Friday, December 09, 2005



This post will touch upon a couple of topics. Gold, and how to beat the “buy and hold” portfolio blues. First, the shiny metal.

Gold was, and still is in the mind of many, the neutral international currency. In fact, under the Bretton Woods Accord (an agreement reached in 1944), the US dollar was pegged at $35 per ounce of gold and other currencies pagged to the dollar. This was the international standard for the world’s money until the early 1970s.

Since then, currencies like the US dollar are backed by the fiscal strength, or the “full faith and credit” of the US government. They are not backed by gold. Currencies like this are often called “fiat” currencies. The value of the dollar, the Euro, the Yen, the Yuan, move against each other and in effect are valued both within a country’s border and in international currency markets.


But there is no magic in gold. Gold competes in the market with everything else. It has some intrinsic value because of its metallurgic properties. But most of its value is reflected in its perceived, not intrinsic, value. History has given it a vaunted economic position.

Gold, in some manner, still functions as an international currency. In the early 1980s, gold soared to over $800 an ounce in the midst of recession, high inflation and international tensions. Gold did retreat from that peak and bounced around under $400 an ounce for much of the 1990s and the first years of this century.

Currently, however, gold is enjoying a run up in price and since early 2003 has moved from $380 an ounce to over $500 an ounce. That is around a 24% return in a little under three years. That is a good return, but not stellar.

The conventional wisdom on gold is that it goes up in value upon fears of inflation, declines in the equity markets, and international tensions. Equity markets have recovered slightly from their 2003 levels and some international tension does exist. Inflation has been low, however, and energy prices are abating. So what drives gold? Beats me!

Other than this conventional wisdom, the Author doesn’t follow gold, track gold, or even consider precious metals “precious”. So why did he buy it in late September at $463 per ounce? And why does he continue to hold it with a 13.27% unrealized gain at $525 per ounce?

Simple. It had good relative strength in September and continues to show good relative strength in December. When it weakens, he will sell it. Kind of a simple formula. Buy what will make money and sell it when it looks like it will stop making money.

Just two more short points and the Author will move on to relative strength as the reason for holding gold. First, the Author does not actually own gold bullion[i]. He owns shares in IAU, an exchange-traded fund (ETF) that is a gold-index fund. Each share of IAU represents 1/10 of an ounce of gold. And in an interesting juxtaposition, IAU, unlike currencies in this age, is backed by gold. IAU holds gold bullion to support its EFT shares.

The other point is that, in the Author’s analysis, gold is no longer the international, neutral currency that its proponents claim. Gold will be less relevant in most international markets, but will still have some investor appeal. But again, the Author does not care. He holds gold only because it is moving up. This point about gold no longer being the lodestar of neutral currency will be the subject of some upcoming posts.


Remember, we are looking for absolute returns in our portfolio. We want things that generate positive returns, whatever they are. (That being said, the Author will not invest in tobacco companies, flagrant polluters, or companies that derive a majority of their revenue or earnings from military sales.) So how do we get absolute returns? Here are some ways:

Hold what is going up! That sounds both sophomorically simple and Einsteinian difficult. But it is neither. First, we find the investment markets that are moving up. Right now, the American stock markets are positive and we jump on that train. We then use relative strength analysis and technical analysis to find stocks sectors that are moving up faster than their peers. When we have located those sectors, we find the stocks with the best relative strength in those sectors.

Stocks flat? Banking sector negative? Don’t hold them. Look elsewhere. If interest rates are going down, buy some bonds. Interest rates going up--buy money market funds. Do what is making money And don’t lose money.

Investing is a lot like baseball. You don’t need to hit homeruns. Don’t swing at bad pitches. Keep a good eye and make contact with the ball. Lots of singles and doubles are all we need to win the game.

Take profits when things are slowing down. Sell when they stop. The same tools that tell us when investments are technically strong will tell us when things weaken. And when they start to fall. Take profits as your investments lose strength. Sell when they break down.

Don’t hang on. Take profits and keep losses short. The deeper you go into the hole, the more dirt you will have to shovel to get out.

Don’t time absolute bottoms or tops. Stay within the sensible middle of trading curves. If you sell a little soon or the investment comes back, buy into it again. Stocks are not like the senior prom or a Bat Mitzvah. You can have them again and again. If you own Sun and lost money on it, you can still buy it again if it looks promising. If we sell IBM early and see that it rallies and keeps going, buy in again. “Once burned, twice shy” has no place on an investor’s PDA of aphorisms.

Let the winner’s ride. Avoid the temptation for taking action when standing pat is working. It is an easy temptation for a trader to take quick profits and keep the trades going. Don’t believe the Author? Look at these WalMart sized words of wisdom from the great speculator Jesse Livermore:
“Fear your losses and let your profits run"
"It was never my thinking that made me money but my sitting tight"
This man made millions when millions where like today’s billions.
The Author has moved quickly through these concepts. They will be elaborated upon more in the upcoming posts. And prior posts have also tackled these subjects. But learning is an ongoing and endless process. We will keep learning together!


[i] One of the problems with owning the metal itself is transferring and storing it. It is heavy and hard to move. Plus, it needs to be secured. It is a tempting target for burglars and robbers.