Returnstream

Gold & SPX Switching Strategy: A Balanced Approach to Investment Stability and Growth

Investing in today’s market environment can be challenging, especially with numerous economic cross-currents that have increased the volatility in traditional stock and bond investments. For investors seeking a resilient, long-term strategy, combining gold and S&P 500 in an active approach can be an interesting solution. The Gold & SPX Switching Strategy capitalizes on the long term upward bias and low correlation between gold and the S&P 500 to produce a return profile that is superior to either asset by itself. This approach involves alternating investments between the two assets, depending on their relative strength and market conditions.

Why Gold?

Gold has long been a tangible, “hard asset” with unique benefits. Unlike stocks or bonds, which can fluctuate with corporate performance and market trends, gold’s limited supply and inherent value make it an excellent hedge against inflation and the devaluation of fiat currencies. Additionally, gold often shines during periods of geopolitical instability, serving as a “safe haven” asset for investors seeking to preserve wealth amidst market turbulence. From the below chart, we can see how gold’s price has had strong momentum during the post-covid global inflation era.

However, while gold is valuable, holding it in isolation isn’t always practical. Gold prices can be volatile, with extended periods where it performs below expectations. As the graph below indicates, gold has had years where its value remained stagnant or even dipped, leaving it “underwater” for long stretches.

Trend Following Strategy On Gold?

Why not apply a trend following approach with gold? For instance, one could hold when gold’s trailing 1 year trend is positive and shift to cash when in downtrend. Here is the backtested equity curve of this rule:

This approach helps mitigate some drawdowns, as we can see in the equity curve above, but it falls short of beating the simple buy-and-hold returns in the long run. We need a more sophisticated and nuanced approach.

Synergistic Effect by Combining Gold with the S&P 500

One way to build a more intelligent investment strategy is to trade gold in combination with the S&P 500. The Gold & SPX Switching Strategy measures the relative strength of gold versus the S&P 500, adjusting investments based on the trailing performance of each asset. This method ensures that capital is allocated to the asset showing stronger momentum.

Additionally, a Risk-Free Rate Filter adds an extra layer of protection, allowing investors to move to a safe money market instrument if neither gold nor the S&P 500 is outperforming the 3-month Treasury Bill yield.

Here are the basic rules of this strategy:

1. Measure relative strength between gold and the S&P500. Compare the trailing performance of each asset and switch to the one with stronger performance
2. Risk Free Rate Filter: selected asset from step 1 needs to be outperforming the 3 month Treasury Bill yield. If not then invest in a money market instrument

Here is the backtest:

We can see that over the long term, the switching system vastly outperforms both the buy-and-hold gold and S&P500 and also has a lower drawdown than either asset.

Performance During Market Stress

The Gold & SPX Switching Strategy shows its merit during market crises. During stressful economic periods such as the dot-com bubble and the subprime mortgage crisis:

From the performance table below, we note that the system gained 7.2% during the dot-com collapse (March 2000 to October 2002) and it gained 5.2% during the subprime crisis (November 2007 to March 2009):

Here is the drawdown graph going back to 1977. It superimposes the system and the 2 assets:

It’s evident from the above chart the system is far superior to buying-and-holding gold or the S&P500. The drawdowns are markedly more shallow and more brief in duration than the raw assets.

Conclusion

For long-term investors, both gold and the S&P 500 are core assets. However, a buy-and-hold approach can expose investors to extreme volatility. By employing the Gold & SPX Switching Strategy, investors can benefit from the momentum of both assets, keeping their investments in the asset with the highest growth potential at any given time. And in times when neither asset performs well, the strategy shifts to a money market position, protecting your capital from potential losses.

Interested in seeing the exact investment rules for this strategy and getting the backtest spreadsheet? The ebook and backtest spreadsheet are available for download: