Beware of analysts using the terms: Always, never and every time, cautions Landon Whaley.
This week’s “Headline Risk” comes courtesy of a well-known “guru” and gold bug.
Peter Schiff of Euro Pacific Capital is no stranger to making calls. He has been consistently calling for an economic and market calamity since the end of the last crisis. Last week he predicted that “Inflation is going to run out of control. This is why people need to buy gold.”
The idea that commodities in general, and gold, is a great hedge for inflation has been a strongly held belief within the investment community. Let’s take a closer look.
Beginning in September 1989, we evaluated regimes when inflation accelerated, or slowed, for at least six months. There have been 11 such periods when inflation accelerated and 12 when it has slowed. Let’s look at the data, it doesn’t lie.
During periods when inflation accelerated, gold posted positive returns 63% of the time, gaining +7.3% on average while experiencing an average drawdown of 11%. During those same inflationary periods, the average monthly return was 66 basis points, and the overall reward-to-risk was 0.78. In short, you risked $1 so that 63% of the time you could earn 78¢.
However, during periods when inflation slowed, the trade stats improved meaningfully. Gold posted positive returns 75% of the time, gaining 9.1% while experiencing an average drawdown of -10.2%. During these disinflationary periods, the average monthly return was 105 basis points, and the overall reward-to-risk was 1.74. Here, you risked $1 so that 75% of the time you could earn $1.75.
Over the last 30 years, if you’re only using inflation data to drive trading decisions in gold, you bull-up when inflation is slowing and not when its “[running] out of control.”
That said, we don’t trade gold based on a single factor. You need a multi-factor, multi-duration model to make accurate market calls.
Always, Never, Every
After pronouncing another bull market in gold, Schiff goes on to say, “In every gold bull market, silver has outperformed gold (on a percentage basis). So, there is a lot of upside in silver.”
When words like “always, never, every” are used to describe economic or financial market developments, the little hairs on the back of my neck stand up. Financial markets are rarely as straightforward as these words imply.
Investopedia says, “the most common definition of a bull market is a situation in which stock prices rise by 20%.”
Using this as a jumping off point, and stipulating a duration of at least 12-months, we evaluated gold’s return over the 358 rolling 12-month time frames from September 1989 through June 2019.
We found that gold gained at least 20% in 55 of those time frames. During these 55 gold bull markets, silver underperformed gold 26% of the time and by an average of 6.4%.
We decided to expand our definition of a bull market and evaluate 12-month periods when gold earned more than 10%. There were 121 such periods, and once again silver underperformed gold 37% of the time and by an average of 9.1%.
Schiff is on the right side of the call; silver does outperform gold most of the time in a gold bull market. However, it's not “every” bull market. In fact, if you bet on silver and find yourself in the 26% to 37% of gold bull markets, your underperformance could cost you 600 to 900 basis points!
The Headline Risk bottom line is that you should demand that everyone talking about markets and economies include data to justify their position. Don’t let anyone get by on their reputation, past market calls, or their pedigree. The only way to be a successful investor in this game is always to remain dispassionately data dependent.
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