The 37 per cent peak-to-trough decline from its highs of September 2011 has been a severe test of faith for such believers, especially since the Federal Reserve and Bank of Japan are still busily practising the witchcraft of quantitative easing. However, the faithful also believe that its second coming might be nigh.
Gold tests the faithful
One reason for this latest glimmer of hope is the state of positioning in gold derivatives. The big players in gold - producers and merchants - have switched from being very short of gold to being much less so. This is an odd state of affairs. It is in the nature of the business of miners and processors to be short overall, as they seek to lock in the price of the gold that they dig up or handle.
Smart money getting more long
The flipside of this is that money managers - including hedge funds and other speculators - are heavily betting against gold. So, who is most likely right? Several studies have shown that the commercials - producers and others - are better at calling the market than the speculators. (For more on this, see my August 2012 article Follow the Smart Money - bit.ly/1djvHJw)
Following commercials pays off
Looking at the chart, spikes in the proportion of net longs among commercial traders do seem to have coincided with the onset of major rallies in gold. Some of these moves have been enormous, such as that from autumn 2008 where it rose from $750/oz to more than $1,200/oz over the next 12 months. Others have been sharp but short-lived, such as that from $1,570 to $1,784 in the third quarter of last year.
There is another possibility, of course. Gold could now have entered another long-term bear market. Towards the end of the secular slump - between 1995 and 1999 - commercial positioning was often substantially net long. (Even though the bear market in gold began in 1980, the CFTC positioning data only starts in 1995.) Perhaps we are returning to such a world today.
In the eyes of the true believers, I am surely a heretic. As I explained the other week, I see gold going very much higher - to $3,000 and more - once the present downtrend has run its course, but think that the selling may have further to go in the near term. Since I follow the trend, though, I am more than happy to try and ride another of the temporary but decent bounces that have happened four times since September 2011.
When to buy gold
So, what would be a decent buying entry? In a simple back-testing exercise, I find that the best opportunities in gold over the past two-and-a-half years have come when the nine-day exponential moving average (EMA) has risen above the 11-day EMA, and selling out upon the converse. This strategy would have produced a $177.25 profit from a total of four winning trades and nine losers. The reward-to-risk ratio was 3.9-to-1. A buy-and-hold strategy, meanwhile, resulted in a loss of $200.75.
For now, the nine-day EMA remains below the 11-day EMA. As such, I would not be seeking to buy yet. However, given today's speculative positioning, I would be especially willing to follow any crossover signal that occurred shortly. And that's better than just blind faith.
