GOLD, SPOUSES, FAITH, AND COMMODITIES by Steven Jon Kaplan, March 2, 2004

"I give my spouse full permission to be exactly the way he or she is." --Bill Ferguson's Mastery of Life,

What in the world does that have to do with the price of gold, you may be wondering. I am thinking about all of the articles that I have read about gold and gold mining shares over the past thirty years. So often one sees a comment such as "gold is bullish as long as it remains above its 200-day simple moving average", which I lifted directly off of a very well-known web site, or "continue to buy gold as long as it remains in its currently defined upchannel".

I, for one, have no intention of "continuing to" buy anything. For one, it would be tiring to put in a buy order every minute or two, thereby wearing out my fingers, missing lunch, and getting fired from my job. For another, even if I use a small trade size, I will eventually run out of money if I do any kind of "continual" buying. Personally, I suffer from the peculiarity of preferring to buy low and sell high. So I am like a leopard, waiting for the right moment to pounce, and willing to wait hours or even days if necessary rather than seize an inopportune moment. I would rather do one great trade per year rather than take a chance on ten trades that are marginally above average.

As for gold being bullish "as long as" it remains above its 200-day moving average, "as long as" gold shares are outperforming the metal, "as long as" on-balance volume remains positive, and especially "as long as" my brother-in-law isn't calling me to complain about his gold funds, gold is either bullish or it isn't. Like one's spouse, one either has to trust gold, or not trust gold. There's no in between. I don't say that I trust my wife as long as she doesn't come home late smelling of a different perfume. If I trust her, then I trust her, no matter what. If she does come home late smelling of a different perfume, she probably had a very tough day at work, had to suffer through an extended dinner with a client, and needs my support more than ever. Similarly, if I trust gold, then that trust must be absolute. I don't mean this in any religious or spiritual sense (though being religious and spiritual won't necessarily impair being profitable), but if gold is going to break below its 200-day moving average, or do anything else nasty or undesirable, then that is precisely the time when I want to be buying it with both hands and both feet. If I don't trust gold, then I should be trading something else, period. Unless I trust it in the exact opposite sense, in which case I should be selling it short. But if I only sort of trust gold, or only trust it when it behaves well, then I am going to get into very big trouble.

In July 2002 and again in March 2003, gold mining shares as measured by HUI broke below their 200-day simple moving average each time. Also each time, when the 200-day moving average could not be regained after several days attempting to do so, there was a sharp break to the downside, probably over disappointment at the failure to hold above the average. In each case, it was the best buying opportunity of the year for these shares. If I didn't have faith in gold shares, I would not have been able to buy them either time, and I might have even been panicked to sell. Even if I had been calm enough not to unload, if I didn't trust gold, I would have had to wait to buy until gold "proved" it was not in a bear market. Therefore, I would have had to wait until the 200-day moving average was broken and held to the upside, which naturally happened on a very sharp gap upward following a steady broken rally, meaning that I would have given up a substantial percentage of its total rise from bottom to top. However, since I had faith, when I saw my favorite gold mining shares failing to regain their 200-day moving averages, I wasted no time in putting in a ladder of GTC buy orders on each of them. That way, I was ready in advance for the anticipated breakdown. (For those who are not familiar with a ladder of orders, this simply means placing five to thirty buy orders on the same security, separated by an equal number of cents, such as a buy order for 100 shares at 68.63, then another 100 shares at 68.13, another 100 shares at 67.63, and so on. Maybe some readers are able to guess exact bottoms and tops, but I am not that smart.) When the collapse came each time, I could have been relaxing on the beach without a laptop or even a radio to follow the markets and I would have been completely confident. I didn't actually remove myself to that extent from the action, wanting naturally to see it up close, but the orders were in and I never considered for a moment removing any of them.

In contrast, there are quite a few investment advisors and others who were bullish on gold in June 2002 or February 2003, including some who were quite vocally bullish at each of those two peaks, but who turned bearish after the 200-day moving average was broken and held to the downside. (I won't mention the name of a VERY famous gold bull who turned "neutral" in March 2003, just before one of the best buying opportunities of the past 15 years.) Whatever their merits or failings as analysts, their fatal flaw was that however loudly they may have proclaimed the benefits of owning gold, deep down inside, they didn't have faith. As Thomas Paine knew only too well over 200 years ago, "These sunshine patriots will find themselves the subjugated servants of Tyranny." Those who are only fans of their favorite team when the team is winning, will soon discover that they will abandon their heroes just when they are about to achieve their greatest triumph.

Turning now to commodities, this is one field in which you simply can't find anyone bearish these days. Even with the U.S. dollar index apparently having temporarily broken out of a very sharp downtrend, those who wouldn't have mentioned the word "commodity" in a polite crowd three years ago are saying positive things about them, and pretending that they have been heavily invested in commodities since their exact bottom. Besides the fact that, as a true contrarian, I am happy to fade any nearly unanimous consensus, it has become impossible to find anyone who has anything negative to say. Not just difficult, but impossible. I checked twenty different web sites in the past week and found not a single bearish article about commodities in general. A reasonable percentage mentioned that this or that commodity was "becoming fully valued", which is a well-known euphemism for overpriced, but no one actually came out and said SELL YOUR COMMODITIES, which is why I'm saying it now, loudly and clearly, so that there is no ambiguity about it. Gold often leads commodities in either direction, and many who follow gold have noticed that even as it has declined from $431 to $391 over the past two months, the other precious metals, most base metals, and even relatively weakly correlated assets such as crude oil have generally continued to move higher, in some cases with a nearly vertical ascent in recent days or weeks. Perhaps gold has merely been making a false move lower by coincidence, and the U.S. dollar rally is pure coincidence, and the amazing percentages that some of these commodities have moved above their 200-day moving averages is also just coincidence. But the failure of anyone to say SELL YOUR COMMODITIES cannot be coincidence; it is the voice of the thundering herd mentality, and that is why I consider it one of the safest short-term plays available in the financial markets right now.

Steven Jon Kaplan, March 2, 2004