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One Approach to the Precious Metals vs. Stocks Relationship

Jay Kaeppel
2021-08-27
Price movements for precious metals and stocks have a relatively low degree of correlation. Nevertheless, there appears to be a significant amount of interplay between the two. This interplay may offer investors some clues regarding which asset class to favor at a particular time.

As I wrote about in this piece, there is a constant ebb and flow to many relationships in the financial markets. This piece will look at the relationship between precious metals and stocks and highlight one potential way to make sense of it.

The chart below (courtesy www.Stockcharts.com) displays:

  • the last 5 years of the relative performance for 
  • ticker DBP (Invesco DB Precious Metals Fund ) versus ticker SPY (SPDR S&P 500 ETF Trust ) 
  • along with a 156-week exponential moving average

In the simplest terms possible:

  • When the bars trend higher, it means that precious metals are outperforming stocks
  • When the bars trend lower, it means the precious metals are underperforming stocks
  • When the bars are above the moving average, it suggests that the trend currently favors precious metals
  • When the bars are below the moving average, it suggests that the trend currently favors stocks

As you can see in the chart above, except for several months in 2020, stocks have been outperforming previous metals for most of the last 5 years.

LOOKING BACK FURTHER

To get a better sense of the precious metals/stocks' relationship, the chart below displays the cumulative % + (-) for both DBP (black line) and SPY (blue line) since DBP started trading in 2007. 

We see in the chart above a great deal of "back and forth" and a low degree of correlation between the two.

The chart below displays the full history of the relationship shown in the first chart we looked at. It measures:

  • the ratio of DBP versus SPY 
  • from early 2007 
  • and draws the 156-week exponential moving average

The gist of the chart above is pretty simple to ascertain:

  • Through 2012, the relationship mostly favored precious metals (i.e., the rising black line above the blue line)
  • Since then, the relationship has mostly favored stocks (i.e., the falling black line below the blue line)

A SYSTEMATIC APPROACH TO TRACKING THIS RELATIONSHIP

What follows is NOT a "recommended" trading strategy and is presented for educational purposes only.

I will track two hypothetical equity curves as follows:

  • A = Price of DBP
  • B = Price of SPY
  • C = A/B
  • D = Exponential 156-week moving average of C
  • E = C - D

The chart below displays the value for Variable E (i.e., the DBP/SPY ratio minus the 156-week exponential moving average).

HYPOTHETICAL SWITCHING RESULTS

The black line ("Switch") in the chart below represents the hypothetical return achieved by:

  • Holding DBP if Variable E above > 0
  • Holding SPY if Variable E above <= 0

The blue line ("Buy/Hold/Rebalance" in the chart below represents the hypothetical return achieved by:

  • Holding 50% in DBP
  • Holding 50% in SPY
  • Rebalancing to a 50/50 split at the beginning of each new year

From 1/12/2007 through 8/24/2021, the hypothetical returns were:

  • Switch Strategy = +505%
  • Buy/Hold/Rebalance = +174%

As a reference, buying and holding each ETF separately:

  • Ticker DBP = +96%
  • Ticker SPY = +213%

SUMMARY

The good news is that the simple switching method detailed above handily outperformed buy-and-hold over the past 14+ years. The bad news is that past performance does NOT guarantee future results. 

Whether or not the strategy detailed above represents a viable trading strategy is for each investor to decide for themself. 

But if nothing else, this simple approach may well serve an investor contemplating whether to allocate money to precious metals or the stock market by considering the current status and trend of the DBP/SPY ratio.

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Risk Disclosure: Futures and forex trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing ones’ financial security or life style. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results.

Hypothetical Performance Disclosure: Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. for example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.

Testimonial Disclosure: Testimonials appearing on this website may not be representative of other clients or customers and is not a guarantee of future performance or success.