Monday, February 18, 2013

Gold/SPY Ratio a Puzzler

If Gold and the stock market are both geometric brownian motion, what are the odds of this pattern? It looks like there's a clear trend from when the US closed the gold window in 1971 to 1981 when the monetarist experiment ended, to the end of the internet bubble, then to today.

Gold peaked in 1980, and basically is at a peak again, but it's interesting that this ratio seems stationary. I bet no one thought that was true in 1980, or even 2001.

Facts are important things, and it's not obvious what they are.  Over my life I've seen papers argue gold has a positive, negative, and zero expected return, reflecting what has happened over the past 10 years.

update: Eddy Elfenbein has a theory that seems pretty interesting...basically, when the real interest rate is low, gold is relatively attractive and generates good returns as investors pile in.


W.C. Varones said...

Gold and stocks have remarkably similar long-term returns in the fiat era, with the significant bonus that they are not highly correlated, making them excellent diversifiers.

Anybody who doesn't have a significant allocation to each of them is crazy. Especially now, with bonds priced for perfection.

Me said...

To W.C. Varones:

I believe this is a flawed statement. Equities are at these levels due to the increase in debt. I point this out on my own blog but it's nothing you cannot find on one's owned.

As we now cannot find what the real yield of bonds/notes etc should be because the Fed's manipulating the curve, we also cannot know what the real value of equities are due to such as capital has moved from the bond market to equities. We have just began to see this trend in Mutual Funds as the retail investor begins to chase this performance.

Also, as I have pointed out on my blog (which was taken from others data points I might add), corporate debt issuance to buyback stock is getting out of hand. Operating earnings are not supplementing buybacks and to keep one's stock at these levels we are seeing company's leverage their balance sheets through issuing debt to buy stock back. These are not just companies where stock prices have dropped either.

This is a debt fueled equity boom and nothing more. That said, I still like equities where companies are paying out dividend's through operating earnings and have NO debt and a very strong balance sheet (less inventories).

And for gold and silver, yes, protection assets should be a part of your portfolio along with some productive assets.

W.C. Varones said...

Oh, I'm under no illusion that equities are a great buy at highish valuations with governments around the globe in debt crises.

But it's a relative game. Cash will be debased. Bonds will be debased.

I'm trying to spread out across real assets, including equities, metals, commodities, and real estate.

Everyone gets ripped off by Zimbabwe Ben, just some asset classes more than others.

LetUsHavePeace said...

When it was money, gold had no price; it was itself the unit of account. In the present circumstance gold is a near-money; it is accepted worldwide as being equivalent to the local currency but it has to be sold for the holder to have legal tender. Gibson's paradox was one only in the minds of economists, who still struggle with the differences between legal tender and credit. No banker in London or New York or Paris or Berlin in 1880 would have found it confusing that the cost of credit - i.e. interest rates - would be "high" when the supply of goods was relatively scarce (which is what economists mean when they say prices were "high"). What else would it be? The risk for lenders was not that the supply of money would change - that was fixed by the amount of gold available; credit had to be expensive because of the uncertainty that borrowers could find a way to generate a return. Because profits were hard to come by, credit must also be difficult. That money (gold and notes backed by gold) should be "dear" when times were "hard" was no paradox at all.

Mercury said...

There may be no good reason for any kind of a relationship between equity prices and gold (as Elfenbein says) but nonetheless it’s probably time to look for a good trade when the two diverge sharply.

EF’s S&P chart is dominated by the story of the tech bubble which is even more spectacular on a NASDAQ/gold chart over a similar period:

As far as bubbles go this one was a real doozy and the different perceptions of value reflected in the respective prices of internet companies and gold couldn’t have been more opposite. I swapped my tech stocks for a house in 1999 which is probably the closest I’ll ever get to a perfect trade. But a pile of Krugerrands would have been even better.

If the price of gold is all about politics (Elfenbein again) and politics is all about the art of the possible I would say that this time around circumstances are such that I don’t think that it is possible for the Fed to raise real interest rates very much without blowing the whole system up so if they try I expect the price of gold will actually go up not down as people start to get VERY nervous.

Anonymous said...

Elfenbein's interest-rate theory is the same as Krugman's.

Peter O said...

Certainly not easy to decide what to do. Investing in bonds is a no go. But gold as stocks might see another correction. All driven by liquidity not by far value.