I have bought gold today. The price has spiked downward in the past couple of days on low volume. Today’s move happened in the morning at a time when volume is usually low — a spike in volume at that time suggests someone who is unaware of the pattern of intraday liquidity is offloading a large position (perhaps year-end window-dressing?). All of this suggests a short-term buying opportunity provided by thin Christmas markets, rather than a falling knife.

Gold has a very close relationship with the 10-year real interest rate on TIPS (R2~0.9 using weekly data since the start of 2009). Earlier in the year, the gold price rose above levels that would have been consistent with this relationship (based on a simple linear regression), and at the same time real interest rates hit zero (they could go lower, but it seems unlikely they will go much lower), and on that basis I shorted gold at the time — a trade that did well. Now the price of gold has dropped significantly below levels that would be consistent with the current level of real interest rates, to the extent that it is possible to go long with a stop in a place that should not get hit: real rates have declined from around 0.7% in July to below zero today, and yet today’s gold price offers the opportunity to go long with a stop below gold’s July lows.

The dangers to the trade are 1) that the relationship between gold and real rates has suddenly broken down (which seems unlikely) or 2) that there is some other factor driving the price of gold of which I am unaware. Comments would be appreciated.

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