlying discontent amongst a large number of Americans that isn’t going to go away. Whether or not there is a President Trump, he is creating space for other politicians to follow his path. The anti-government, protectionist sentiment that’s given rise to Donald Trump is a global phenomenon and will have worldwide repercussions in the months ahead.
So while short-sighted investors dump gold, take this opportunity to add to your positions. Certainly there are no guarantees and investors should, as always, maintain stop loss orders. But all signs point to a continuation of the gold uptrend in the months ahead.
One easy way to own gold is through the SPDR Gold Shares Trust ETF (code O87 in Singapore; ticker GLD on the New York Stock Exchange) or the Value Gold ETF on the Hong Kong exchange (code: 3081).