Gold Price Not Overbought But Reverting To Its Mean
June 22, 2014
In this article, author and fund manager Frank Holmes from USFunds.com looks at the recent gold price action and puts it into perspective.
The gold price was at record lows, in extremely oversold territory, only six months ago. Sentiment was extremely negative, so it’s no surprise that price spike of this week consider gold in an overbought status right now. The key question which this article focuses on: “Is gold overbought?”
Based on historical observations and the math of the markets, gold seems NOT overbought; it is simply reverting to its mean. This mean reversion has shown that eventually, both gold stocks and gold bullion will move back to their historical averages.
From USFunds.com:
Right now, as you can see from the chart below, gold stocks have seen a reversal to the long-term mean, but we are still waiting for gold bullion to do so as shown in the second chart.
^gold stocks price oscillator between 2004 and June 2014
^gold price oscillator between 2004 and June 2014
Similarly, for gold bullion to reach overbought territory it would need another 20 percent move, and for gold stocks to be overbought they would need another 30 percent move.
There is always an emotional bias against gold, whether it is soaring high or dipping low, and that is why it’s important to manage these emotions when positioning a portfolio. At U.S. Global Investors we look objectively at the action of both gold stocks and gold bullion by monitoring these long-term data points and paying attention to buy and sell signals based on the trend of mean reversion.
Additionally, I remind investors that moderation is key when it comes to gold. Your exposure should be 5 percent to gold stocks, 5 percent to gold bullion, while rebalancing annually.
Another reason that gold is moving is it’s beginning its seasonal cycle, driven by cultural gold buying. The demand of gold reflected over the next several months and characterized by the purchase of the metal for cultural celebrations and religious holidays, I refer to as the Love Trade.
If you look at the chart below, you will see that July marks the beginning of the Love Trade with the celebration of Ramadan.
^gold price chart with historical patterns
The Indian Festival of Lights comes after, followed by wedding season and, of course, Christmas.
This seasonal pattern is one of the most powerful drivers for gold demand. Monitoring this pattern, while remaining aware of other fundamentals to gold, such as mean reversion and a prudent 10-percent portfolio weighting (5 percent in gold stocks and 5 percent in gold bullion, while rebalancing annually), are imperative to understand when investing in gold. These trends allow us to manage short-term swings, small or large, that usually cause more concern than they are truly worth in the long term. |
