Market participants are often heard saying things like "you can't trade gold on fundamentals." With no cash flows to discount, gold is a different animal than stocks or bonds. It is said to swing higher and lower due to changes in investor sentiment alone. Many a trader will advise you to simply follow the trend:

• When gold is in an uptrend, own gold.
• When gold is in a downtrend, go to cash.

Going back to 1975 (when gold futures began trading), how would such a strategy have fared?

At first glance, pretty good. Owning gold when it closed above its 200-day moving average and moving to cash when it closed below it would have resulted in a higher return (5.1% vs. 4.6%) with lower volatility (16.5% vs. 20.0%) than buy-and-hold.

The cumulative return for this trend following strategy: 752% versus 581% for buy-and-hold.

The maximum drawdown: 51% for trend following versus -69.6% for buy-and-hold.

Case closed, trend following wins?

Not so fast. We have yet to include the transaction costs that exist in the real world. The trend following strategy would have traded around 3.75 times per year going back to 1975. At a cost below 0.14% per trade, trend following still beats buy-and-hold. At anything above 0.14%, trend following underperforms.

While 0.14% may seem somewhat high in today's world, for a long time it would have been deemed quite cheap (see chart below). It's likely that the average transaction cost (slippage and commission) since 1975 was well above 0.14%. Which means it would have been difficult for trend following to beat a buy-and-hold strategy in practice.

Source: A Century of Stock Market Liquidity and Trading Costs, Jones (2002)

Does that mean trend following in gold "doesn't work"? It depends on what your definition of "work" is. If by "work" you simply mean a higher return, then that might be be an accurate assessment (if we include transaction costs). But looking back at history, the real value in trend following is not on the return side of the equation, but on the risk side. (Note: we showed something similar in our research paper on moving averages and leverage in the equity market).

As evidence of this, trend following produced a higher return in all of the worst years for gold. This is what leads to the lower volatility/drawdown profile, as you are cutting your losses after a break of the 200-day moving average that continues lower.

The trade-off, beyond higher transaction costs? Missing out on upside during strong periods (ex: 2002 - 2012) and being whipsawed in choppy, sideways markets (ex: 1990, 2014, 2017). Overall, the trend following strategy would have outperformed in only 35% of years since 1975 (ignoring transaction costs). This includes a long stretch from 1998 through 2009 where a simple buy-and-hold of gold outperformed a trend-following strategy in every year except one (2002, when they were tied).

What should a trader/investor take away from all of this?

Markets are hard. The notion that simply "following the trend" in gold will lead to vast riches is a false one. It would have been far from easy for someone to stick with such a trend following strategy over time (many, many periods of underperformance) and far from conclusive that doing so would have been superior than buy-and-hold (if we include transaction costs). And while most traders talk of trend following in terms of capturing profits from strong upward moves, the real value in trend following is just the opposite: in avoiding strong downward moves that continue lower for a period of time.

So while the saying "you can't trade gold on fundamentals" may be true, that doesn't mean trading it on technicals is any easier.