How to play the next phase of gold's bull market

published 18 June 2010

The gold market just entered an incredibly exciting phase. It's now poised and ready to make its next move. Let me show you how you can play this bull market to maximum effect.

If you want to give this strategy a go, please bear in mind it's a trader's strategy, not the normal long-term investment style that we're used to.

That said, if the trade goes our way, it's going to be a belter. So my advice risk a small amount on the trade and give it a go. After all, The Right Side is all about making the right move at the right time. And now could be the time for this trade.

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To help explain why I think gold could be ready for the next move, I'd like to take you on a little trip through time.

Comparing the current gold bull with the 1970s could make serious profits

To understand what's likely to happen to the current gold price, we need to look back to the seventies. Take a look at this.

This chart from zeallc.com shows the incredible gold bull market of the seventies - that's the blue line. Maybe you were there and you remember it, or maybe you've read about it since. Whatever way, it looks like history might be about to repeat itself and that's how we cash in.

The red line on the left hand side shows gold's price action from 2001 until 2004 when the chart was produced. And here's the incredible thing - this chart correctly predicted today's gold price of $1.230 spot on.

If you'd have had your hands on this chart back in 2004, you could have foreseen gold's run from around $400 to $1,230 now. That's more than a 300% gain.

Getting in now could spell serious profits

The next stage in the gold bull is referred to as 'popular speculative mania'. And there's evidence that we could be heading there.

There's talk of shortages of physical gold in Austria, Germany and Greece as people dump euros in favour of the yellow metal. For the last twenty years or so, gold has been something for the cranks. But today you'll hear investment professionals talking about gold as a serious investment.

Make no mistake, a LOT of professionals are serious about gold. And if this chart pans out, the smart guys are going to cash in.

In my opinion, it's only a matter of time until the public put their full weight behind the bull. If it happens, we need to get in first there's only a small amount of gold to go round!

Up until now, gold's up-trend suffered crushing down-legs which have shaken many a trader out of their positions.

The next stage of the cycle should be very different. It's an almost vertical rise in the gold price. This is trader's paradise and you'll not want to miss it.

'The Right Side' way to trade gold

This sort of price action means we need to trade like our old friend Jesse Livermore. Livermore earned the nick-name 'boy wonder' because of the amazing way he could tell where a stock was heading just by looking at where it had been. Livermore bought when a stock was going up, and sold when it was going down. Sounds simple huh?

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Let's see how we can use it in the gold market today. This strategy is elegant in its simplicity.

We buy a tranche of gold now at $1,230 and then keep buying new tranches every time the price goes up $100. So if and when the price hits $1,330, we buy another lot, then another at $1,430 etc, etc. You can use whichever route into the market you prefer, be it physical gold, gold ETFs, or a spread-bet.

I prefer the spread-bet as profits won't suffer capital gains tax, which will be an even greater concern after Osborne's June budget. A bet is easy to open and you can set up orders to buy and sell at specific prices in advance. And there's another advantage with a bet. you can use your gains from earlier trades to finance new bets as you build your position.

I know spread-betting can sound daunting, but once you're familiar with the concept, it's a simple and great way to trade like a pro. For more information on how it all works and how to set up an account, just click here. Please bear in mind, spread betting can be risky if not handled with care. Make sure you understand how it works as you can lose more than your initial stake.

As with all investments, the key is knowing when to sell. And that's a lot easier if the chart goes straight up - because you don't sell! You just keep building your stake like we talked about.

Up until now, this strategy wouldn't have worked as every down-swing would have given us a sell signal. Let me explain.

Stop losses can shake you out of the market

Using Livermore's strategy, you'd use a 'stop loss' to sell if the price moves down by a pre-determined amount. I use a 'trailing stop loss' and for gold I put it at 15%.

This means that if gold falls by 15% from its high, I sell the lot. So, if gold goes up to $1,500, but then falls back $225 (15%) to $1,275, I sell. A fall of this magnitude would signal the end of the bull run.

But, if gold follows the price action of the seventies, then you'll not get 'stopped out' for quite a while. On the contrary, your position builds very quickly as you keep buying all the way up.

If we follow the pattern of the seventies, expect gold to continue rising to around $3,500. If it keeps going up after that, then we keep buying on every $100 leap. But if it falls back to $2,975 (15%), we sell. We assume the bull has finished its work.

It's that simple.

This article was first published in the free investment email The Right Side on 16 June 2010

Spread betting is not suitable for everyone - ensure you fully understand the risks involved and never risk more than you can afford to lose. Spread betting carries a high level of risk to your capital. Prices can move rapidly against you and resulting losses may be more than your original stake or deposit. Margin amounts vary between spread betting companies and the type of markets spread bet. Commissions, fees and other charges can reduce returns from investments. Tax treatment depends on individual circumstances and may be subject to change in the future. Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. The FSA does not regulate certain activities. This includes the buying and selling of commodities such as gold. Please note that there will be no follow up to recommendations in The Right Side.

Managing Editor: Theo Casey. The Right Side is issued by MoneyWeek Ltd. MoneyWeek Ltd is authorised and regulated by the Financial Services Authority. FSA No 509798. https://www.fsa.gov.uk/register/home.do

Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.

He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.

Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.