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Monday, September 10, 2012 - 07:30
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Monday, September 10, 2012 - 07:30
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Monday, September 10, 2012 - 07:30

Gold is a Good Investment, But Not as Good as This

Monday, September 10, 2012 7:30 AM

After a steep decline last fall, metal markets traded sideways for months and many traders seemed to move on to other opportunities. In recent weeks, gold broke out of a consolidation pattern, leading to higher prices. SPDR Gold Trust (NYSE: GLD) had formed a very clear pattern on the chart, and the breakout prompted buying from traders who were watching that pattern.

GLD's upside breakout was not a surprise. I use a 26-week rate of change (ROC) system to find the strongest ETFs, and GLD was flagged as a buy in late July. Buying before a breakout, or selling before a breakdown, is not uncommon for this system. Momentum, measured here with the 26-week ROC, often leads price at turning points.

For those following this system, the gain on the GLD trade is about 4.76%, based on buying at the open on July 30 when the signal was given. As a point of comparison, SPDR S&P 500 (NYSE: SPY) has gained about 1.73% during that period. The ROC strategy is designed to outperform the broad stock market over time.

From its current level, GLD could catch the attention of momentum traders and move higher. Stocks have been struggling, and SPY shows a loss of about 1% since GLD broke out. With global economic uncertainty rising and potential inflation concerns growing as the Federal Reserve and the European Central Bank consider monetary easing programs, traders may be looking at GLD as a relative safe haven while policymakers make tough decisions.

When gold is outperforming stocks, miners can also provide big gains. This is because mining stocks are a leveraged bet on gold prices. For example, miners may have costs of about $1,200 an ounce to bring gold to market. At $1,700 an ounce, they have a $500 an ounce profit. If gold goes up 10%, to $1,870 an ounce, the miners' profit would increase by 34% to $670 an ounce. With greater profits, the stock prices of miners should go up and those gains usually outpace the gains in the metal in a bull market for gold.

All that glitters is not gold

Some traders refer to silver as "the poor man's gold" since it trades at a fraction of gold's price. At a recent price of $32.40, an ounce of silver is priced at about 2% of the price of an ounce of gold. Both metals generally move in the same direction. This allows traders with small amounts of trading capital to potentially profit more with silver if both metals are moving higher.

These factors are most likely contributing to the trade that the 26-week ROC system is signaling. This week, the system is selling GLD and buying Global X Silver Miners ETF (NYSE: SIL). The chart below shows that there is short-term upside potential of about 14%, but more importantly, gains in SIL are now outpacing gains in GLD.

Below the price chart, the 26-week ROC indicator is shown. We can see that SIL has been underperforming GLD since metal prices peaked last year. In the past few weeks, that has changed and SIL is now moving up faster than GLD. That is a signal that we should switch to SIL in order to maximize potential gains in this sector.

This is not meant as a sell signal on all GLD positions. There are likely more gains ahead for GLD and there are other reasons to be buying gold. This system is selling GLD now simply because SIL offers greater potential returns than GLD.

Action to Take --> Sell GLD at the market. Buy SIL at the market.

There are no other changes to the positions in the portfolio this week. After completing the trade to buy SIL, the system will be holding:

This article originally appeared on TradingAuthority.com:

Gold is a Good Investment, But Not as Good as This

Michael J. Carr does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.