If you ask market players to compare physical gold and simple arithmetical relative performance, which do you think they would choose? Definitely gold. When it comes to gold, we can short all sanity and go long on all owning gold. The very fact that the society is so long on irrationality is the reason that time cyclicality works.
Markets move from one extreme to the other, and it is between these two extremes that the society pauses, gets into excitement lows, becomes conservative, talks about value, lays down new foundations and structures, talks about ethics and corporate governance, gets debt smart, etc. This pause is also known as rationality.
Gold is a part of the global asset complex that moves with market mood. Market players see the rise and fall, but the society can’t calculate relative performance. How much did my gold portfolio deliver compared to the rest of the market from the start of the year? A very basic question to secular gold bulls who never stop believing in gold. How much did gold rise from March 2009 compared to the dollar? Should gold bulls worry about dollar strengthening? How much did gold deliver in a currency other than dollar?
Gold underperformed S&P 500 from March 2009 by 14 per cent. This means gold bulls would have done 14 per cent better by holding just the S&P 500 and not gold. How do the gold bulls know the next six months are going to be any better for gold? Well, there is a probability that gold bulls might not know. Gold generally moves against dollar. A dollar strengthening is accompanied by a weakness in gold and vice versa.
However, traditional relations fail at times, like they did from the start of 2010. Both gold and dollar rose. This means if you were holding a gold portfolio in a currency other than dollar, year to date gold delivered on average four per cent more than S&P 500. This is marginal when we compare it to the gung-ho mood surrounding gold.
Behavioural finance clearly highlights that investors diversify less. Diversification is also suggested as an action point to reduce risk. Inability to look at gold relatively to other assets, including dollar (denominated currency), is likely to prevent investors from comprehending a macro portfolio of global assets. Most of the times, investors are so regional in their outlook, or so focused on a few assets, that they don’t realise the foregone opportunity cost and other macro adjustments.
Other aspect locals typically miss but foreigners understand is the forex risk. If one converted euros into dollars and invested in US stocks, year to date that portfolio delivered 10 per cent with a marginal change on S&P500.
Investors are so focused on historical highs that extrapolation becomes intuitive, irrationality looks normal. The view sans relative value turns out costly over the longer term. Gold is moving up exponentially and has been rising for a record 10 years without a retracement of more than 38.2 per cent. The metal has not witnessed a fall bigger than nine months in time. Technical indicators are non-confirming and suggest weakness rather than strength.
Gold is not in a solo negative run. All of copper, platinum, silver, and aluminium structures look weak and many global metal indices still seem negative. Above this, we have crude oil which, after struggling at $80 a barrel, has sunk lower. We continue to maintain that oil will retest $70 and move down till $60. The Reuters CRB index also seems to have a further downside left.
The long silver-short platinum pair we mentioned last time delivered 10 per cent since February 22. Long Industrials index-short Nickel is up four per cent since May 19, long precious metals-short Nickel delivered 47 per cent since April 16. A more than 10 per cent divergence between two different metal groups indicates market inefficiency and why understanding relative performance could be profitable.
Performance reverses polarity, the reason outperformers get kicked out from the top ranks. It’s time for under-performing copper to reverse polarity. A long copper, short gold pair should deliver along with long precious metals index (AIGP) and Short Gold.
The author is CMT and CEO, Orpheus CAPTIALS, a global alternative research firm
Top funds that have stepped up buying in OMCs include Vanguard Group, Brandes Investment Partners, Bank of New York Mellon and DNB Asset Management