With the price spike in gold this week (spot gold up nearly 3% and gold stocks up around 7%) some of the perpetual gold naysayers are suggesting the metal had shifted to overbought status but that just is not the case. Below I explain why gold has taken off.
The above comments are edited excerpts from an article* by Frank Holmes (usgold.com) entitled Ah, the Power of Mean Reversion.
The following article is presented by Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and the FREE Market Intelligence Report newsletter (register here; sample here) and has been edited, abridged and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.
Holmes goes on to say in further edited excerpts:
Based on our historical observations, and the math of the markets, gold is not overbought but is simply:
- reverting to its mean and
- entering its seasonal up cycle, driven by cultural gold buying
1. Reversion to the Mean
Mean reversion has shown that eventually, both gold stocks and gold bullion will move back to their historical averages. 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.
Similarly, for gold bullion to reach overbought territory it would need another 20% move, and for gold stocks to be overbought they would need another 30% 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…Additionally, I remind investors that moderation is key when it comes to gold. Your exposure should be 5% to gold stocks and 5% to gold bullion, 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 followed by the Indian Festival of Lights, then the wedding season and, of course, Christmas.
This seasonal pattern is one of the most powerful drivers for gold demand.
Monitoring seasonality while remaining aware of other fundamentals to gold such as mean reversion and a prudent 10% portfolio weighting (5% in gold stocks and 5% in gold bullion, while rebalancing annually), are imperative to understand when investing in gold.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
*http://www.usfunds.com/investor-library/investor-alert/ah-the-power-of-mean-reversion/#.U6XEdlVOXIU (©2014 U.S. Global Investors, Inc. All Rights Reserved.)
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