Trader’s Narrative

The poor besieged dollar gets a short reprieve as the gold bull market pauses. But the gold bugs suddenly have an unexpected and persuasive ally in their camp. As an interesting addendum to what’s next for gold? in the most recent quarterly client letter, Paul Tudor Jones II builds a fundamental case for a long term bull market.

He compares the relative historical value of the precious metal to the US monetary base, crude oil and the S&P 500 index. Their econometric model declares “gold is 20% undervalued over the next 24 months”. But the rationale is not restricted to the monetary forces which are at play.

Strengthening his case, he delves into the basic demand and supply of the commodity. On the supply side, mining production has been stagnant for the past 10 years. And central bank selling has slowed to a trickle with no new sales planned in the future.

On the demand side, the physical investment allure of gold continues strong. As well, to that we can add the penchant of modern investors for digital investment in gold. Relative to the gargantuan size of the equity market, the bond market and alternative investments (real estate, timber, etc.) gold’s share continues to be lilliputian. This means that even a sliver of asset flows diverted to gold will dramatically alter the equation.

Source: Tudor Investment 3rd Quarter Letter

Gold ETF holdings as a ratio of above ground stocks has increased incrementally 4 years. And the trend, does not look like it is about to reverse.

While Paul T. Jones presents a text book case for the long term bull based on fundamental analysis, I can’t help but think it is all an elaborate window dressing to rationalize a position he has arrived at through other, shall we say, more esoteric means. Clients obviously prefer logical, well thought out reasons for why a professional is allocating their money a certain way.

No one would be comfortable to be told that their trust fund is being gambled on nothing more than squiggles and trend lines or better yet, something called Elliott Wave (which we know, by the way, that Paul T. Jones II used to make a killing on Black Monday while practically everyone else on Wall Street was busy having an aneurysm). Interestingly enough right now Elliott Wave is bearish on gold.

This is just speculation on my part, of course. I have no way of knowing exactly why Tudor Investments is bullish on gold. Maybe I’m too cynical and we can take them at face value. In any case, even if the long term gold case is solid, you might want to fine tune the entry by looking at the gold sector sentiment.

Here is a chart comparing the price of gold and the Hulbert Gold Sentiment Index, which measures a subset of newsletters which time the gold stock sector:

Source: Risk Management and Convex Return Profiles

While the Hulbert gold sentiment metric isn’t as high as we’ve seen it historically, at these levels it does not bode well for another leg up. At least not without a pause first. As I mentioned before, to me it isn’t just the altitude of the bullish sentiment, it is also the attitude: as gold has corrected recently sentiment continues to reflect the same amount of optimism.

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

• Why the Goldman Sachs-AIG Story Won’t Go Away
• Europe Shows the Way: ING Broken Up
• Wall Street Revalued: Imperfect Markets and Inept Central Bankers
• Get a FREE Subscription to SFO Magazine (US residents only)
• Why Paul Tudor Jones Favors Gold
• Number-Crushing: When Figures Get Personal
• Ten Characteristics I See Among Successful Traders
• FREE 60-page eBook: The Deflation Survival Guide
• Stiglitz: Death Cometh for the Greenback
• George Soros Lectures (video)
• Why Big Banks Should Be Broken Up, But Why White House & Congress Don’t Want To

The above is a small sample, for the complete list, follow the graphic link below to news.tradersnarrative.com:

And remember to check back during the week as there are interesting links added throughout the week. If you are a twitter user, add the news.tradersnarrative.com twitter stream to get new stories in real time.

The Week Ahead:

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

• 18 US Banks Miss TARP Payments
• The Missing Paul Tudor Jones Tape (he uses Elliott Wave!)
• Initial Public Optimism - The IPO Market Bounces Back
• Will “Cash-on-the-Sidelines” Really Drive Stocks?
• Get a FREE Subscription to Futures Magazine (limited time for US residents only)
• Taibbi’s Upcoming Article on Naked Short Selling
• Good Trades are not Sexy
• Larry Summers and the White House economic team
• FREE 50-page eBook: The Ultimate Technical Analysis Handbook (lmt time offer)
• Contrarian analysis of current gold market

The above is a tiny sample, for the full list, follow the link to news.tradersnarrative.com:

And remember to check back regularly since there are interesting links added throughout the week. If you are a twitter user, add the news.tradersnarrative.com twitter stream to get new stories in real time.

The Week Ahead:

As much as trading seems complicated, or perhaps, as much as we fall into the trap of making it complicated, there are really only three types of trades you could ever put on. In order of difficulty, here they are:

With the Trend
Trading with the trend is perhaps the most common, and I would argue the easiest of the three types. Turtle trading would fall into this category, as would dummy trading, Linda Raschke’s “Holy Grail” setup and many others. When you trade with the trend, your thesis is to go along with the crowd and ride the emerging or existing trend. A break-out type play would go under this category, as would a retracement type play - since both are anticipating a continuation of the dominant & previous trend.

Counter Trend

The opposite is to go against the crowd and to anticipate a change in direction. Most would tell you to never “fight the trend”. Although I wouldn’t recommend it to newer traders, it is a legitimate way to trade and make money. Or as Paul Tudor Jones II puts it: “I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms.”

Non-Directional

This is perhaps the most “advanced” form of trading and therefore the most difficult to execute. And for those new to trading, it is perhaps the most difficult to grasp. How can you make money if the thing just meanders??! You do so through the modern marvel of financial derivatives. Within a range of prices (blue lines), many option combinations allow you to make money through the sale of a ‘premium’. The simplest is a covered call position (or if you flip it around, a short put position). There are other combos that are incredibly complex and would make a PhD math student go cross-eyed. Do not venture into this territory without a good grasp of the greeks (delta, gamma, vega, etc.).

That’s it! So if you’re totally new to trading, or are a veteran trying to come up with a new strategy, it may be usefult to step back, wipe the slate clean and realize that no matter what kind of trade you put on, it will fall into one of these three categories.

Ahhh, the elegance of simplicity.