This makes gold eerily similar to Bitcoin – it has value largely because we collectively agree it does. Proponents of gold-backed currency often overlook this circular logic. While fiat money has value because some entity says so, gold is ultimately in the same boat. Backing currency with gold just pushes the “trust problem” down one level.
3. Store of Value… By Consensus
We call gold a “store of value,” but this is only true because everyone says so. It has limited intrinsic value beyond our cultural attachment to it. And while gold can back currency, gold itself isn’t something you can easily spend.
4. Regime-Switching Behavior
The most fascinating aspect of gold from a trading perspective is its regime-switching behavior. Much more than bonds, gold tends to flip between being a:
- Safe-haven asset during crises
- Risk-on asset during certain inflationary environments
These regime shifts are identifiable in retrospect but notoriously difficult to predict in advance. This bifurcated nature makes gold both valuable and frustrating as a portfolio component.
Gold and other precious metals are fundamentally different from stocks and bonds, so allocating a portion of your portfolio to them makes mathematical sense for diversification. But I wouldn’t rely on it as a consistent, all-weather hedge.
Now, let’s examine how to actually gain exposure to these peculiar assets.
There are several ways to gain exposure to precious metals, each with distinct characteristics:
1. Physical Ownership
This refers to the buying and holding of actual gold/silver bars or coins.
Physical metals can make sense for some people as a small “insurance policy” portion of your portfolio, but they’re impractical for most trading strategies.
2. Exchange-Traded Products (ETFs, ETNs)
These are financial products tracking metal prices, traded on stock exchanges.
Examples:
- GLD, IAU (gold ETFs)
- SLV (silver ETF)
- PHYS, PSLV (Sprott’s physically-backed trusts)
ETFs are the most practical vehicle for most investors and traders. In some circumstances, you might prefer physically-backed ETFs like PHYS where the metal is actually held in allocated storage. For active trading strategies, the liquidity of products like GLD is hard to beat.
3. Futures Contracts
These are standardized contracts for future delivery of precious metals.
Examples:
- GC (COMEX Gold futures)
- SI (COMEX Silver futures)
- PA, PL (Platinum and Palladium futures)
Futures are the professional’s playground and the most efficient vehicle for systematic trading of precious metals. Most of the strategies I’ll describe later are implemented most efficiently through futures, but they require more sophistication and capital than ETFs.
4. Contracts for difference (CFDs)
Contracts for difference (CFDs) offer leveraged exposure to price movements without owning the metal. You profit from the difference between opening and closing prices.
While CFDs are easy to use, as traders don’t have to worry about rolling contracts on expiration, between spreads and interest charged to keep your position open, they tend to err on the expensive side compared to other instruments. And the counterparty risk should not be downplayed.
5. Options on Metals
These are contracts giving the right (not obligation) to buy/sell metals at predetermined prices.
Examples:
- Options on GLD/SLV
- Options on gold/silver futures
Options are powerful tools for specific scenarios, particularly for exploiting volatility regimes in precious metals or implementing tail-risk hedging strategies. They’re not ideal for beginners, but can be incredibly useful for specific tactical trades.
6. Mining Stocks/ETFs
These are a means of owning shares in companies that extract precious metals.
Examples:
- Individual miners (NEM, GOLD, AEM)
- Mining ETFs (GDX, GDXJ, SIL)
Mining stocks are a different animal entirely from the metals themselves. They’re equity investments first, metal investments second. They typically offer leverage to metal prices, which cuts both ways. They’re worth considering as a tactical overlay, but not as a direct substitute for metal exposure.
Now for the fun part. Let’s look at how we can systematically trade these markets instead of just buying and hoping for the best. I’ll look at gold for most examples, but you can probably try something similar with other precious metals as well.
It goes without saying that past performance and successful backtests are not indicative of future returns, and the samples showcased here did not include trading costs or taxes, but they might be a good starting point for your research.
1. Time Series Momentum Strategies
Time series momentum (TSM) exploits the persistence of price trends in metals.
Theoretical foundations:
TSM is based on the idea that assets tend to continue moving in the same direction over intermediate time frames (1-12 months). In gold markets, this effect can be amplified during periods of macroeconomic uncertainty, where safe-haven demand creates self-reinforcing price trends.
A simple implementation:
- Calculate the 12-month trailing excess return for gold futures
- Go long if the return is positive, short if negative
- Rebalance positions monthly
Performance:
Trend following is incredibly noisy on individual assets. Nevertheless, using GLD prices, which I extended back to 1996 using gold mutual fund data, the long-only version of this approach delivered similar returns (CAGR 6.1% vs 6.8%) to buy-and-hold with lower drawdowns (max drawdown 29% vs 43%):