Risk On, Risk Off and the Gold Trade

Unless you have been hiding under a rock for the past year, you are aware of the dramatic rise in the price of gold and also its use as a safe haven for investors trying to escape the tumultuous markets. Traditionally, investors around the world have also been using US Treasury Debt as an additional safe haven due to the reliability of payment from the US Government.

Even with the recent news of downgrades on that US debt, the treasuries are still viewed as a safe haven. The recent turn downward in the markets was not caused by the downgrade by Standard and Poors on the US debt, but rather renewed fears of an economic slowdown. If it were from the debt news, there would have been a large selloff in the treasuries and a sharp increase in interest rates.

So, if an increase in the price of treasuries signals a flight to safety and risk aversion, we can also look to the price of the stock market represented by the S&P 500 as the risk trade. When investors' appetite for risk returns, they attempt to seek out greater gains in the equity market. Currently, both of those securities are moving in opposite directions. When economic conditions change, so can this relationship. However, in the foreseeable future, they are moving inversely.

In TradeStation, I can use the spread ratio tool to identify when the risk trade (buying stocks), is on or off (sell stock & buy treasuries.) In the chart below, you can see risk is off when the ratio line rises and breaks supply or trend. Risk is back on and so is buying the stock market when the uptrend or a demand in the ratio is broken.

We can obviously use this to assist us in trading and investment decisions on treasuries and equity trading. It should not take the place of supply and demand studies on the security itself. Rather, this analysis can supplement our work and be used as an odds enhancer.

If we can see the risk on, risk off trading in this spread, it stands to reason that we could also use the analysis technique for trading other risk aversion assets like gold. Looking at the following chart, I have compared the gold ETF, GLD, to the spread ratio. You could also substitute the TY (treasury futures), ES (S&P 500 futures) and GC (gold futures) in this analysis.

So, we could trade with the gold bugs and play this speculative bubble in the shiny yellow metal until the risk is back on. Obviously, you should use your technical analysis skills on the gold charts themselves to time entries and exits. But now we have an additional odds enhancer to help improve our success in trading the markets.

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