Last Updated on May 21, 2022 by Quantified Trading
Trend following systems in gold work. Below we present a very simple trend following system in gold:
In this article, we look at how you can use the 12-month (250-day) moving average to outperform the gold price. Gold spends most of the time going nowhere, and it seems the 12-month moving average does a great job in capturing trends in gold. Trend following strategies in gold has worked well in the past.
Gold is different than stocks: it has no particular use and doesn’t provide any cashflows. If you own stocks, you own something that is producing value. Gold doesn’t produce many tangible values.
Moreover, gold doesn’t provide any services to society (at least very little). Additionally, you need to pay to store and insure gold. Despite all this, presumably gold has served as a good hedge against inflation for thousands of years. However, we believe the stock market is a much better hedge than gold:
We are no fans of owning gold, even though we own a few ounces. The reason for not owning gold is simple: it doesn’t produce any valuable products or services and gold requires cash outlays for storage unless you bury it in your garden. The good thing is that if all goes to hell, you can dig out your gold and use it for barter.
If you’re a gold bug, is it better to buy and sell gold by trend-following the gold price?
Trend following involves riding the trend. But what is a trend? You want to be long when the trend is up, and you want to be out or short when the trend is down. But just like stocks, gold has an upward bias, thus shorting is, of course, very difficult.
Besides, you need to define what a trend is, and in this article, we use the moving average to define the trend.
Prior to 1971, the USD was part of the Bretton Woods system, but in 1971 Richard Nixon “shocked” the markets and took the dollar off. Thus, from that date, the USD and gold were formally independent of each other. Because of this we only test gold from 1971 onwards.
Gold moves by leaps and bounds
Gold tends to move in leaps and bounds:
The monthly chart above shows that gold tends to move in leaps and bounds and being “idle” for long periods of time, something that bodes well for trend-following strategies.
Trend following gold by using moving averages:
Let’s first look at how the 12-month average fits on the gold price:
Some days back we published an article about trend following the S&P 500 by using a 200-day moving average, which is pretty similar to 12-month average:
How does a similar system work in gold?
We only have monthly prices in our database, and we tested by using a 12-month simple moving average.
The results are pretty good:
When the gold price is above the 12-month (250-day) moving average, we are long. When the gold price is below the average, we stay on the sidelines in cash. Such a simple system beats buy and hold by a wide margin. 100 000 invested in 1971 grew to 10 million by using the 12-month moving average system while buy and hold ended at only 4 million.
There are 26 trades in this period and the system is long as of today (May 2021). Slippage and commissions not included.
Which moving averages are best for trend following gold?
We tested several moving averages and we get the best results around the 12-month moving average plus/minus a few months. On a daily time frame, this equals a 200 – 250-day moving average.
Why does trend following work?
The main reason why it works is that it takes you out of big drawdowns. This is extremely important to compound efficiently. You got out early after the tops in 1980 and 2012 and preserved your capital.
Thus, you start the next trade on a higher “plateau”.
How to buy and sell gold: ETF or gold futures
Gold is a physical asset that is not easily transferred and it involves huge transfer costs. In practice, you only have two options: ETF (ticker GLD) or futures. In our tests, we only tested by using the spot price. If you tested on futures there is always the possibility that the result is somewhat different.
Gold futures exist in two contracts: the “normal” contract that has a value of 100 per point (177 500 USD in May 2021) and a mini contract at a much less value of 17 750 USD (a multiplier of 10).
Conclusion: trend following in gold works
Commodities often have huge moves up and down, thus trend-following tends to work reasonably well. The very simple trend following system in gold we provided in this article, has captured all the major moves. It has worked well in the past and we suspect it will continue to do so in the future, but there are no guarantees, of course.