Forget Gold… At Least Until June

I had a dream that one day I would be rich and I could switch out all my normal jewelry for gold jewelry to finally acquire that classy 1980s gangster look. Then it hit me: Why don’t I just invest it all in gold directly? Jokes aside, this is a legitimately good question for a starting point to a gold investment because it hits the investor deep and where it matters: What exactly is a gold investment?

So, we know gold trades like a commodity, but we also see it used as a hedge. Unfortunately, gold cannot be treated as a pure commodity because it is not necessarily consumed by its buyers (except for the jewelry and electronics industries), but rather held like a stock. It is not a great hedge, either, as we will see later in this article.

Overall, the best gold investments are timely, made based on either clear macro theses or on seasonal commodity theses. The average investor holding gold as a hedge is often acting sub-optimally due to 1) the existence of better hedges, and 2) the fact that gold trades like any other commodity on the futures market.

Today, I want to dispel some myths about the gold hedge, discuss gold seasonality, and provide a superior holding strategy for those using the SPDR Gold ETF (NYSEARCA:GLD) as their gold investment.

Gold as a Hedge

Let’s start with dispelling the hedge myth because it’s easiest. I prefer to use a simple chart example, one that many gold investors should remember — if not print out and hang on the wall:

In the last market crash, GLD did well. We see this from the numbers. But from the chart one thing becomes much more apparent: GLD trended sideways during most of the market’s downward trend.

With the last rate increase showing how fragile the current overbought market is, investors should think twice about using gold as hedge. Recall the selloff of August 2015, which was fueled in part by a fear of the end of easy, cheap debt. As rates rise, holding gold becomes harder to justify as interest on the dollar becomes stronger.

Simply put, the gold hedge does not have a track record as the-inverse-to-the-market as many investors erroneously assume. It also does not have the logical backing to be a hedge as we move into a year when rate increases seem highly likely. This brings me to my next point, that March to May are the danger zone for gold:

The market is predicting a 90% probability of a rate hike by May. This coincides with a rather weak seasonal market for gold.

Gold, Seasonally

Gold shows some statistically significant seasonality on a month-to-month basis:

March and May have been consistently down for the past decade. This trend has recently eaten into April, as seen when running the numbers since the last volatility regime (2012):

The seasonality in the charts above represent a bull-bear cyclical pattern over the course of six months. The traditional beliefs about the stock market are matched by this seasonality, justifying the pattern. Essentially, as the market cools down after the end of the year and during the summer, investors move their funds into suspected hedges and defensive investments, which gold falls into.

With March upon us, we are looking at the beginning of another bear cycle.

A Superior Gold Short

Most people reading this are likely gold bugs and won’t take kindly to my prediction of gold beginning a pullback. However, gold has already begun a pullback, exactly on March 1:

If anything, this chart is another piece of the puzzle as to where the gold market is headed. We have rising rates, weak seasonality, a strengthened dollar — the list goes on. Is a call for a gold short really unreasonable at this time?

I don’t think so. And you can open that short for free with options. In fact, you should always play GLD with options because it is taxed as a collectable otherwise, taking away 28% of your gains, if any. However, options are taxed as usual, even on GLD, meaning you can bypass that extra tax rate.

Here’s my general strategy for opening options in place of buying or shorting stock:

The idea is to open a combo and buy an OTM call above it to manage risk. Here’s my recommendation of a play that can help you manage the gold pullback during the March-to-May danger zone:

  • Buy GLD May $115 put
  • Sell GLD May $115 call
  • Buy GLD May $127 call

The above strategy costs nothing and only requires roughly $600 margin. In return, you get to mimic being short 100 shares of GLD during the danger zone. Let me know what you think in the comments section below.

Notes

All unlabeled figures were created by me. I used R to pull data directly from Yahoo and ADVN. Charts with blue backgrounds are from E-Trade Pro. Fundamental charts from a paid subscription at simplywall.st.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.