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Apparently Its All Over For Commodities

Commodities form an important part of my trading universe, in fact as a I par back my universe of instruments they form a more and more integral part of what I do. This pivotal role occurs for a few reasons ranging from ease of trading, price discovery and familiarity. The first trade I ever did was on a gold stock and the interest has stuck with me for decades.  You would therefore expect that I take an interest in the market so I had more than a passing interest when this article dropped into my news feed. There are a few points I want to dissect. However before doing that it has been my experience that there are two interesting phases in the life of any market. The first is when people start to tell me this time its different. Etched indelibly into my brain are the words of Irving Fisher who could be considered one of the worlds first celebrity economists who days before the 1929 crash uttered the immortal phrase stocks have reached a permanently high plateau. The second phase is that when someone tells you that a given instrument is stuffed beyond repair and will never go up again. Neither sentiment is reflective of either the cyclic nature of markets nor the psychology of traders.

Point 1 – Firms leaving the business.

This is an interesting point because it points to the number of prop firms leaving the business. However the number of retail investors exposed to commodities via ETF’s has grown dramatically so there has been a shift in the markets demographic away from wholesale to retail. The five largest commodity ETF’s managed almost $6 billion in assets.

Point 2 – Low Volatility

This point highlights one of my enormous bug bears it is the confusion between volatility and trend – the two are not the same and one doe not rely upon the other. I thought I would take a further look at this and just have a look at the distribution of volatility within the gold market. The first thing I did was simply look at the average 15 day volatility for a given number of years ranging from 15 years to the YTD and the results are shown below.

v1

Depending upon the look back period you can make a point that there has been a drop off over time in volatility . However volatility is relative concept and the current volatility in the gold market is sitting at 11.8% which is just below the average volatility for the YTD. Yet price has trended from around $1,000 to $1,350 and then back down to around $1,000. Looking at short term volatility tells us nothing about the trend. When looking at volatility I thought I might be missing something so I broke the look back period into five year blocks to get a sense of how it might have changed over time and the results are below.

v2

When volatility is broken into blocks you can see that over time volatility has increased and then tapered off a little. The so called halcyon days of two decades ago that every longs for actually had markedly lower volatility than recent times.

I should also point out that volatility in the crude oil market regularly spikes to beyond 60% so i am not sure where this missing volatility has ended up. Again it is probably the perennial confusion between trend and volatility.

Point 3 – Correlation

This point always interests me because people very rarely make it clear whether they are talking about price correlation or returns correlation. Most people when they talk about correlation talk about price without meaning to. The correct measure in such situations is the correlation between the returns across asset classes. True diversification is generated when you generate uncorrelated returns. Te first chart below looks at the daily performance correlation for gold, S&P 500 and crude oil.

p1

There is what appears to be an emerging positive correlation between gold and the S&P 500 and this surprised me a bit and I was suspicious that it was an artefact in the data so I generated a new series of data that looked back to the beginning of the century because my suspicion was that what I was seeing was actually the stagnation in gold and the rise of the US market post the GFC.

p2

Looking at the data over much longer term gives a clearer picture of what is actually happening. As US markets collapsed gold recovered and as US markets recovered gold suffered so to my eye the emerging correlation is somewhat of an artefact in the data. Much is implied in the article about how good commodities trading was in the past but it needs to be remembered that gold took 31 years to surpass its 1980 highs. That’s a long time between drinks if you are a long only trader as many commodities firms were. Commodities are the magic swing through mutli hundred dollar range tools that people think they are.

Point 4 – Leverage

An irrelevant point if you know what you are doing. Leverage has been a function of commodities markets from day one and is the staple of FX markets and they dont seem to have any problem coping.

Point 5- Liquidity –

I am not certain what the point is here since volume in the majority of commodity markets has increased dramatically over the past decade.

Point 6- Regulation

This is an old catch cry – if you dont know what you are doing blame the regulator. In some ways this is the same as football coaches who blame the umpire for their team being rubbish.

Point 7 – Its downright difficult

There is a particular sentence here I want to highlight –

For one, their idiosyncratic characteristics can make price forecasting practically impossible.

Price forecasting for all instruments is impossible. For those who need a quick refresher on how stupid this sort of thing is I give you Jon Boormans wonderful, regularly update guru predictions chart.

Predictions-2

Any attempt to predict price in any instrument is an exercise in delusional stupidity of the highest order.

The upshot of all of this is that the majority of things written about markets that have any sort of predictive narrative about the trajectory of a given market or markets is largely irrelevant and that includes this piece. The simple fact of all markets is that they are cyclical in both tone and the level of investor involvement. If I can defer momentarily to a local example. If you were to look at a comparison between housing and equities as an investment choice you would say that equities are dead. Yet funds continue to invest in them and prices continue to go up and down and some prices go up a lot.  The same is true for commodities and I doubt it will ever stop being true.

 

 

Gold Vs S&P500

I am still intrigued by the US markets reaction to the results of the US election when viewed in tandem with an instrument such as gold which is generally seen as a hedge against uncertainty (in this instance read outright dickheadedry) As such I though I would look at the relative returns of both instruments over a series of times frames if that told me anything about the market currently being uncertain about its own uncertainty. In looking at these two instruments I have cheated a little bit in that I am using a proxy for gold. I am using GLD which is an ETF that tracks the physical price of gold. I accept that this is a broad brush approach given the nature of the construction of GLD. However, I am looking for at a battleaxe approach not a rapier so the small inconsistencies dont bother me. I am more interested in looking at the broad pattern. If you have to look too hard then there is no pattern at all. If the relationship is not then when being as subtle as a sledgehammer then it is not there at all.

The firts thing I wanted to do was to look at the relative performance of the two since the US election and this can be seen in the chart below.

gld 1

My reading of this from left to right is that Trump wins the election and the long term rally that has been in place since 2009 reasserts itself with equities taking off and GLD drifting. A few weeks later the ramifications of electing a buffoon become apparent and the market stalls and GLD rallies slightly. We now have the situation where the market is rallying in the short term as is GLD. A cynic might suggest that trades are hedging their bets a little.

However, it is important to note that these sorts of performance comparisons are dependent upon the starting date. If I roll the starting date back a year a different picture emerges.The big picture alters every time you change the starting date.

gld2

We can see that GLD actually begins to drop off in the second half of 2016 as physical gold runs into a wall and begins to fall back. The out performance of the S&P500 over this time becomes even more apparent but the bounce in GLD is still there but the performance of the S&P500 is so much more apparent. This raises the question as to whether this sort of analysis whilst mildly interesting on an academic basis actually provides any insight that is worthwhile. Such a question also highlights a simple fact of analysis and of system design in general. Everything you do needs to add some form of value to the system. Unfortunately academic interest does not add value to a system so on this basis my feeling is that this sort of thing doesn’t add any value outside of curiosity and the vague conclusion that traders are uncertain about being uncertain. To be blunt you have to ask the question does it help make money since that is the aim of trading. For some it might but for me it just kept me occupied for half an hour.

 

 

 

Gold Stocks

In this weeks Talking Trading I mention the idea of taking a strategic observation and making some tactical decisions around it. My global overview is that at present precious metals and in particular gold are moving. This is evidenced by my systems generating buy signals across a variety of time frames. It has been awhile since I actually looked at domestic gold stocks so armed with excel I thought I would look at the one month return of a series of stocks as shown in the chart below.

Gold

Revisiting these stocks was an interesting experience, I had forgotten how much shit is actually listed locally. Whilst many of these gains look impressive on paper a closer examination reveals that some are simply the result of extremely poor price discovery. This makes trading many of these issues impractical. So whilst gold is showing some signs of life it is still buyer beware.

No Man Is An Island

So said John Donne and the same is true of markets. One of the most fascinating features of trading is that markets at times they display interesting interrelationships and that these relationships tell you something about the underlying emotional state of the market. Below are three markets I am currently involved in and all seem at this point in time to be telling a story about how the market is currently coping with a President – Elect who seems to have the IQ of a trout and the stability of a slinky falling down Mt Everest.

Markets

As  personal disclaimer I am currently long gold, short the USD in various iterations and my short term Dow system just threw me out from my last long position. So this is my story so it reflects my internal bias. What is interesting is that the Dow didn’t power through 20,000. I remember when it hit other “significant” numbers and it just burst straight through – there was no prevarication or hesitation. Yet at the same time the Dow paused gold began to move up and the USD Index began to move down. Whilst is is interesting to try an assemble a narrative from this – it is easier to simply trade the charts and let others build a narrative as to what they mean.

As a final point it is worth looking at how a few major markets have performed YTD – as you can see precious metals seem to be doing a fair bit of heavy lifting.

YTD

 

Gold

With the Gold Index showing some signs of life….

Gold Index

I thought it might be time to dust off my  list of gold stocks….

Gold

The Year That Was.

It is that time of the year when everyone involved in this business looks in the rear vision mirror and attempts to make sense of what happened.  And of course to everyone involved everything is so obvious and predictable. What is worse is that they take this data and attempt to make some form of prediction about the year ahead. Hindsight is all we have and whilst it is the perfect investment tool; we are denied its luxury in the real world. Even looking at a league table of performance of various instruments is somewhat meaningless. However, since they are all the rage below is one such table I quickly knocked up for a few common instruments.

League Table

Part of the problem is that these tables are looked at from the perspective of the buy and hold investor. It is assumed that you simply bought one of everything last year and held onto it and your performance either good or bad is a function of this. However, this is not how trading works. For example the AUD/USD began the year with a 15% gain, which is then gave back and settled into a meandering decline resulting in its ordinary year on year performance. Likewise all the gain in heating oil came in the first half of the year. Conversely, cocoa which turned in a shocker traded in a range for most of the year and then collapsed in October.

Whilst it is twee to say so in trading only the journey counts not the destination, in fact I would go a little bit further and say that even the starting point is irrelevant. As such tables such as the one above whilst vaguely interesting are essentially irrelevant to us.

Ten Minutes With Tate – One Month In


 

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