The Limits Of Commodity Charting

Technical analysis is depended upon by a lot of gold-watchers; I myself use some in my commentary, and sometime get fooled while using it. This post is presented as a caution, as it seems that chart-watching is uniquely hazardous in the commodities market.

Consider this vignette from David Dreman, found in p. 45 of the hardcover edition of Contrarian Investment Strategies: The Next Generation (1998):

"There is nothing wrong with the charts, only the chartists," runs another old Wall Street axiom. Maybe, but charting requires a very high degree of interpretive capability.

I learned this myself as a teenager when I visited my father's small commodities trading firm. His chief trader, although excellent at executing orders, was a passionate chartist. He was convinced that, if given the capital, he would make zillions. He kept the office covered with every conceivable type of chart. My father, not wanting to lose the man's skills, gave him a small amount to trade by the charts at the beginning of each year. The money was always gone by the end of January. This meant more intensive study and many more charts before the next yearly stipend came around. When I visited the office many years later, the cycle yet revolved.

Dreman was a teenager in the 1950s. Back then, there was no London Gold Pool and hardly any action in gold itself. Any speculative trading in gold was arbitrage-driven. The Bretton Woods system was in operation then, and there was no fact-based reason to question its viability at the time. To all appearances, gold was ensconced at $35 an ounce and would stay that way. So, that fellow wasn't looking for any "action" in the gold market. Not at that time.

And yet, depite the presumed help his charting gave to his order-execution skill, he kept getting cleaned out when trading on his own.

There's one way to take this anecdote, the way that Dreman intended it to be taken: charting doesn't help, and it often hurts; chartists are often fools. Another way of taking it is the assumption that the big players in the commodities markets read charts too, but size up chartists as the sheep to be shorn - as weak (and undermargined) hands who are easy to push out of their positions at a loss.

Again, this vignette comes from the commodites jungle at a time when gold didn't promise any action at all. It's a facet of the commodities market in general.