Gold is used in many portfolios as an alternative type of currency and helps diversify both in terms of betas (i.e., asset classes) and as a hedge against concentrated exposure to the US dollar. Equity- and credit-only investors generally don’t see the point of gold because it’s outside the purview of those particular investing focuses. But for those more into macroeconomics, gold is often used to smooth portfolio fluctuations and, if desired, allow for higher leveraging of other assets even if not used as an outright bullish bet. The following portfolios on WhoTrades Live contain gold in a smaller portion. Here we see gold in a ~2% allocation, in a portfolio that’s returned 35%+ over the past year: Source: WhoTrades Live Portfolio Page __ In this portfolio it’s used in a small – actually negligible – portion in a portfolio up approximately 22% over the past year: Source: Portfolio Page __ This trader commits 17% of the portfolio to it in a more concentrated approach: Source: Portfolio Page __ To be clear, gold is not the best investment. If you’re expecting big returns from it, you’re going to be disappointed. Over the long-run, it returns about the same as cash or a little bit better. But as a relatively cheap market hedge, having it in some low amount (either owning the metal outright or through derivatives), it can benefit your portfolio due to few different key themes impacting financial markets going forward: __ 1) Treasuries Short Squeeze US Treasuries have been a heavily shorted market and crowded trade ever since the November 2016 US election. In 2016, the general collective sentiment was that we were supposedly in some disinflationary ice age. But now the average opinion is closer to the idea that we’re in a red-hot labor market and inflationary pressure is picking up. The reality is that neither of these is completely true. There is no evidence that inflation is picking up much in developed markets outside of housing. But the current inflation in housing in not sustainable as gains exceed the rise in wages. 30-year mortgage rates are also flirting with levels not seen in over seven years. Higher financing fees and an eventual slowdown of gains in excess of wages will moderate price increases in the property market. Short Treasuries has nonetheless been a popular trade due to Fed hiking and perceptions that inflation is making a comeback. Gold hasn’t traditionally had any particular notable directional correlation with Treasuries, though it’s been positive since 2013. But a Treasuries short squeeze (prices up, yields down) can benefit gold through another channel, which is a declining dollar, which brings us to number two. __ 2) Fading Dollar Momentum The US dollar holds the most notable inverse correlation with gold. There are historical reasons for this, with the former Bretton Woods monetary system (1944-1971) that held the USD as the reserve currency, with the US being on the gold standard – namely, gold could be directly convertible into USD. The US went off the gold standard nearly 50 years ago but the historical relationship still supports a negative correlation between the USD and gold (-0.40 correlation coefficient). The inverse USD-gold correlation was near an all-time high this past May. Like all correlations, they sometimes break, but a dollar reversal is statistically likely to be bullish for gold. Dollar momentum will fade, though the current bullish pattern is a consequence of US monetary policy diverging from that of other developed markets. This has made the USD a carry currency and carry is the main reason why you tend to see directional currency moves sustain themselves over the course of months or years. Higher rates attract capital into assets denominated in that currency, boosting its value. Over the next two years, going by futures curves, the dollar is actually expected to depreciate slightly against developed market currencies. The Fed will keep raising rates up toward a 3% overnight rate, but the curve will keep flattening because inflation isn’t going to pick up that much. And though balance sheet reduction will continue, yields further out along the curve will remain anchored and limit Treasury demand. __ 3) Slowing US Growth US growth will start slowing within the next six months and fall below long-run expected growth in approximately two years assuming the pace of short-term rate increases molds to the Fed’s expectations. This will have the effect of slowing the rate of credit creation and also deferring more capital toward debt servicing rather than productive investment and consumption behavior. This will result in lower real (inflation-adjusted) yields, also an element that is bearish for the dollar and bullish for gold. __ 4) Hedge Against Macroeconomic Volatility Gold can also be a viable hedge against broader macroeconomic volatility. Dollar volatility has actually decreased since the Fed started increasing rates in December 2015. This is rational. When interest rates are at the lower zero-bound and can no longer be lowered and relative interest rates can’t be changed (because all are at zero, like they were for a point in the US, EU, and Japan simultaneously), currency volatility needs to pick up. If this isn’t true, then you get economic volatility. When this policy is being rolled back as it is in the US, the opposite is true and currency movements generally become less pronounced. The anticipation back in 2013 that the Fed would be the first developed market central bank to increase rates has led to US dollars becoming an increasing concentrated share of the total world FX reserves. The USD stood at just 37% of total world FX reserves in late 2013 and is now at 58% (well ahead of the euro, in second at 20%). This is the highest in at least two decades since the earliest the data was reliably tracked. But even if currency volatility has been abating, other volatility will pick up, noticeably in risk assets, such as equities. This does not necessarily mean that if equities move lower, gold is likely to pick up. The two assets generally move independent of each other. The same goes for credit, but depends on the type. Gold generally has a slight positive correlation with US Treasuries when taking into account recent history as aforementioned, both nominal and inflation-protected due to some mutual safe-haven characteristics. But it has no general long-term correlation with investment-grade or high-yield corporate debt. __ Conclusions Gold has cheapened to a point where buying options or the metal outright could make sense in a smaller portion of the portfolio to obtain a relatively cheap hedge against the themes mentioned above. All portfolio ideas can be considered on WhoTrades Live, where you can find thousands of portfolios and traders by filtering by portfolio yield, trades count, drawdown, and performance history. 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