Gold Momentum Trading Strategy

In this article, we present you a Gold Momentum Trading Strategy, originally based on research by Cyril Dujava of Quantpedia, suggests that gold performs significantly better when its momentum aligns with that of other asset classes – specifically US Treasuries.

This article is based on an article by Allocate Smartly called Gold Cross-Asset Momentum.

Related reading: –Why Every Trader Should Diversify Into Gold Strategies

How the Gold Momentum Strategy Works: Trading Rules

The core of this Gold Momentum Trading Strategy is a well-established relationship between gold prices and Treasury yields. Instead of looking at gold in isolation, this strategy uses a simple two-step verification process at the close of each month:

• Measure 12-month Total Return: Calculate the 12-month total return for both gold (represented by GLD) and 10-year US Treasuries (IEF).
• The Signal: If the 12-month return for both gold and treasuries is positive, you go long on gold.
• The Exit: If either return is negative, the strategy dictates moving to cash until the next month-end evaluation.

Why Simplicity Prevents Overfitting

While many trading models are complex, the beauty of this Gold Momentum Strategy lies in its simplicity. Complexity often increases the risk of overfitting, where a strategy is too closely tailored to past data and fails in real-time.

While traditional gold momentum (buying gold simply because its own returns are positive) provides a benefit over buy-and-hold, adding the treasury requirement makes the returns even stronger. By requiring positive momentum in both assets, the strategy reduced exposure by 19%, effectively cutting out a significant number of low-performing months over the last 50 years.

Performance Insights: 50 Years of Data

Backtested results from 1970 show that this Gold Momentum Strategy has been consistent for over five decades. However, there are nuances to its performance:

• Cash Returns: Since roughly 2002, the advantage of the strategy versus a simple buy-and-hold approach has appeared to wane slightly. This is largely due to weaker returns on cash during that period, meaning investors weren’t rewarded as much when the strategy moved out of gold.
• Effectiveness: Despite the lower cash returns, the strategy remains similarly effective when looking strictly at the periods when the investor is actually in the market.
• Volatility: Gold naturally “runs hot and cold”. This strategy can go through long periods, up to two decades, where it might drastically underperform the broader market.

Here is the equity curve from Allocate Smartly:

These are the performance metrics:

We backtested the strategy ourselves and got the following results for GLD (the gold ETF) from its inception until today:

The return is almost 6% per year, while buy-and-hold returned 10.5%.

If we use the same trading rules on weekly bars, the results improve slightly:

The annual returns increase to 6.2%.

Gold Momentum Strategy: Final Thoughts

Because gold is highly volatile, this approach is generally not considered a standalone portfolio solution and should usually be limited to a small percentage of total assets.

Alternatively, it can be used as an overlay for other gold-related strategies. In an overlay application, an investor only follows a gold signal from another strategy if the Gold Momentum Strategy also confirms that both gold and treasury momentum are positive.