In this article we’ll explore the usage of gold through history, its relationship to the US dollar and interest rates and its appeal as a safe haven. Finally, we’ll break down some specific technical trading strategies for trading gold.
Gold played an important role in ancient Egypt, around 5,000 years ago. It had a place in ancient Egyptian mythology, viewed as an indestructible and heavenly metal. The sun god, Ra, was often referred to as a mountain of gold and the Royal Tomb was known as the “House of Gold”. The capstones on the Pyramids of Giza were made from solid gold. However, the Ancient Egyptians never used gold as a currency, instead using a complex barter system of cashless exchange.
The first known civilization to use gold as a form of currency was the Kingdom of Lydia, in Asia Minor (now Western Turkey) in the late 8th century B.C. These coins were simply stamped lumps of a 63% gold and 27% silver mixture known as electrum. The Kingdom of Lydia prospered and had amassed a huge hoard of gold the the time of Croesus of Mermnadae, the last King of Lydia (570 -546 B.C.) This is the origin of the expression rich as Croesus.
The Mycenaean civilization (1600 – c. 1100 B.C.) also widely used gold coins, as did the later Greek and Roman Empires, although silver was more commonly used.
What makes Gold so Valuable?
Warren Buffet is famously critical of gold. Speaking at Harvard University he said;
Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.
Gold doesn’t produce earnings or dividends and costs money to store. However, A single ounce of gold, roughly the size of a sugar cube, currently sells for over $1,200. Here are some of the reasons it holds such a high value:
- Due to its chemical properties it doesn’t rust or tarnish.
- It is easilly malleable and ductile.
- Highly rare: all the gold ever found would only fill two Olympic-sized swimming pools.
- Timeless aesthetic appeal, attractiveness to the human eye
- Liquid: easily exchanged for money
- Impossible to counterfeited
- Can’t be inflated artificially (it can’t be reproduced by the whim of a central banker)
- Gold is valuable because it has intrinsic financial traits that no other asset does.
Gold in Recent Times
From the Roosevelt administration during the Great Depression in the 1930’s until President Nixon removed the gold standard in 1971, the U.S. dollar was backed by gold which had been fixed at the price of $35 an ounce.
Following the removal of the gold standard, gold prices soared over the next nine years, peaking briefly above $800 in 1980. From the 1980’s to early 2000’s there was little interest in gold amid strong economic growth and stock markets. Between 1982 and 2002 gold stayed in a range between $300 and $500 an ounce. However, Gold spiked higher again with the onset of the financial crisis of 2008, reaching record highs above $1,900 in 2011.
Factors that Influence the Price of Gold
Geopolitics, US interest rates and the US dollar are three major drivers of the price of gold.
Gold and US Interest Rates
The level of real interest rates, or the interest rate less inflation has a major long term impact on the price of gold.
Low real interest rates, making holding cash and bonds less appealing and increase the attractiveness of alternative investments such as gold. Conversely, when real interest rates are high, gold becomes a less desirable investment.
The yield on Treasury Inflation Protected Securities (TIPS) reflects the level of real interest rates in the United States.
Real yields below 1% have historically been supportive of gold prices while real yields above 2% have pressured gold prices.
Gold and the US Dollar
The fact that gold is priced in U.S. Dollars, suggests that the two assets have an inverse relationship or a negative correlation. The correlation is negative the majority of the time, although there have been times when both gold and the greenback have risen at the same time. Both gold and the U.S. dollar are viewed as safe haven assets and can see strength in periods of geopolitical instability.
The Commitment Of Traders (COT) Report
The Commitment of Traders (COT) reports are updated each Friday at 3pm CST and provide valuable information about changes in the open position commitments in gold and other commodities of various types of investors.
Technical Gold Trading Strategies
Gold is an interesting market to trade for the very fact that it’s value is so abstract -which in turn causes it to be volatile and often trend nicely. Moving average strategies tend to work well in trending markets and as such can be good technical strategies for trading gold.
Here is an example of a set of rules for a trend following strategy in the gold market.
Timeframe: Daily Chart
Entry Trigger: 5 period EMA crosses above 10 period EMA for buy trade, 5 period EMA crosses below 10 period EMA for sell trade
Filter 1: Favour buy trades when price is above the 200 period SMA, favour sell trades when price is below the 200 period SMA
Filter 2: Favour buy trades when RSI is crossing upwards above 30, favour sell trades when RSI is crossing downwards below 70