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“On a final note, what was the one asset you did not want to own when I started Duquesne in 1981? Hint … it has traded for 5000 years and for the first time has a positive carry in many parts of the globe as bankers are now experimenting with the absurd notion of negative interest rates. Some regard it as a metal. We regard it as a currency and it remains our largest currency allocation.” – Stan Druckenmiller
Stan Druckenmiller made headlines at the Sohn conference saying the bull market in stocks had “exhausted itself” and that Gold remains his “largest currency allocation.”
“Largest currency allocation.”
Interesting choice of words. But what is Gold in actuality? Is it a currency, commodity, or some combination thereof? Is it an inflation hedge or a safe haven?
Let’s examine each of these labels.
Gold as a Currency
Since the end of the Gold standard in 1972, we see an overall correlation of -0.37 between Gold and the Dollar Index, meaning that on average Gold and the Dollar move in opposite directions.
But on average doesn’t mean always. In looking at calendar year returns, Gold and the Dollar have moved in opposite directions 75% of the time. That means in 1 out of every 4 years they are actually moving either up and down together.
And while Gold and the U.S. Dollar tend to move in opposite directions, the moves are not anything close to proportional. Since 1972, the Dollar Index has fallen 16% (-0.4% annualized) while Gold has risen 2875% (8% annualized). There is clearly more to Gold than just a falling Dollar.
Gold as a Commodity
Is Gold more of a Commodity? Let’s take a look.
Since 1972, the monthly correlation between Gold and the Thomson Reuters Equal Weight Commodity Index (CCI Index) is .39.
While Gold and Commodities tend to move together, they don’t always move together and the cumulative appreciation since 1972 has not been close to proportionate. In 31% of years Gold has moved in the opposite direction to the equal weight commodity index, with an annualized return of 8.0% for Gold versus 3.1% for the CCI Index.
Note: for our research on Lumber and Gold, click here.
Gold as an Inflation Hedge
How about Gold as an inflation hedge?
Since 1972, Gold’s 2875% advance has far surpassed the cumulative rate of inflation in the US of 480% for the overall CPI and 473% for Core CPI.
Digging in a little deeper, though, reveals that Gold is anything but a constant or proportionate inflation hedge. From 1972 through 1980, Gold surged 1256% versus a 110% increase in the CPI. During the next 20 years (from 1981 through 2000), the CPI rose 101% while Gold fell 54%.
Gold as a Safe Haven
How about Gold as a safe haven?
We know that Gold is uncorrelated to the U.S. stock market, with a monthly correlation of 0.00 since 1972.
But uncorrelated does not mean negatively correlated. There are times when Gold is up when the market is down but there are also times when Gold is down when the market is down. The same is true when the equity market is up.
Looking at monthly data since 1972, we find that in months where the S&P 500 finishes lower, Gold is positive only 54% of the time, little better than a coin flip.
On a calendar year basis, this improves to 67% but the sample size is much to small, with only 9 down years for the S&P 500 since 1972.
The Enigma that is Gold
The truth is that Gold cannot be simply defined as a currency, commodity, inflation hedge or safe haven. At various times it has been some/all of these things and at other times none of these things.
Gold is not a pure play on any one factor but the sum product of multiple factors. If you believe the U.S. Dollar is going lower, short the U.S. dollar. Gold will likely rise but the inverse Dollar ETF (UDN) is certain to rise. If you believe commodities are going higher, go long a basket of commodities. Gold will likely rise with them but a broad-based commodity exposure (DBC) will have better odds. If you are concerned about inflation Gold may end up protecting you in the long run but as we have seen Gold can be a terrible inflation hedge in the shorter run (see 1981-2000). Long-term bonds and stocks have actually been a much more consistent hedge against inflation than Gold over the past 40+ years. Finally, if you are seeking a safe haven – Gold may provide such an exposure at times – but the odds of that are not nearly as high as the consistency of Treasury bills/bonds.
Perhaps the most important thing we can say about Gold is that it is truly an enigma. Its behavior is unique in terms of its lack of sensitivity to economic activity and non-correlation to stocks and bonds. That uniqueness, while frustrating to those who need to explain its every move, is what make it an interesting component in a diversified portfolio (see Gold, What is it Good For?). It also makes Gold an effective baseline to which you can compare more economically sensitive commodities such as Lumber (see our research on Lumber and Gold).
To extract long-term value from Gold, embrace the enigma. Leave the storytelling to those whose job it is to come up with a reason for its every move.
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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
You can follow Charlie on twitter here.
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