How to Profitably Trade the 2016 Gold Rush

Investors that buy commodities hope that someone will pay a higher price sometime in the near future, because of some speculative event. For this reason of “hope”, I personally have never been a big fan of gold. While it has some economic use, it will never pay a dividend and when bought, it basically just sits there and risks getting stolen.

Warren Buffet has a similar view:

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Gold was an everyday source of money not too long ago, but modern fiat currencies essentially make gold obsolete in that sense.  Everyday economic uses for the metal include: jewelry, computers, electronic parts, dentistry, and aerospace. So while you will never use gold to buys goods, you use it in your everyday life and might not even know it.

Since 2013 shorting gold has been a very profitable approach, but this might be changing. Over the last three months, there have been both fundamental and technical changes in gold which have caused me to get bullish.

Gold’s Fear Trade

When markets go into panic, traders will buy up gold. In a fearful market investors will avoid most assets involving paper money and turn to things that are material, just in case this is the time the world ends. This is a foolish long term approach, but it can work in the short term as a panic intensifies.

Looking back at the financial crisis, gold more than doubled, going from $800 an ounce to almost $2000. The fear of central banks losing control and endlessly printing money made gold an eventual alternative if everything fell apart.

However, the apocalypse never happened and gold eventually fell back under $1100 late last year.

This fear trade typically correlates with the VIX, but lately this has not happened. While markets have rallied earlier in the year, the VIX sold off and has remained low, but yet gold has continued to be strong, up over 20% this year. This is a very bullish signal as gold doesn’t seem to care what the stock market does at the moment.
The Effect of Negative Interest Rates

A fundamental reason gold has continued higher is negative interested rate policies by central banks around the world, the most recent being Japan. The country is a major economic power and their move to go negative brought buyers both gold and silver.

Gold as an alternative store of value suddenly looks attractive because you aren’t paying a government to hold your money when invested. Gold still doesn’t pay a dividend, but at least you aren’t paying for storing your money.

Looking at the chart below, we see gold since early January. The BOJ introduced negative rates in late January and since we have seen gold rise 15%, from $1120 to almost 1300 per ounce. A continuation or expansion of these policies could lead to higher prices.

Gold is Technically Turning Bullish

Below is a long term chart of the gold futures contract. Since the plunge in 2013, gold has slowly drifted lower in a nice bearish channel down to almost $1000 per ounce. Recently this channel has broken, we now see a challenge of the $1300 price level and a possible long term bearish trend line. If gold can break and hold 1300 I see gold coming hallway back from 2012 highs around the $1420-50 area.

This possible move higher will be controlled by central bank policies. If BOJ were to change their stance or if the Fed were to get Hawkish, gold will sell off, so pay attention to central bank policies when in this trade.

Now let’s get started on how to make profitable moves on gold…

How to Trade a Gold Move Higher

SPDR Gold Shares (GLD) – Perhaps the easiest way to play is buying GLD which will simply reflect the price of Gold Bullion. The trust holds gold bars that will only be sold to pay off expenses. With this fund you are essentially holding physical gold through the trust.

This ETF pays an expense ratio of 0.40% and pays no dividend. GLD is up almost 22% year to date and down 4.68% over the last three years. It has more than $33 Billion worth of assets under management.

VanEck Vectors Gold Miners ETF (GDX) – Seeks to replicate the price and yield performance of the NYSE Arca Gold Miners Index. Higher gold prices means higher payouts to those hat pull the commodity out of the ground. The gold miners become more profitable with every tick higher in gold.

This ETF pays an expense ratio of 0.53% and pays a dividend yield of 0.46%. GDX is up 88% year to date and down 4.46% over the last three years. It has more than $7 Billion worth of assets under management.

VanEck Vectors Junior Gold Miners ETF (GDXJ) – Replicates as closely as possible the price and yield performance of the MVISÃ Global Junior Gold Miners Index. The companies within this index are riskier and will go up faster when gold goes higher and head lower when the price of gold falls. This ETF would be considered risker then GDX due to its exposure to smaller sized gold mining companies.

This ETF pays an expense ratio of 0.55% and pays a dividend yield of 0.39%. GDXJ is up 100% year to date and down 8.4% over the last three years. It has $2.5 Billion worth of assets under management.

How to Gamble on a Gold Move Higher or Lower

I say gamble because the ETFs listed below are very volatile.  If gold moves higher you will be paid, but if it goes lower, these leveraged instruments can evaporate your investment quickly.

Direxion Daily Gold Miners Bull 3X ETF (NUGT) – This is the same thing as GDX just on steroids. It moves up and down three times as much and GDX and has very volatile and violent overnight moves.

Before today, it’s up 390% on the year, but down 55% over the last three years.

Direxion Daily Jr Gold Mnrs Bull 3X ETF (JNUG) – This moves just like GDXJ just on steroids. It moves up and down three times as much and GDXJ and like NUGT is very volatile. Considering that GDXJ is already riskier with exposure to smaller companies, the leverage makes this trading instrument on of the most volatile out there.

It’s up a whopping 476% this year.

Direxion Daily Gold Miners Bear 3X ETF (DUST) – This is the opposite of NUGT and showed be bought if an investor doesn’t think gold will be going higher. If the Fed came out tomorrow and raised rates gold would be sold pretty hard and this ETF would pop higher.

Because of golds strength this year DUST is down 92% year to date.

Profitable Gold Moves In Summary

Gold typically goes up with fear of recession, economic collapse, or war. In 2016 we have seen unprecedented moves by central banks that give investors a new reason to buy the yellow metal. Negative interest rate policies are forcing money to shift to gold as a store of value and this idea will continue to intensify until policies reverse course.

As I write this article Gold is off almost 2% for the day. This might be a perfect opportunity to get for the rest of 2016.

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