How We Trade Gold

Posted on

It’s no secret that we like to trade gold.  Our affinity for the yellow metal has nothing to do with its use as jewelry, store of value, or industrial use. We like to trade it because, over the last several years, there has been a predictable pattern in which it rallies strongly near the end of December, and then again in the June-July period. Catching these rallies with leverage can provide a nice addition to our annual performance, so we spend a lot of time trying to trade them effectively. Once gold is in the timing window for a rally, we look to the Euro, USD, Silver, and Gold mining stocks for dialing in our entry. These sectors all seem different, but they are connected in one way or another. We’ll take a quick look at each one to show what we look for, and why.

Screen Shot 2020-03-09 at 10.11.28 PM


Living in the US, we price gold in dollars. This means that if the dollar is rising, we typically expect gold to be falling. They may not do so on exactly the same day, and they may not trade inversely every single day, but in general, a rising dollar is bearish for gold, and a falling dollar is bullish for gold. You can see this inverse correlation by comparing the chart of gold above, with the chart of the USD over the same time frame, below.

The DXY is the “dollar index,” which measures its value against a basket of foreign currencies. To trade the DXY directly, you would purchase the ETF UUP. Because other sectors move in tandem with the dollar, but by a greater percentage, we very rarely trade the dollar directly. By far, the largest foreign currency in the dollar index is the Euro, at 57%.

Screen Shot 2020-03-09 at 10.17.20 PM


Since the Euro is the biggest competitor to the dollar, it stands to reason that the Euro and Gold should trend in the same direction—which is the opposite direction of the dollar. If you compare a chart of the Euro to the dollar, you will see they look like mirror opposites. You will also see that a chart of the Euro looks quite similar to a chart of gold over the same period. Usually, gold and the Euro will bottom within a couple weeks of each other, and when we are expecting gold to rally, we look at the Euro to help us with timing our entry. The ETF for trading the Euro directly is FXE, but like the dollar, we prefer other instruments that offer more leverage than a direct currency trade. EUO and ULE are leveraged ETFs that track the Euro.

Screen Shot 2020-03-09 at 10.22.54 PM


Silver is often referred to as poor man’s gold. While gold tends to be the go-to investment for big money, smaller traders gravitate to silver’s lower price. Silver is a much smaller market than gold is, and therefore more highly influenced by speculative demand. In general, silver will trend in the same direction as gold will, but by a greater percentage. Silver doesn’t always bottom or top on the same day as gold does. Think of silver as a little child taking a walk with a parent. At times it runs ahead, only to get distracted with something while the parent passes, then it sprints to catch up. When gold rallies for a couple of days, or by a greater percentage than silver did, we will often attempt to trade this discrepancy by buying silver and waiting for it to close the gap. It is possible to trade the price of silver directly through the leveraged ETF SLV, but our preference is to utilize leverage, so we typically trade the price of silver via 3X ETF USLV if gold is rising, or DSLV is gold is falling.

Screen Shot 2020-03-09 at 10.27.28 PM


The mining companies typically provide the most leverage to price movements in gold. In real trending moves, the miners will often provide 2-5X’s leverage to gold’s move. When gold isn’t trending up or down, the miners can also be influenced by the stock market, so over longer periods, the correlation won’t look as neat as the correlation between a currency and gold might. But if you look at the major bottoms, you will see gold and the miners bottom very closely to one another. Extra leverage in the miners makes sense if you think about it. Imagine if gold were selling for $1000/oz, and it cost gold mining company XYZ $990/oz to mine it, refine it, and bring it to market. When all is said and done, XYZ makes $10 profit for every ounce they produce. Now, if gold increases $10 to $1010 that’s only a 1% increase. Nobody is going to get rich off of a 1% return. But, for XYZ gold mine, a 1% increase in the price of gold means their profit goes from $10/oz to $20/oz. That’s a 100% increase! A company that is doubling its profits doesn’t go unnoticed on Wall Street.

Several indexes track a basket of gold mining companies. The HUI, XAU, and GDM are the most well-known. They are all quite similar, and there are ETF’s that track them directly, as well as ETF’s that provide leverage on them. GDX and GDXJ are non-leveraged ETF’s that track a basket of gold and mines. GDXJ tracks the MVIS Global Junior Gold Miners Index, which is basically a basket of junior (small) gold mining companies, while GDX tracks the stocks that comprise the GDM index, which is primarily large-cap gold mines. The HUI and XAU tend to be the most popular indexes for charting, so we typically chart them, but trade leveraged funds for higher returns. For the miners, we generally trade JNUG or NUGT if gold is rising, and JDST or DUST if gold is falling. JNUG and JDST provide 3x leverage of GDXJ, while NUGT and DUST provide 3x leverage of GDX.

Just like with silver, the miners don’t always rise and fall on the same day as gold does. It is when there is a divergence between them that we sense an opportunity. Roughly 75% of the time, the miners will lead gold at the turning points. When we expect gold to rally, we watch closely for the miners to lead the way. Sometimes, the miners will rally in a way that we can’t trade without taking on unnecessary risk. In those cases, we will look for a laggard, either silver or gold, and trade a leveraged ETF on one of them instead. That is why we sometimes buy JNUG, while at other times buying UGLD or USLV. Which one we buy depends on what the current price is, versus what the stop price would be. For example, if USLV is only 5% away from its stop, while JNUG is 15% away, we would likely be more inclined to purchase USLV, even though we expect both of them to rally.

Screen Shot 2020-03-09 at 10.30.18 PM

In summary—the rally in gold is what we are attempting to profit from, but we may do so via leveraged silver or gold mining ETFs. When we expect gold to rally, we also expect the Euro, silver, and gold mining stocks to rally. At the same time, we expect the USD to fall.

Wanderer Financial