Recent performance of gold and managed futures

May - 2020

Concerns about the debasement of fiat money, following extraordinary monetary stimulus from global central banks, have raised investor interest in gold as a portfolio diversifier. The metal has historically been regarded as a safe haven asset, with the potential to produce diversification for equities. Year to 8th May 2020, gold is up +9.3% [1] amid strong inflows into physical backed exchange traded funds (“ETFs”). Total gold held by ETFs has risen by 17% this year according to Bloomberg.

Managed futures or gold as a diversifier

In a previous paper Managed Futures or Gold, we assessed the merits of including managed futures or gold as a portfolio diversifier. Our analysis showed that there may be a role for both gold and managed futures in a diversified portfolio as both gold and managed futures have exhibited a low long-term correlation with equities*. Furthermore, their performance profiles differed, reflecting the fundamental differences between them.

*Diversification does not assure profit, nor does it protect against a loss in a declining market.

 

Chart 1. Annual Return of Gold vs. Change in Real US 10-year Treasury Yield: January 1970 to December 2019

Source: Bloomberg & Abbey Capital.

Indeed, although gold is one of the many markets that Commodity Trading Advisors typically trade, at the end of September 2018, we found a long-term correlation between gold and managed futures of 0.17, and that their best periods of performance have tended to occur in different market environments. Historically, managed futures performed best in periods when several markets experienced strong, prolonged trends such as during the US recession in 2001-2002, the Global Financial Crisis in 2008 and in 2014.  In contrast, the best years for gold since 2000 were 2002, 2007, 2009 and 2010. Our analysis found that in general gold performed well in periods of declining real yields (Chart 1, above) and a weakening US dollar.

Performance in 2020

As equities have come under pressure in 2020 due to the spread of COVID-19, investor focus has again returned to examining which assets and strategies can deliver diversification in times of equity weakness. Although long duration US government bonds have performed strongly to date this year, some industry commentary has questioned whether they will continue to be a strong portfolio diversifier going forward given the significant decline in US bond yields.

We previously examined how gold behaved at different stages of the current crisis in our paper The four phases of the coronavirus. Gold initially rose as the crisis unfolded but then sold off sharply during March as investors liquidated assets to meet margin calls and as the USD rallied sharply. We saw a similar scenario in 2008: although gold posted positive returns in that year, it sold off in October 2008 during the height of the market stress, as investors liquidated assets to raise cash. Returns for gold have been stronger since the aggressive intervention from the Federal Reserve (“Fed”) on March 23rd 2020 which has produced a decline in bond yields and a notable expansion in the Fed’s balance sheet.

Table 1. Performance of Gold, S&P 500, US dollar index, SG CTA Index, SG Trend Index, SG Short-term Traders Index:
20th January 2020 to 8th May 2020

Source: Bloomberg & Abbey Capital. US Bonds are represented by the JP Morgan US Government Bond Index. Gold is represented by spot gold prices. A full explanation of indices referenced can be found in the Appendix at the end of the document. Each of Gold and these indices may not be directly comparable and the above is shown for illustrative purposes only.

 

In contrast, as illustrated in Table 1 above, managed futures strategies have exhibited a different return profile. Short-term traders generated positive performance in January and February as market volatility increased and Trendfollowing managers generated positive performance in March as trends extended. Performance for the SG CTA and SG Trend indices has also been positive in April, although more muted relative to gold and US equities. While past results are not indicative of future results, the period again highlights the different return profiles of both gold and managed futures: managed futures strategies tend to do well in periods of expanding volatility and sustained trends in markets whereas gold’s performance tends to be more linked to the trend in bond yields and the US dollar. As illustrated in Table 2 below, it is notable that each of the managed futures strategies have had a negative correlation to the S&P 500 this year and gold has had a slightly positive correlation.

Table 2. Correlation of daily returns in 2020: Gold. S&P 500, US Dollar index, SG CTA Index, SG Trend Index, SG Short-term Traders Index: 1st January 2020 to 8th May 2020

Source: Bloomberg & Abbey Capital. US Bonds are represented by the JP Morgan US Government Bond Index. Gold is represented by spot gold prices. A full explanation of indices referenced can be found in the Appendix at the end of the document. Each of Gold and these indices may not be directly comparable and the above is shown for illustrative purposes only.

However, looking at the rolling 20-day annualized volatility of gold versus the SG Trend Index we can see that gold has exhibited a much more variable volatility profile in 2020 with 20-day volatility rising to close to 40% during March whereas the volatility of the SG Trend Index has been relatively consistent. Year-to-date, gold’s realised annualized volatility has been 22%, about 1.3 times its volatility since 2000, while the volatility of the SG Trend Index is just below its longer-term level. One of the features of managed futures is that managers have the ability to size positions in relation to volatility and consequently portfolio volatility can be managed in times of elevated market volatility. Consistent with its higher volatility this year, gold also realised a much larger drawdown during the period, experiencing a peak to bottom decline of -12.5% in mid-March.

Chart 2. Gold and SG Trend Index rolling 20-day annualized volatility in 2020: 28th January 2020 to 8th May 2020

Source: Bloomberg & Abbey Capital. See Appendix for index definitions.

Conclusion

The recent period has again highlighted the potential diversification value of holding both managed futures and gold in a diversified portfolio*.

However, a closer examination of the period highlights some of the contrasting characteristics of each. Within managed futures, the performance of Short-term strategies was strongest in January and February when market volatility was rising, while Trendfollowing performed best in March when trends extended. In contrast gold, had solid performance in the early part of the year but suffered a sharper drawdown in mid-March when investors sold assets for liquidity before performing strongly since late March supported by aggressive central bank actions.

As we highlighted in our previous note, there may be a role for both assets in a diversified portfolio; we believe it is important for investors to understand the different return drivers when considering asset allocation.

*Diversification does not assure profit, nor does it protect against a loss in a declining market.

[1] For the purposes of this article, Spot Gold is used to represent gold performance. Managed futures is represented by the referenced SG Indices which consist of the SG CTA Index (in respect of the managed futures industry generally), the SG Trend Index (in respect of Trendfollowing managers) and the SG Short-Term Traders Index (in respect of Short-term managers). US equities are represented by the S&P 500. See the Appendix for a description of the indices.

Appendix

Description of Indices

S&P 500 Index (Start Date: March-1957)

The S&P 500 Index is an index of 500 US stocks chosen for market size, liquidity and industry grouping, among other factors. It is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in its aggregate market value.

JP Morgan US Government Bond Index (Start Date: December-1985)

The JP Morgan US Government Index is a leading measure of US government bond market performance. The Index measures the total return of US Treasury securities across the whole yield curve.

SG CTA Index (Start Date: January -2000)

The SG CTA Index is a daily performance benchmark of major CTAs; it calculates the daily rate of return for a pool of CTAs selected from the larger managers that are open to new investment. Selection of the pool of qualified CTAs used in construction of the index is conducted annually.

SG Trend Index (Start Date: January -2000)

The SG Trend Index is designed to track the 10 largest trend following CTAs (by AUM) and be representative of the trend followers in the managed futures space. The index is equally weighted and rebalanced annually on the 1st of January.

SG Short-term Traders (“SG Short-term”) Index (Start Date: January -2008)

The SG Short-Term Traders Index is designed to track the daily performance of a portfolio of CTAs and Global Macro managers executing diversified trading strategies with a less than 10-day average holding period.

U.S. dollar Index

The U.S. dollar index is a measure of the U.S. dollar’s value relative to a basket of foreign currencies

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