I did a short Q&A this week with Drew Voros, Managing Editor at Hard Assets Investor. We talked about false moves and what I look for to initiate low risk trades in trending assets. It was fun. Check it out:
HAI: You’ve written recently about false price breakdowns in gold and how that can lead to fast moves in the opposite direction, as you like to say. How do you identify them?
Parets: The first and most important thing is to find a trend. One of the reasons that 2011 was difficult for stock traders was the lack of trends. We were down some, we were up some. But we were just in a sideways market. That makes it real difficult. But there were trends in other asset classes like gold. It’s been in a long-term bull market since the turn of the century, not just on an absolute basis, but on a relative basis as well, which I think is even more important, relative to stocks.
Back in 1980, the ratio of the Dow Jones industrial average to gold was 1-to-1. Over the next 20 years, that ratio went from 1-to-1, to 42-to-1. In other words, in 1980, one share of the Dow bought you one ounce of gold. In 2000, one share of the Dow bought you 42 ounces of gold. That’s the bubble that popped at the turn of the century. You don’t hear a lot of people talking about it. Ever since then, that stocks-vs.-gold ratio has been declining; 20-to-1, 10-to-1. Earlier this year we got below 6-to-1. Right now, if I’m doing the math correctly, the ratio is probably somewhere around 7- or 7.5-to-1.
But that trend is still down. Historically, gold doesn’t make top until that ratio is somewhere between 1–to-1 or 2-to-1. We still have a long way to go. We know the trend is there, not just on an absolute basis. We know gold is making higher highs, but on a relative basis, compared to stocks as well. Where do you get involved?
Let’s use gold as an example. Stocks can temporarily make new lows and quickly recover. A lot of times that might happen in a slow week. And, in this case with gold, that’s exactly what happened in between Christmas and New Year’s Day. Gold made new lows. And, sure enough, it quickly recovered and came back. Thursday [Dec. 29] was a key reversal day. It followed through a little bit on a slow Friday [Dec. 30]. And then, sure enough, we come back to work on Tuesday morning [Jan. 3], and we are a gap higher in gold.
Tags: $GLD $GC_F $DJIA