Mastering the New Gold Playbook
„You are never really playing an opponent. You are playing yourself, your own highest standards, and when you reach your limits, that is real joy.“
Arthur Ashe
- The new rules in the gold market require a rethinking of traditional asset allocation and portfolio construction. Our historical analysis indicates that an optimal gold allocation lies in the range of 14-20%. However, given the current market conditions, an increased allocation of approximately 25% appears appropriate.
- The gold price is being driven by new catalysts. As a result, gold is being revalued to resemble the queen in a chess game.
- In addition to gold, there are other beneficiaries of the new set of rules: commodities, which have risen from pawns to anchors of stability in the portfolio, and Bitcoin as a new piece that is establishing itself on the playing field.
- The risks for equities and bonds have increased. Bonds in particular only play a subordinate role in the new gold playbook: Anything But Bonds (ABB) is the new credo.
- Following the successful breakout of the gold price, now is the time for performance gold. However, mining shares are not a simple buy-andhold investment and require active management.
- An active mining stock strategy using our new, proprietary Incrementum Active Aurum Signal is clearly superior to a passive strategy from both a performance and risk perspective.
A New Set of Rules
Like an experienced chess player who adapts his strategies to his opponent’s moves, the investment world requires a similar degree of flexibility. Investors need to be aware that the investment world is not a static terrain. Rather, it resembles the complexity of a 3D chess game.
In recent years, there have been several structural changes that have shaped not only the gold market but also the entire financial system and the geopolitical landscape. In our view, these transformations require the development of a new gold playbook.
A game without trust
Trust is the key: Wherever confidence in the currency or monetary policy wanes, alternatives are sought. We described this dynamic in detail in the In Gold We Trust report 2019, “Gold in the Age of Eroding Trust”. Since then, confidence levels have not risen again. On the contrary, trust in political decisionmakers has continued to decline, particularly due to the wave of inflation in recent years.
Confidence in National Government*, 2020–2023
Source: Gallup, Incrementum AG
*Percentage of people having confidence in national government.
The financial world is increasingly trying to counteract this loss of trust in institutions by increasing its degree of independence.[1] But which assets are truly independent?
Shares are highly dependent on economic and political developments. Changes in legislation, political decisions, or international events can have a direct impact on the business environment. In addition, sanctions and regulations can severely affect certain sectors or companies. Bonds, on the other hand, are particularly dependent on interest rate changes, credit risks, and other macroeconomic factors. However, both asset classes are always dependent on respective locations and economic policy decisions and therefore cannot be classified as independent assets.
In the search for alternative investments, commodities have become the focus of attention. Their independence is manifested in the fact that most of them can be found or grown in many parts of the world. Despite this independence, supplies are frequently distributed unevenly, which poses a risk of them being manipulated by political decisions in the geopolitical power play. Concepts such as re-shoring, near-shoring and friend-shoring have experienced a boom since the outbreak of the war in Ukraine.
Commodities that serve as a store of value have some similarities with consumer commodities but fulfill a different function, which means they are less likely to be misused as a political instrument. The oldest and best-known asset of this type is gold. However, other assets such as silver and Bitcoin also fall into this category. Silver embodies a hybrid form of store of value and consumer commodity, as it has both monetary and technological or industrial uses due to its properties.
Gold and Bitcoin are closely linked conceptually. The value of both assets derives precisely from their nonconfiscability through inflation or as a result of bank failures, or, in the case of Bitcoin, through state expropriation. In a fiat currency system, this is precisely what gives store-ofvalue assets their value. The recent rises in gold and Bitcoin reflect that the market is valuing the portfolio property of nonconfiscability more highly.
The fact that gold has been in high demand as an independent investment alternative, and not only in the past two years since the outbreak of new geopolitical conflicts or the escalation of old conflicts, is underpinned by the following statistics: The share of gold in the currency reserves of global central banks has been rising since the 2008/09 financial crisis and, according to IMF and WGC data, stands at just under 15% as of Q4/2023.
Share of Gold Reserves, as % of Total Central Bank Reserves, 1964–2023
Source: IMF, World Gold Council, Incrementum AG
By comparison, the US dollar’s share of global currency reserves fell from 71% in 2000 to 58% in Q4/2023.
Share of USD Currency Reserves, Q1/2000–Q4/2023
Source: IMF, Incrementum AG
These figures not only illustrate the trend of increasing diversification of currency reserves but also the continued importance of gold as a currency reserve. In fact, the importance of gold has increased again in recent years, underlining its role as the ultimate hedging vehicle against political and economic uncertainties.
We believe it is likely that gold, as well as other store-of-value assets, will emerge victorious from this confidence game. Because in an environment where trust is on thin ice and the past serves as a basis for trust, many players are turning to gold with its inherent independence.
Fiscal dominance replaces monetary dominance
A significant change is crystallizing in the new gold playbook with the shift from once-dominant monetary policy in favor of greater consideration of fiscal policy as a stimulant for the real economy. This transformation has been underway for several years and has gained momentum since the outbreak of the Covid-19 pandemic, when many governments went into a veritable frenzy of fiscal expansion.
We paid particular attention to this development in our In Gold We Trust report 2021, “Monetary Climate Change”, when we wrote:
Fiscal conservatism has been in retreat for some time. […] But since the onset of the pandemic, governments have embraced their role as big spenders more enthusiastically than ever. Whether it is debt-financed subsidies for “green” companies or permanent transfer payments to ever larger parts of the population, there are more and more goals that are seen as so important that higher debt is accepted for them. […] More and more aspects of the Modern Monetary Theory now seem to be subjected to a practical test.[2]
In last year’s In Gold We Trust report 2023, “Showdown”, we painted a portrait of an impending monetary policy showdown and the threat of a US recession from Q4/2023 to Q1/2024. However, the US economy has shown little sign of an economic downturn to date, even though the first GDP estimate for Q1/2024 fell well short of expectations at 1.6%.
US Real GDP, yoy, Q1/1992–Q1/2024(P)
Source: Reuters Eikon, Incrementum AG
Numerous leading indicators show a much gloomier picture ahead for the US economy and the global economy in general. The Leading Economic Index (LEI), the inversion of the yield curve, and the crisis in the regional banking sector in the US played a central role in this economic storm.
The development of the LEI, which summarizes 10 leading indicators and is designed to predict the dynamics of the economy for the coming quarters, has improved slightly in recent months. A soft landing would mark the end of an impressive series of successes that the LEI has recorded in recent decades: the accurate prediction of all recessions in the US since 1970.
Conference Board Leading Economic Index (LEI), yoy, 01/1960–03/2024
Source: Reuters Eikon, Incrementum AG
The University of Michigan’s Consumer Sentiment Index rose by 17.7 points in two months from November 2023 to 79, the strongest two-month increase since 1991. In April, it stands at 77.2, which is still a robust level. Meanwhile, the unemployment rate has remained below 4% for 27 consecutive months, the longest period of full employment in more than 50 years. Historically, there have only been two periods of full employment that lasted at least as long: in the 1960s with 27 consecutive months and in the early 1950s with 35 months.
US Unemployment Rate, 01/1960–04/2024
Source: Reuters Eikon, Incrementum AG
In Europe, the collapse of the banking institution Credit Suisse was painted as a storm sign on the economic horizon. In view of these gloomy cloud formations of negative economic signs and early warning indicators, which in the past predicted the approach of a recession with remarkable accuracy, the expectation of such an economic storm front was obvious, and the wisdom of these words from Shakespeare became increasingly apparent: “So foul a sky clears not without a storm.“
While many European countries did indeed find themselves under the predicted recession clouds and some are still lingering in them, the storm passed the US economy by in 2023.
Real GDP Across Countries, yoy, 2023
Source: Reuters Eikon, Incrementum AG
So, were our analyses wrong? The fact is that the US is still not in a recession. This forecast was off the mark, just like David Beckham’s legendary penalty kick in the 2004 European Championship quarter-final. We believe the main reason for this is the diminishing but still intact effects of the fiscal stimulus packages, which have kept US consumption at a high level so far.
The next chart illustrates this fiscal effect. While the disposable income of private households skyrocketed in the wake of the stimulus packages, spending plummeted at the same time as a result of the Covid-19 measures and general uncertainty. A consumption gap therefore formed, which has led to a significant increase in the savings rate. At the moment, however, the savings rate is back at a low level of 3.2%. Before the Covid-19 pandemic, the last time such a low figure was recorded was in September 2008. In other words, US consumers, especially those in the lower income segment, are increasingly living from hand to mouth.
Disposable Personal Income, and Personal Outlays, in USD bn, 01/2015–03/2024
Source: Reuters Eikon, Incrementum AG
The fact that fiscal dominance is currently playing a key role for the US economy is also reflected in the sector performance of the S&P 500. While consumer-driven sectors are currently chasing all-time highs, interest rate-sensitive and defensive sectors are well below their highs.
MSCI USA Sector Performance, in USD, 01/2020–04/2024
Source: Reuters Eikon, Incrementum AG
Nevertheless, we should bear in mind that, historically, a recession in the US only occurred when the inversion of the yield curve normalized. In this respect, we do not dare to claim that the recession clouds have finally passed. The current euphoria, which has mutated from a hard landing to a soft landing and finally to a nevercession scenario, with interest rates rising sharply, is reminiscent of the deceptive mood before the 2007 financial crisis.
US 10Y-2Y Spread, 01/1980–04/2024
Source: Reuters Eikon, Incrementum AG
In this respect, our recession forecasts last year may have been a little premature – at least for the US. But regardless of this, many economies around the world went through a recession last year or remain in the shadow of recession clouds. If the recession does not materialize, it would be a notable example of the increasing dominance of fiscal policy measures – and thus a fundamental change in the new gold playbook.
Structural inflation – a game changer
There is another aspect to consider in the new gold playbook: structurally higher inflation rates, which go hand in hand with increased inflation volatility. These will most likely accompany us in the coming years.
Rising interest rates, as we have seen recently, lead on the one hand to a reduction in lending by banks, which has a disinflationary effect. On the other hand, however, they also lead to an increase in budget deficits and debt due to rising interest payments. The central bank’s instruments hence lose their effectiveness when debts are high and rising. The source of inflation no longer lies primarily in bank lending and monetary policy, but increasingly in the government’s high deficits. This creates a structurally pro-inflationary environment.
In principle, the gold price reacts positively to rising inflation expectations, as was seen in 2020. The renewed pricing in of a higher inflation risk would therefore, in all likelihood, once again have a positive effect on the gold price.
Gold (lhs), in USD, and US 10Y Breakeven Inflation Rate (rhs), 01/2005–04/2024
Source: Reuters Eikon, Incrementum AG
After 40 years of the Great Moderation, a stubbornly higher inflation level seems like an unexpected move that brings back memories of the legendary boxing match between Mike Tyson and James “Buster” Douglas in 1990, when the supposed underdog defeated the seemingly invincible champion in a complete surprise.
The wave of inflation in 2022 could have been just a foretaste of what is to come. Fiscal policy is increasingly driving monetary policy. However, the fact that the narrative of victory over inflation currently prevails, particularly in the eurozone, shows that we could be surprised by the same train twice.
Confrontational team constellations
A study by Baur and Smales, which is well worth reading, makes it clear that geopolitical risks and a geopolitical threat situation have a greater influence on gold price formation than actual actions. Gold purchases that correlate in time with political, economic or financial shocks strengthen this thesis and demonstrate the close link between geopolitical events and fluctuations in the gold market, as Arslanalp, Eichengreen and Simpson-Bell show in their study.
The study results are supported by the behavior of the gold price in the recent past following the outbreak of war in Ukraine and the resurgence of conflict in the Middle East, when the gold price rose sharply in both cases, at least briefly.
Gold, in USD, 01/2022–04/2024
Source: Reuters Eikon, Incrementum AG
10-Year-CAGR of GDP per capita, and Population in Developed and Emerging Markets, 2013–2023
Source: worldeconomics.com, Incrementum AG
In 2024, around 50% of global GDP will be generated by emerging markets. A quarter of a century ago, this figure was just 19%. The development of GDP per capita, which grew by an average of around 5.4% per year from 2013-2023, shows that this growth is not only due to the population doubling in the emerging markets. The increasing economic potential of the growing population is therefore a key driver that is likely to result in continued robust demand for gold in the coming years.
In addition to increasing consumer demand, gold will also be in greater demand from the central banks of the emerging economies in Asia. While the industrialized nations have at best left their gold reserves unchanged since the Bretton Woods era, emerging markets are consistently pursuing an increase in their gold holdings. This strategic reorientation reflects not only the historical experience of phases of financial repression but also the desire for more independent currency reserves.
Indeed, nonfinancial factors such as historical experience can play a crucial role in explaining central banks’ gold holdings. For example, Monnet and Puy have shown how institutional habits from the time of the gold standard influenced monetary policy decisions even decades later. In other words, the collective memory of a central bank has a decisive influence on the level of gold reserves.
The game is getting rougher
A new era is dawning in the investment world, accompanied by a change in the interest rate paradigm. The days of ultra-loose monetary policy and the ongoing zero interest rate policy are a thing of the past – at least for the time being.
A structurally higher interest rate level requires a reassessment of investment strategies and an adjustment of portfolios. We have recently witnessed the substantial vulnerability of equities and bonds in an environment of higher inflation and rising interest rates. Commodities, on the other hand, proved to be an excellent hedge in 2022, with a positive annual performance of 16.1%, while adding gold to the portfolio would have at least significantly cushioned the losses.
Annual Performance, S&P 500*, US 10Y*, 60/40 Portfolio*, Gold, and BCOM*, in USD, 2022
Source: Reuters Eikon, Incrementum AG
*Total Return
Gold and commodities hold a significant advantage over equities and bonds because they carry no default risk, a benefit that is particularly relevant in the current challenging interest rate environment. The integration of alternative asset classes therefore offers sensible diversification of the portfolio, not least due to their low correlation to equities.
Rolling 1-Year-Correlation of BCOM* vs. 60/40 Portfolio*, and Gold vs. 60/40 Portfolio*, 01/2002–04/2024
Source: Reuters Eikon, Incrementum AG
*Total Return
The New Gold Playbook in Action
In the following, we will address the question of what a portfolio based on the new gold playbook can look like and what role gold plays in it. We specifically address the various forms of investment on the gold market, outline specific investment strategies, and present our new proprietary Incrementum Active Aurum Signal.
For both private and institutional investors, gold accounts for only a very small proportion of their portfolios, if any at all. This is despite the fact that gold has impressively confirmed its renaissance with its breakout above the USD 2,000 mark.
The current scenario is reminiscent of the exciting beginnings of the previous bull market at the start of this millennium when gold broke through the symbolically momentous USD 1,000 mark. After a brief phase of correction during the recession following the global financial crisis in 2007/08, gold began a rapid advance towards the USD 2,000 mark. Although this target could not yet be reached in September 2011, we saw the enormous potential that was unleashed as soon as momentum picked up.
Gold, in USD, 01/2000–01/2012
Source: Reuters Eikon, Incrementum AG
Now that gold has sustainably exceeded the USD 2,000 mark, new targets are coming into focus. In our view, it is not unrealistic for gold to go on a run similar to that at the beginning of the millennium and roughly double from its current level of around USD 2,400 over the next few years, which would correspond to our decade target of USD 4,800, which we presented in the In Gold We Trust report 2020, “The Dawning of a Golden Decade”.
Gold, in USD, 01/2016–01/2030
Source: Reuters Eikon, Incrementum AG
The golden queen
The history of chess spans centuries and is characterized by a series of adaptations and evolutions. One of the most revolutionary changes, considered a turning point in the history of chess, was undoubtedly the introduction of the queen in its modern form towards the end of the 15th century – a development known as the birth of the modern queen or mad queen’s chess.
In the new gold playbook, gold undergoes a similar metamorphosis, which raises the significance and versatility of the yellow metal to a higher level and ultimately leads to its transformation into the golden queen and thus the most important piece on the investment chessboard. This transformation increases complexity and opens up new strategic dimensions. However, the scope of this transformation does not end with gold but also encompasses the other assets in a portfolio, which now act in different roles.
Up to now, gold has usually been part of a portfolio as a reliable defense strategy. But just as a skilled chess player does not use the queen exclusively for defense, gold should not be viewed solely with defensive intent. In view of the recent breakout in the gold price, one should familiarize oneself with the golden queen as an offensive piece.
Time for performance gold?
The current gold bull market may still be in its early stages. It therefore makes sense to consider performance gold as an additional position in the portfolio. We define performance gold as assets that have the potential to benefit disproportionately from a rising gold price.
Attentive readers of our gold studies will already be familiar with the distinction between safe-haven gold in the form of physical gold on the one hand and performance gold such as (gold) mining shares and mining funds on the other. While the primary aim of acquiring physical gold, i.e. safe-haven gold, is to preserve purchasing power, gold and silver shares and mining funds, i.e. performance gold, offer the possibility of capital growth and cash flows, for example in the form of dividend payments.
Source: Incrementum AG
GDX, GDXJ vs. Royalty & Streaming Stocks, in USD, 100 = 01/2011, 01/2011–04/2024
Source: Reuters Eikon, Incrementum AG
Thanks to their business model, which allows them to benefit from rising gold and silver prices without bearing the direct operational risks of mines, they exhibit remarkable anti-fragility. Their diversified portfolios reduce the risk of individual mines and thus offer a better hedge against market fluctuations.
Gold mining stocks: Active management is required!
The fact is that the gold mining sector is currently about as unpopular with investors as Marco Materazzi has been with every neutral soccer fan since the 2006 World Cup final.[5] A look at the performance of the past few years immediately shows why this is the case.Gold, GDX, and MSCI World, in USD, 100 = 01/2020, 01/2020–04/2024
Source: Reuters Eikon, Incrementum AG
And from a long-term perspective, buy-and-hold investors in gold mining stocks have also experienced a relatively lackluster and emotionally unsatisfying rollercoaster ride, like the German soccer club Bayer 04 Leverkusen, which was awarded the thankless title of “Vizekusen” after having lost the Champions League final, the German Cup final, and the national title in the very last game of the season. In this respect, it is perhaps a good omen that Leverkusen won the German championship this season for the first time in history.
Gold Miners* and Gold (lhs), 100 = 01/1970, and Performance (Gold vs Gold Miners) (rhs), 01/1970–12/2023
Source: Nick Laird, Reuters Eikon, Incrementum AG
*1970–2000 BGMI, 2000–Today HUI
For us, one thing is clear: Gold mining shares are not a buy-and-hold investment. The assumption that they are merely a direct lever on the gold price is an oversimplification. In fact, every type of mining company – whether explorers, developers, producers, or royalty companies – harbors a multitude of risks that can have a significant impact on the share price beyond the pure gold price.
Source: Jefferies, Incrementum AG
In view of the many risks, we advocate an active investment strategy when dealing with gold mining stocks. This is because not only bear markets but also bull markets are generally much more pronounced in these stocks.
Gold Miners* Bull/Bear Markets, 01/1970–12/2023
Source: Nick Laird, Reuters Eikon, Incrementum AG
*1970-2000 BGMI, 2000-Today HUI
The Incrementum Active Aurum Signal
But what indicators are there to help you recognize the optimal time to add performance gold to your portfolio? Over the past few years, we have been working intensively on this question and have developed a signal that helps us to precisely anticipate this critical point.
We are proud to present the result of our analysis: our new, proprietary Incrementum Active Aurum Signal. The signal has been developed to determine the optimal time to adjust gold exposure in the portfolio.
It examines when it is advisable to acquire performance gold in the form of mining shares in order to increase the gold beta. It also determines when it is appropriate to take a more defensive approach to gold exposure. This can be implemented, for example, by shifting from higher-risk mining stocks – particularly in the small-cap segment – to bonds issued by mining companies or royalty and streaming companies, or simply by reducing exposure in order to achieve a lower beta to gold overall.
However, the Incrementum Active Aurum Signal is not only suitable for complex strategies but also enables the implementation of simple investment strategies via funds or ETFs. The signal provides a clear buy or sell recommendation.
Composition
The Incrementum Active Aurum Signal is made up of two sub-signals: the cycle signal and the fundamental signal. The cycle signal is made up of five anticyclical components:
- Momentum: relative strength index (RSI) of gold mining stocks
The RSI of the gold mining sector provides information on whether gold mining shares are overbought or oversold. This can indicate whether the market is overheated or whether there are signs of a trend reversal. - Sentiment: CFTC net gold positioning
Total net gold positioning as measured by CFTC data can give an indication of how market players such as hedge funds and other institutional investors are positioned. Extremely positive or negative sentiment can indicate that the market may be at a turning point. - Risk appetite: Bollinger bands on gold mining stocks/gold ratios
Analyzing the Bollinger Bands of mining stocks versus gold and junior mining stocks versus senior mining stocks can give an indication of how risk averse investors are. High volatility and strong movement in the bands can indicate increasing uncertainty and risk aversion. - Macro environment: Treasury Inflation-Protected Securities (TIPS)
The TIPS analysis compares the real yield of inflation-protected bonds with their 52-week moving average. This can provide an indication of market expectations regarding inflation and real interest rates, which in turn can have an impact on the attractiveness of gold as an inflation hedge and thus also on the price performance of gold mining shares. - Boom/bust indicator: gold mining stocks relative to their moving average
The delta between the current price and the moving average can indicate whether gold mining shares are fundamentally overvalued or undervalued. A significant delta can indicate that the market is in an overbought or oversold phase and that a correction is likely.
All sub-indicators of the cycle signal oscillate between 0 and 100 and affect the cycle signal with different weightings. Overall, this results in the cycle signal, also with a value between 0 and 100. Buy or sell signals are achieved when the cycle signal is above 85 (= sell signal) or below 20 (= buy signal). A high value therefore indicates a potentially overbought situation or a largely exhausted upside, while a low value indicates an oversold situation and a limited downside.
Gold Mining Stocks* (lhs, log), in USD, and Cycle Signal (rhs), 01/1972–04/2024
Source: Reuters Eikon, Incrementum AG
*BGMI = 01/1972–06/2006, GDX = 06/2006–
The second cornerstone of the Incrementum Active Aurum Signal is the fundamental signal, which can be understood as a pro-cyclical market environment indicator for gold mining companies. A gold mining stock margin trend channel was created as a central input factor that takes into account developments on the commodities market.
In contrast to the cycle signal, the fundamental signal only has two levels:
– 0: negative/weak fundamental environment
– 100: positive/strong fundamental environment.
A buy signal is triggered at a value of 100 and a sell signal at a value of 0.
Gold Mining Stocks* (lhs, log), in USD, and Fundamental Signal (rhs), 01/1972–04/2024
Source: Reuters Eikon, Incrementum AG
*BGMI = 01/1972–06/2006, GDX = 06/2006–
Interpretation:
The combination of the two sub-signals results in the Incrementum Active Aurum Signal, which has three levels:
– Offensive: Both sub-signals indicate buy.
– Neutral: The two sub-signals give different indications.
– Defensive: Both sub-signals indicate sell.
Gold Mining Stocks* (log), in USD, and Incrementum Active Aurum Signal, 01/1972–04/2024
Source: Reuters Eikon, Incrementum AG
*BGMI = 01/1972–06/2006, GDX = 06/2006–
Backtest properties
Backtesting the Incrementum Active Aurum Signal for the period since 1971 shows an average of 1.5 signal changes per year. We interpret this result as positive.
A simple backtest strategy using the Incrementum Active Aurum Signal can be implemented by investing 100% in gold mining stocks in the case of an offensive signal, 50% in the case of a neutral signal, and 0% in the case of a defensive signal. We used the Barron’s Gold Mining Index (BGMI) as the investment instrument for the backtest from 1971–2005 and the VanEck Gold Miners UCITS ETF (GDX) from 2006 onwards. While the BGMI is the oldest gold mining stock index worldwide, the GDX is an investment vehicle in the gold mining sector in which the vast majority of investors can invest globally.
How does the performance of an active gold mining stock strategy using our Incrementum Active Aurum Signal compare to a passive strategy, i.e. a strategy where you are always 100% invested in gold mining stocks? The results speak for themselves.
Performance Comparison: Active vs. Passive Gold Mining Stocks Strategy*, in USD, 100 = 07/1971, 07/1971–04/2024
Source: Reuters Eikon, Incrementum AG
*BGMI = 01/1972–06/2006, GDX = 06/2006–
While a passive strategy has achieved a performance of around 470% since 1971, our Incrementum Active Aurum Signal strategy achieved a performance of over 7,000%. Note that the excess return was not achieved due to a period-dependent outperformance in a short period, but rather consistently over the entire period. The results of the relative performance backtest are therefore independent of the chosen time period.
Excess Return Active vs. Passive (lhs), and Gold Mining Stocks* (rhs, log), in USD, 07/1971–04/2024
Source: Reuters Eikon, Incrementum AG
*BGMI = 01/1972–06/2006, GDX = 06/2006–
Previously, we made it clear that their pronounced volatility might deter many investors from investing in gold mining stocks. It is therefore important not only to look at performance as part of the backtest but also to analyze key risk figures.
The next chart illustrates the drawdown comparison between a passive mining strategy and an active strategy using the Incrementum Active Aurum Signal. The result is evident: The active strategy recorded significantly lower drawdowns. In addition, the annualized volatility of the active strategy is 26.01%, which is more than ten percentage points lower than the volatility of the passive strategy (36.80%).
Drawdown Comparison: Active vs. Passive Gold Mining Stocks Strategy*, 07/1971–04/2024
Source: Reuters Eikon, Incrementum AG
*BGMI = 01/1972–06/2006, GDX = 06/2006–
The results obtained suggest that an active strategy supported by the Incrementum Active Aurum Signal is clearly superior to a passive gold mining stock strategy in terms of both performance and risk characteristics.
A look at the remaining pieces
Just as the multi-layered moves in a chess game do not depend on the queen alone, a sophisticated portfolio consists not just of a single asset but is a multifaceted ensemble of different asset classes. In addition to managing the gold allocation, the other pieces in the new gold playbook also need to be rethought.
Of course, the size of the gold position also depends on the other assets held in the portfolio. For example, if we consider a portfolio that increasingly contains interest rate-sensitive stocks such as REITs, utilities, or tech companies, then it makes sense to increase the gold position.
The same applies to bonds. The longer the duration in the portfolio, the more appropriate a higher gold allocation in the portfolio appears to be, as Van Vliet and Lohre show in their study. This correlation is based on the fact that certain assets react more sensitively to market fluctuations than others. Put simply, the more sensitive the assets in the portfolio, the higher the gold allocation should be in order to achieve adequate diversification and optimize risk-adjusted performance.
In the following, we will examine the impact of the new gold playbook rule changes on the remaining protagonists. The selected players include equities, bonds, commodities, and Bitcoin.
Stocks – the threatened king
In our view, the king symbolizes equities, which make up the lion’s share of a traditional portfolio. The recent rule changes under the new gold playbook have undoubtedly had an impact on equities. While these changes are not immediately apparent when looking at the prices of many equity indices and their mostly intact uptrends, the inherent risks in the equity markets have changed.
In particular, a structurally higher inflation rate in conjunction with rising interest rates could lead to further valuation discounts, especially for interest rate-sensitive sectors. Geopolitical tensions contribute to making this scenario even more likely, whether through ongoing deglobalization or measures that have a direct impact on the commodity markets and therefore influence inflation dynamics. Furthermore, the possibility of a recession should not be ruled out.
At the time of publication of this In Gold We Trust report in mid-May, the yield curve between 10-year and 3-month US government bonds had already been inverted for 556 days, a period previously only achieved before the outbreak of the Great Depression in 1929. Although the number of observations is too small for a statistically significant analysis, a positive correlation can be seen between the duration of the inversion and losses on the stock market.
Number of Days US 10Y-3M Spread Inverted (x-axis), and S&P 500 Drawdowns (y-axis), 01/1920–05/2024
Source: Game of Trades, Reuters Eikon, Incrementum AG
In view of these risks, it is essential to protect the king. Various options are available, including bonds and commodities. However, in our view, the golden queen offers the best solution due to its flexibility and versatile hedging properties.
Nevertheless, equities remain of central importance even after the rule changes in the new gold playbook. Overall, we believe that a broad reduction in equity holdings is not appropriate and that the long-term growth prospects for the equity market remain solid. However, the current situation requires a differentiated analysis: While the changes brought about by the new playbook entail increased risks for some sectors, opportunities are opening up in certain industries such as the commodities sector and in certain regions (Europe, emerging markets).
Bonds – just another historical character?
The offensive players are in the spotlight, but you can’t win a championship without a solid defense. And bonds are no longer that solid and reliable defender in the wake of the rule changes in the new gold playbook. Equities and bonds have been positively correlated for some years now, and the performance of bonds has recently left a lot to be desired in times of falling equity prices. Currently, the 1-year correlation between 10-year US bonds and the S&P 500 is just under 0.7.
1-Year Correlation of US 10Y and S&P 500 (lhs), and US 10Y Average Yield (rhs), 01/1955–04/2024
Source: FRB, S&P, BofA Merrill Lynch US Equity & US Quant Strategy, Reuters Eikon, Incrementum AG
In particular, the rise in interest rates in response to the wave of inflation is contributing to this. This development proves that an inflationary environment is poison for traditional portfolios. Since the first quarterly outflow from the bond market since Q4/2020 was recorded in the US in Q1/2024, the “anything but bonds” rally in markets continues apace.
Performance Comparison, S&P 500*, Gold, BCOM*, 60/40 Portfolio*, and US 10Y*, in USD, 100 = 01/2020, 01/2020–04/2024
Source: Reuters Eikon, Incrementum AG
*Total Return
Even though bonds will benefit from the expected interest rate cuts just like other asset classes, we see bonds as the big loser in the changed rules of the game. However, the paradigm shift in the bond market is not a sudden phenomenon, but rather the result of a gradual development, as can be seen in the historical course of the annualized, real returns of 10-year US bonds. However, the events of the last 24 months reinforce the conciseness and intensity of this shift, which will at least not be reversed in the new gold playbook.
US 10Y Treasury Annualized Real Returns, in USD, 01/1900–04/2024
Source: Robert J. Shiller, Incrementum AG
Share of Population Owning or Using Cryptocurrencies, 2019–2023
Source: Statista.com, Incrementum AG
Commodities – from pawn sacrifice to anchor of stability
The perception of commodities as an asset class is low. One of the main reasons for this is their high volatility, coupled with the fact that commodities are not productive goods. In addition, commodity investments are often made via derivative instruments, which are only accessible to a limited circle of market participants and can potentially cause negative rolling costs in a state of contango.
There are many reasons to invest in commodities, and in the new gold playbook they have the potential to act as an anchor of stability in a structural inflationary environment. While commodity investments are generally considered to be risky, we firmly believe that commodities are no longer an afterthought, but rather an indispensable component of a resilient portfolio, especially due to its characteristics as a liquid alternative investment and its lack of correlation with stocks and bonds.
Commodity Prices* (log), 01/1915–04/2024
Source: Alpine Macro, Federal Reserve St. Louis, Reuters Eikon, Incrementum AG
*1913-1934 US PPI Industrial Commodities, 1935-1949 Spot Price 28 Commodities, 1950-1969 Spot Price
In previous supercycles, commodities have significantly surpassed their respective all-time highs. We believe that in the current cycle, there is still considerable upside potential for commodities, and after the consolidation phase, price dynamics could resume.
Bitcoin – The new piece in the game establishes itself
Bitcoin’s market capitalization as a percentage of gold’s market capitalization has steadily increased in recent years and currently stands at around 7.7%. This is just below the record level set in 2021, when Bitcoin reached its all-time high in US dollars. Bitcoin thus appears to be establishing its position as an asset class, which is supported by the Spot ETF approval by the SEC in January 2024.
Spot Bitcoin ETF Holdings, in Bitcoin, 01/2024–04/2024
Source: hildobby, Incrementum AG
Weekly Rolling Correlation over 1 Year of Gold and Bitcoin, and Silver and Bitcoin, 08/2011–04/2024
Source: coinmarketcap.com, Reuters Eikon, Incrementum AG
A combination of gold and Bitcoin is also uncorrelated with a traditional 60/40 portfolio. In November 2023, the 1-year correlation of a portfolio comprising 75% gold and 25% Bitcoin compared to a 60/40 portfolio slipped into negative territory for the first time since early 2020, enhancing the diversification properties of a gold/Bitcoin combination.
Weekly Rolling Correlation of a 60/40 Portfolio*, and a Portfolio of 75% Gold / 25% Bitcoin, 03/2011–04/2024
Source: Reuters Eikon, Incrementum AG
*60% S&P 500 TR / 40% S&P US Aggregate Bond Index TR
We also see many of the rule changes presented in the new gold playbook as positive for Bitcoin, as it is a neutral and noninflationary asset, like gold. With the latest halving, Bitcoin has already overtaken gold in terms of the stock-to-flow ratio.
Stock-to-Flow Ratio for Gold and Bitcoin, 1900–2030e
Source: blockchain.com, USGS, World Gold Council, Incrementum AG
*Gold Production (2024–2030) = average growth rate (2004–2023)
Conclusion
For a long time, well-known drivers such as real interest rates, growth expectations, the inflation rate and the external value of the US dollar determined the performance of gold. However, the last two years have shown that these traditional factors are no longer sufficient to explain the dynamics of gold price movements. Gold has proven to be surprisingly resilient to the rise in real interest rates.
This development marks the emergence of new catalysts for gold, which are joining the traditional bullish drivers and giving the precious metal a tailwind. The new gold playbook underlines this fact, making a reassessment of gold and other asset classes necessary. Gold is experiencing a significant revaluation due to the potpourri of rule changes. In general, it can be assumed that the search for alternative investments to the established players on the financial markets will intensify significantly, which should have positive implications not only for gold but also for commodities, silver and Bitcoin.
Market Capitalization of Various Assets and Central Bank Balance Sheets, in USD bn, Q1/2024
Source: coinmarketcap.com, World Gold Council, US Treasury, Fed, ECB, Reuters Eikon, Incrementum AG
The new gold playbook demands more than just an adjustment from investors. It requires a rethink of the strategic portfolio. Old certainties are fading; established strategies are failing. The willingness to question established patterns of thought and break new ground often requires courage, but for those who recognize the signs of the times and have the courage to change, implementing the new gold playbook opens the door to growth and stability.
The exact asset allocation depends on several factors. Van Vliet and Lohre illustrate in a study that the inclusion of gold in a portfolio can significantly minimize downside risk. The estimated optimal allocation of gold for investors with a portfolio duration of 10 years is around 13%. Investors with a higher tolerance for interest rate risk may find greater diversification benefits in gold than investors with shorter portfolio durations. A study by SPDR also shows similar results: The integration of gold into a portfolio improves the Sharpe ratio and reduces risk ratios such as standard deviation and maximum drawdown, while at the same time achieving a higher return.
In the case of gold, we differentiate between safe-haven gold, which is held in physical form as a crisis-proof portfolio component, and performance gold. The latter comprises investments that have the potential to benefit disproportionately from a rising gold price, but that also entail a higher risk than safe-haven gold, which makes active management advisable. These are primarily gold mining stocks, but also silver and silver mining stocks. A similar differentiation is made in a study by Sprott, in which a distinction is made between gold and gold-like investments. These studies suggest that the gold allocation should account for a total of 10-15% of a diversified portfolio, with 10% invested in physical gold and a maximum of 5% in gold-like investments.
WisdomTree took the poor performance of a 60/40 portfolio in 2022 as an opportunity to conduct a study on gold as a resilient asset class and its optimal allocation. This research, using a Monte Carlo simulation with 20,000 simulations of different 10-year observation periods and allocations, found that a 16–19% allocation of gold in a portfolio maximizes risk-adjusted performance.
The range of the gold allocation proposed in the studies is between 10% and 19%, depending on the investment period and the other assets held in the portfolio. Even the lowest allocation in this range is therefore well above the gold exposure of a standard asset allocation.
Based on these findings, we analyzed the effects of different gold allocations in an equity/bond portfolio. The study period extends from 1970 to 2024 and includes monthly data on gold as well as the total return indices of the S&P 500 and 10-year US government bonds in US dollars.
Our calculations show that the integration of gold into an equity/bond portfolio has a clearly positive impact on the Sharpe ratio. The optimum is achieved in an allocation range of 14–18%. An excessive increase in the gold allocation, on the other hand, leads to a decrease in the Sharpe ratio.
Optimal Gold Allocation for Risk-Adjusted Returns Maximization: Gold Allocation (x-axis), and Sharpe Ratio (y-axis), 01/1970–04/2024
Source: Robert J. Shiller, Reuters Eikon, Incrementum AG
While maximum performance is achieved with a gold allocation of around 40%, this is also associated with significantly higher risk, characterized by higher volatility and larger drawdowns.
Optimal Gold Allocation for Performance Maximization: Gold Allocation (x-axis), and Performance p.a. (y-axis), 01/1970–04/2024
Source: Robert J. Shiller, Reuters Eikon, Incrementum AG
For investors seeking to limit risk, a gold allocation in the 14–20% range is the sweet spot.
Optimal Gold Allocation in a Stock/Bond Portfolio, 1970–2024
Source: Robert J. Shiller, Reuters Eikon, Incrementum AG
Our results suggest that a gold allocation of 14–20% ensures a balanced portfolio structure. These findings harmonize well with the results of previous studies, which recommend a gold allocation of 10–19%.
Aside from gold, we also see other alternative asset classes such as commodities and Bitcoin as beneficiaries of the new gold playbook. We are therefore convinced that these two asset classes are indispensable in a portfolio that is to be prepared for the new playbook. A suitable portfolio consists of 60% equities and bonds and 40% alternative asset classes.
The New 60/40 Portfolio: Strategic Model Allocation Based on the New Gold Playbook
Source: Incrementum AG
Our interpretation of the new 60/40 portfolio for long-term investors provides for the following allocation:
Source: Incrementum AG
This marks a clear departure from traditional 60/40 portfolios. Of course, this positioning is not a rule set in stone, but rather a guideline that is based on current market conditions and will evolve with time and changes in the currency environment. The new playbook applies as long as we are in a period of currency instability, characterized by vast debt burdens and above-average inflation volatility. In other words, until we return to an environment with a stable hard currency – be it a sovereign hard currency or a gold/Bitcoin standard – a higher proportion of hard currencies seems necessary.
The timing for a portfolio rebalancing currently appears favorable. Disinflationary tendencies are showing signs of abating, while geopolitical risks are increasing, and gold is advancing with a strong tailwind after its breakout. As performance gold, gold mining stocks could benefit disproportionately from the more positive sentiment in the gold market. As our analyses show, mining stocks are not a passive buy-and-hold investment but require active management. Here we rely on our new, specially developed Incrementum Active Aurum Signal.
The Incrementum Active Aurum Signal enables an investment process that takes into account not only long-term market cycles but also short-term volatility and trends in order to better adapt the gold (mining stock) exposure in the portfolio to changing market conditions. In the backtest, the Incrementum Active Aurum Signal impresses with clear outperformance compared to a passive mining stock strategy. This is illustrated by the following table, which shows both performance and risk figures.
Passive vs. Active Gold Mining Stock Strategies, in USD, 07/1971–04/2024
Source: Reuters Eikon, Incrementum AG
The Incrementum Active Aurum Signal also shows that the time may now have come for gold mining stocks: Since December 2023 it has been recommending an offensive positioning. Compared to past periods with offensive signal characteristics, we are still in an early phase. The average performance during such phases has so far been 23% over a period of 45 weeks. Currently, however, with a performance of 7% over 21 weeks, we are still well below this average, which statistically indicates further upside potential for gold mining stocks.
Gold Mining Stocks Performance*, when Incrementum Active Aurum Signal = 1, in USD, 08/1971–04/2024
Source: Reuters Eikon, Incrementum AG
*BGMI = 01/1971-06/2006, GDX = 06/2006-
Furthermore, there is a positive correlation between the duration of the Incrementum Active Aurum Signal at its offensive level and performance. The longer the duration, the higher the profits that can be achieved during these periods.
Our proprietary signal provides invaluable support by equipping the investor with the necessary tools to grasp the golden queen as a versatile player and leverage her skills optimally. Armed with these insights, one can comprehend the intricate game dynamics and ultimately master the diverse challenges of the new gold playbook.
[1] See “Gold in the Context of Portfolio Diversification,” In Gold We Trust report 2016
[2] “Introduction” In Gold We Trust report 2021, p. 6
[3] See the chapter „Enter the Dragon: De-dollarization and the Eastern Push for Gold“ in this In Gold We Trust report as well as “The Rise of Eastern Gold Markets: An Impending Showdown with the West,” In Gold We Trust report 2023
[4] See “Royalty & Streaming Companies: An Excellent Way of Investing in Gold,” In Gold We Trust report 2022
[5] Although, one of the authors of this report is known for his fondness for Italian defensive players, which explains his sympathy for Marco Materazzi.
[6] See “Status Quo of Debt Dynamics” in this In Gold We Trust report
[7] See “Showdown in Sound Money,” In Gold We Trust report 2023; “The Plan B Model: The Holy Grail of Bitcoin Valuation?,” In Gold We Trust report 2020; “Gold and Bitcoin: Stronger Together?,” In Gold We Trust report 2019
